Earnings Call Transcript - SBFG Q2 2022

Operator, Operator

Good morning, and welcome to the SB Financial Second Quarter 2022 Conference Call and Webcast. I would like to inform you that this conference call is being recorded and that all participants are in listen-only mode. We will begin with remarks by management and then open the conference up to the investment community for questions and answers. I will now turn the conference over to Sarah Mekus with SB Financial. Please go ahead, Sarah.

Sarah Mekus, Investor Relations

Thank you and good morning, everyone. I would like to remind you that this conference call is being broadcast live over the Internet and will be archived and available on our website at ir.yourstatebank.com. Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; and Steve Walz, Chief Lending Officer. This call may contain forward-looking statements regarding SB Financial’s performance, anticipated plans, operational results, and objectives. Forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied on our call today. We have identified a number of different factors within the forward-looking statements at the end of our earnings release, which you are encouraged to review. SB Financial undertakes no obligation to update any forward-looking statements except as required by law after the date of this call. In addition to the financial results presented in accordance with GAAP, this call will also contain certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. I will now turn the call over to Mr. Klein.

Mark Klein, Chairman, President and CEO

Thank you, Sarah and good morning, everyone. Welcome to our second quarter conference call and webcast. Highlights for the quarter include a small mortgage servicing right recapture of $239,000, including the following; net income as we disclosed in our earnings release of $2.8 million, down $1 million or 25% from the prior year quarter. On a year-to-date basis, net income was $5.6 million. The year-to-date impact from the PPP initiative on our results compared to the prior year is a reduction in revenue of $2.1 million and net income of $1.6 million. Return on average assets is 0.87%, up from the prior quarter of 0.83%; diluted EPS of $0.40; net interest income of $9.6 million was up 4.8% from the prior year as loan growth and rate increases were supplemented by the 12.4% reduction in interest expense. Loan balances from the linked quarter rose by $45 million and when we adjust for PPP balances, loans were up nearly $80 million, a strong 9.7% compared to the prior year. Annualized, our first half loan growth was 17.7%, driving our loan-to-deposit ratio up from 75% to 84%. Deposits declined from the linked quarter by $66 million and were down $19 million from the prior year. Expenses were down $274,000 or 2.5%, primarily due to lower mortgage commissions. Mortgage origination volume for the quarter was $95 million, down $69 million or 42% year-over-year. The mortgage business line attributed $4.7 million in total revenue for the first six months of the year, compared to $12.3 million for the same period in 2021. Asset quality metrics improved from both the prior year-end linked quarter and our consistent level of 42 basis points of non-performing assets remained strong while tangible book value when adjusted for other comprehensive income is $10.53. As prior quarters, we continue to believe that our focus on our five key strategic initiatives will drive our future success. They are revenue diversity and expansion, organic growth, scale, better services and household for scope, excellence in operation and more intimacy with client communications, and of course, asset quality. Revenue for Peak Title continued to move forward by nearly $700,000 and net income by $168,000 or $0.09 EPS annualized. We made a strategic shift last quarter to generally follow legal protocol and reported Title terms on nearly all real estate transactions while driving operational revenue higher with a more intentional focus on the commercial real estate segment. These initiatives are responsible for the 23% increase we delivered in revenue and 12% of net income. This quarter, mortgage volume and loan sale gains were down from the prior year, 42% on volume, 72% on gains. For the trailing 12 months, we have delivered nearly $500 million in total mortgage origination volume that's down 24% from 2020 and 32% from 2021. Our initiatives to drive our volume of private client originations higher are clearly working. This quarter, 27% or $25.5 million of our total residential real estate volume originated from our PCG business line. Of that production, 41% came from our Columbus market, 22% from Northwest Ohio; Northeast Indiana, and over a third from our newer Indianapolis market. Outside of our PCG initiatives, higher rates and compressed inventory continue to constrain our level of production. Non-interest income decreased to $4.7 million from the prior quarter of $6.5 million. The current quarter includes a mortgage servicing recapture of $239,000 compared to an impairment of $99,000 in the second quarter of last year. Non-interest income to total revenue remained relatively strong at 33%, but well below our expectations on historical levels of near 40%. Our wealth management team contributed $936,000 in revenue and is on pace to achieve total revenue in 2022 of nearly $4 million. Despite the volatility in the markets that we've all witnessed, we have retained balances in excess of $500 million, including $38 million in our brokerage platform. Secondly, more scale, loan growth in the quarter was very good as we were up $45 million from the linked quarter and $79 million net of PPP from the prior year. All of our regional markets have very strong pipelines, including a number of client proposals currently under credit analysis. With this quarterly growth noted, we have now grown our book over the last five quarters. This quarter saw evidence of consumers and our small business clients drawing down their liquidity and deposits declined from the linked quarter. Funding needs to support our loan pipelines are much more important today and as a result of our current deposit runoff, we have begun to selectively increase deposit rates to not only provide higher future industries, but also protect existing balances and grow newer relationships. Third more scope; the traditional SBA market has begun to loosen a bit as we've witnessed and the PPP focus is clearly all but gone. Thus far this year, we've originated nearly $5.5 million in qualified SBA products. We continue to execute on strategies in each of our markets that include more calls on client prospects that are in either rate growth mode or a business acquisition mode who have identified a strong need for capital. We remain committed to this true complement to our commercial loan production machine and intend to return to the production levels we experienced prior to the pandemic, that is, in 2015 through 2019 when we averaged approximately $12.3 million production each year in that five-year period. Operational excellence, the fourth theme, the mortgage business line has certainly been a key contributor to our success for the entire past decade. However, rate increases, operational challenges of construction lending, limited housing inventory, and a rapid increase in inflation have compressed our volume. That said, we have focused on flexibility in our products and structure to remain competitive. With fixed-rate pricing now at or above 5%, our portfolio products have become more relevant. These portfolio loans have increased our balance sheet outstanding and added the potential for expanding margins as rates drop. Expense levels for the quarter were down from both the previous and prior year quarters, driven by the variable nature of our mortgage production. As we discussed last quarter, we are evaluating the resources allocated to both our mortgage and retail business lines. Our goal has been for the residential business line the past six months to elevate our number of producers in order to keep our ecosystem in balance and optimized. I am pleased to report that in the last 30 days, we have made offers to over a handful of MLOs and we have landed three of those producers, one in the greater West Central Ohio market, Lima, and two additional producers in the Columbus market. That's five more than the same quarter last year in the number of producers and brings our MLO number to 25, an increase over the prior end of '22. Additionally, we intend to selectively utilize some of our traditional retail staff who do non-saleable consumer loans to originate some saleable residential loans to broaden our production capacity as we discussed in the prior quarter. Likewise, with walk-in visits moderating in our retail offices due in part to our commitment to leverage our digital platform to enable access to our client's data 24/7, we continue to re-evaluate our hours we staff and operate our offices. This strategy hinges on the deployment of our new contact center that we delivered in early July that seeks to provide seamless service to clients using multiple communication channels. Rebalancing our resources here with market requirements will improve efficiency. Our fifth and final initiative is asset quality; this quarter saw again, strong results in key asset quality metrics. Despite the significant loan growth in the quarter, we remain quite pleased with our current allowance of nearly $14 million during 2021. When PPP and mortgage refinance volume were adding to our revenue, we chose to add $5.5 million to our loans. We do not intend to release reserves anytime soon. Currently our level of allowance to total loans is 1.54% and our non-performing coverage ratio is now 295%. Both metrics are well above the median level of our peer group. And now, I'd like to ask CFO Tony Cosentino to provide a few more details on our quarter, Tony?

Tony Cosentino, Chief Financial Officer

Thanks, Mark. Good morning, everyone. Again, as Mark indicated for the quarter, we had GAAP net income of $2.8 million or $0.40 per diluted share. So we're highlighting this quarter; operating revenue was down $1.4 million or 9.1% as mortgage gains from lower volume and reduced sales percentages were down nearly $3.1 million or 72%. We were able to offset some of the mortgage variance with higher title agency revenue and deposit fees. Loan sales delivered gains of $1.4 million for mortgage, small business, and agricultural loans, and margin revenue, which was up $436,000 or 4.8% due to slightly lower funding costs and higher security revenue. Adjusted for PPP, loan interest income was higher by $468,000 or 5.5%. Looking further into our income statement; on the margin side, our average loan yield for the quarter was 4.11%, decreased by 22 basis points from the prior year but did increase 21 basis points from the linked quarter. As Mark discussed earlier, the PPP impact on loan yields for 2021 was significant. In essence, without that impact, our average loan yield would have decreased by just nine basis points for the prior year. Overall earning asset yields were up 20 basis points from the prior year and 49 basis points from the linked quarter due to the change in the mix of the balance sheet and higher loan growth. Loan yields were impacted by the fees of the PPP portfolio, which were $2.15 million for the first six months of '21 compared to $98,000 for the 2022 six-month period. As we have indicated, funding needs and costs will begin to accelerate as customer liquidity draws down and our loan pipelines are closed. As we look at funding costs for the current quarter, our deposit costs of funds came in at 21 basis points with the cost for interest-bearing liabilities at 36 basis points. This compares to 22 basis points and 39 basis points respectively for the linked quarter. Given the rise in funding rates, we were pleased with a negative beta on funding costs in the quarter. However, we recognized that our liquidity was a bit higher by our standards coming into the quarter and we expect deposit and overall funding costs to rise in the coming quarter. Interest margin at 3.16% was up 22 basis points from the prior year and up 34 basis points when PPP is excluded. Compared to the linked quarter, NIM was up 48 basis points. That significant NIM improvement from the linked quarter was driven by a positive change in mix on the asset side of the balance sheet as interest-bearing cash with allocated loans and deposit levels declined. Total interest expense costs were down from both the prior year and linked quarters. Total non-interest income was down $1.9 million or 28.5% from the prior year, reflecting lower mortgage origination and sales volume, which offset the $336,000 positive swing in servicing rights recapture. As I discussed last quarter, gains on sale yields have stabilized at the mid-2% level. The gain on sale yield for mortgage sales this quarter was 2.4%, which is still strong historically but well off from the 3.6% yield from the second quarter of '21. This quarter, our sale percentage was just 52% and 63% for the year as we have done much more portfolio and private client loan originations. These levels are well off from our traditional 85% sale percentage. Our servicing portfolio, however, continues to grow and is now $1.37 billion and provided revenue for the quarter of $863,000. The market value of our market servicing rights improved slightly this quarter with a calculated fair value of 111 basis points. This fair value was up 27 basis points from the prior year and up six basis points from the linked quarter. We now have a servicing right balance of $13.4 million and remaining temporary impairment of just $327,000. We've held expenses relatively flat for the last five quarters and for the year-to-date, total expenses are down 1.5%. We expect to trend down in the coming quarters, which we just resources in our retail mortgage business lines as Mark has discussed. The impact of the mortgage business line on our efficiency ratio is significant as our 25% decline in efficiency from 2021 would be reduced to an 11% decline when the results of that business line are excluded. Now, as we finish up turning to the balance sheet, loans outstanding at June 30, still at $895 million, which was 69.2% of the total assets of the company. As we said, the quarter saw a significant mix shift within our earning assets as we saw cash and security decline by nearly $100 million from the linked quarter due to loan growth and deposit runoff. Our loan-to-deposit ratio ends the quarter at 83.6%, up nearly six percentage points to our highest level since the third quarter of 2020. Looking at capital, we finished the quarter at $124.6 million, down $19.5 million or 13.5% from June 30 with our equity asset ratio standing at 9.6%. However, when we exclude the OCC at $22 million, equity has grown from the prior year despite nearly $7 million in stock buybacks and $3.3 million in common dividends. The buyback continued in the quarter with 94,000 shares repurchased at an average price just above book value. We did also take advantage of our on-balance sheet liquidity and purchased some additional policies in the quarter. It's been some time since we've added to this portfolio, and there's a nice benefit for both the company and those participating employees. And finally, as Mark commented, all of our asset quality metrics have improved and charge-offs were minimal for both the quarter and year-to-date. Our reserves to loans was just two basis points down from the prior year. Total delinquency levels are 32 basis points in the quarter, down 27 basis points for the linked quarter and down nine basis points from the prior year. I'll turn the call back over to Mark.

Mark Klein, Chairman, President and CEO

Thank you, Tony. I want to conclude by again acknowledging the dividend announcement we made yesterday of $0.12 per share, which equates to approximately a 30% pay-out ratio and a dividend yield of approximately 2.8%. Clearly, while mortgage volume and resulting gains are off considerably, marginally higher rates and a steepening yield curve with our asset-based balance sheet provide some lift to our total operating revenue. With continued organic loan growth, strong pipelines, stable deposit costs, and more intentional expense control, we certainly expect to continue our earnings growth well into the second half of the year. And I'll turn it back to Sarah for questions, Sarah?

Sarah Mekus, Investor Relations

Thank you. Now, we're ready for our first question.

Operator, Operator

Operating revenue has benefited from higher rates and a steepening yield curve, along with our asset-based balance sheet. We anticipate continuing our earnings growth into the second half of the year due to ongoing organic loan growth, strong pipelines, stable deposit costs, and focused expense management. Now I’ll hand it over to Sarah for questions. Thank you, Sarah. We're ready for our first question.

Sarah Mekus, Investor Relations

While we're waiting for any additional questions, I'd like to remind you that today's call will be accessible on our website @YourStateBank.com.

Operator, Operator

There are no questions at this time. I would like to turn the conference back over to Mark Klein for closing remarks.

Mark Klein, Chairman, President and CEO

Once again, thanks for joining us on our conference call and webcast. We look forward to speaking with you again in October to discuss the third quarter 2022 results. Thanks again for joining. Goodbye. Take care.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.