Southern Missouri Bancorp, Inc. Q2 FY2024 Earnings Call

Good morning, everyone, and welcome to the Southern Missouri Bancorp earnings call. Operator Instructions. I would now like to turn the conference call over to Stefan Chkautovich, CFO of Southern Missouri Bancorp. Please go ahead.

Thank you, Kathy. Good morning, everyone. This is Stefan Chkautovich, CFO with Southern Missouri Bancorp. Thank you for joining us. The purpose of this call is to review the information and data presented in our quarterly earnings release, dated Monday, January 29, 2024, and to take your questions. We may make certain forward-looking statements during today's call, and we refer you to our cautionary statement regarding forward-looking statements contained in the press release. I'm joined on the call today by Greg Steffens, our Chairman and CEO; and Matt Funke, President and Chief Administrative Officer. Matt will lead off our conversation today with some highlights from our most recent quarter.

Thank you, Stefan, and good morning, everyone. This is Matt Funke. Thanks for joining us. I'll start off with the highlights from our December quarter, the second quarter of our fiscal year. Quarter-over-quarter profitability was down a bit as a higher cost of funds weighed on our margin, but for this current environment, we remain relatively pleased with the results and the outlook ahead. We believe we've absorbed the largest part of the impact of the prior year's sharp increase in short-term rates, and we've seen 22.1% net interest income growth year-over-year due to a larger balance sheet, with the addition of the Citizens loan and securities portfolio early in the third quarter of the prior fiscal year, along with continued solid deposit and loan growth so far this fiscal year. We earned $1.07 diluted earnings per share in the December quarter; that's down $0.09 from the linked September quarter and down $0.19 from the December 2022 quarter. During the quarter, the bank executed a securities loss trade, selling bonds with a book value of $12.4 million, realizing a loss of $682,000 or $0.05 of earnings per fully diluted share after tax. These proceeds were reinvested into $11.9 million of higher-rate bonds, which are expected to result in an earn back of the realized loss in less than two years. Excluding this loss for the quarter, noninterest income would have been $6.3 million, net income after tax $12.7 million, earnings per diluted share $1.12, and our return on average assets would have been 1.12%. Book value per share was $41.66 and has increased by $4.98, or 13.6%, over the last 12 months with AOCI roughly unchanged since the year-ago period. Net interest margin for the quarter was 3.25%, as compared to 3.45% reported for the year-ago period, and 3.44% reported for the first quarter of fiscal '24, the linked quarter. This decrease was attributable to a higher cost of deposits as well as an increase in cash balances. Net interest income was down 2.6% quarter-over-quarter, and up 22.1% year-over-year as we grew average earning asset balances. We had a slightly lower amount of margin benefit from accretion of purchase accounting marks in the current quarter as compared to the linked quarter, and a larger benefit as compared to the year-ago period, which was just in advance of the Citizens merger. On the balance sheet, gross loan balances increased by $32.2 million during the second quarter. Compared to one year ago at December 31, 2022, gross balances are up $736.9 million, or 25%. The Citizens merger, which closed during the third quarter of fiscal '23, accounted for $447.4 million of net year-over-year growth, and our adjusted annual growth rate over those 12 months adjusting out the acquired Citizens loans would be a little under 10%. Due to strong deposit growth quarter-over-quarter, cash and equivalents grew $127.9 million, and compared to December 31, 2022, cash and equivalents are up $161.9 million. Deposit balances increased by almost $153.8 million in the second quarter and increased by $989.1 million compared to December 31 of the prior year. That included an $851.1 million increase net of fair value attributable to the Citizens merger, which again was during the third quarter of fiscal '23. Strong growth in deposits this quarter was a result of CD and savings account growth from well-received special rates offered during the quarter as well as seasonal deposit inflows. With all that, I'll hand it over to Greg for some discussion on credit.

Thank you, Matt, and good morning, everyone. I'm pleased to report overall our asset quality remains strong as of December 31 with adversely classified assets at $39 million or a little over 1% of total loans, a decrease of about $3 million or 10 basis points over the last quarter. Nonperforming loans were $5.9 million at 12/31, which was relatively flat compared to last quarter and totaled 0.16% of gross loans. In comparison to December of 2022, the nonperforming loans increased a little over $1 million, but in line as a percentage of total loans outstanding. Loans past due 30 to 89 days were $7 million, down nearly $20 million from September and at a low 19 basis points on gross loans. This is a decrease of 53 basis points compared to the linked quarter and down 5 basis points from one year ago. Total delinquent loans were $0.3 million, down $20 million from September. This quarter's drop in past due and delinquent loans is primarily from the cure of the large relationship that was delinquent that we noted in last quarter's call. As compared to the prior quarter ended September 30, ag real estate balances were down nearly $2 million, and they were up $15 million compared to December 31 a year ago. Ag production and equipment loan balances were down $18 million over the quarter due to normal seasonality, but they were up $33 million year-over-year due in part to Citizens-acquired loans and slower marketing periods for some of our farmers this year. In the 2023 agricultural season, our farmers experienced a successful harvest with above-average yields, particularly in cotton, rice and corn. Despite facing a similar drought in most markets, water availability for irrigation contributed to better-than-average yields. Looking ahead to 2024, we anticipate our farmers will diversify their crop mix, specifically away from corn due to the combination of lower corn prices, the impact of the 2023 drought on river levels, and higher input costs that all have contributed to more anticipated expense for that crop. While rice cultivation is expected to increase, cotton farmers aim to maintain production levels, and soybean acres will likely remain stable. Financial reviews indicate that most farmers will meet their 2023 obligations and are entering 2024 with somewhat lower working capital than the prior year, attributed to declining commodity prices, drought impacts and increased input costs. Still, we feel good about the agricultural segment of our portfolio. During the renewal season, we conduct stress tests on our farm cash flows, ensuring strong underwriting of these credits as we move into new production lines. Looking at the loan portfolio as a whole, gross loans grew $32.2 million or 3.5% annualized during the quarter. We are in the slowest part of the year for loan growth due to seasonal factors, especially related to agriculture. The bank experienced some well-rounded growth stemming from multi-payable and nonowner-occupied CRE, C&I, construction and owner-occupied 1 to 4 family. This loan growth was led by our West and South regions, which are in good growth markets. We are continuing to prioritize making credit available to our core clients. In between that and normal winter seasonality, we would not anticipate seeing much net loan growth during the March quarter, even though our pipeline continues to include many construction line draws. That said, due to improved liquidity, stable credit and increasing commercial demand, we expect to opportunistically evaluate additional high-quality credits that could lead to a real pickup in loan growth this summer. Our pipeline for loans to fund in the next 90 days totaled $140.5 million at quarter end, as compared to $158.2 million on September 30 and $121.6 million one year ago. Our volume of loan originations was approximately $242 million in the December quarter, an increase of $12 million as compared to the September quarter. In the December quarter a year ago, we originated $281 million. The leading categories this quarter for lending were C&I and multifamily. Our nonowner-occupied CRE concentration at the bank level was approximately 323% of Tier 1 capital and allowance for credit losses at 12/31, down by 1 percentage point as compared to September 30. Stefan?

Thanks, Greg. Matt hit some of the key financial items already, but I wanted to share a few details. Looking at this quarter's net interest margin of 3.25%, this included about 14 basis points of fair value discount accretion on acquired loan portfolios and premium amortization on assumed deposits compared to the linked September quarter's 16 basis points and the prior year's December quarter of 6 basis points. The primary contributor to the net interest margin compression compared to the linked quarter was the increase in the cost of deposits by 42 basis points to 2.61%, primarily led by CD and savings specials, which was partially offset by lower FHLB balances. At the end of last quarter, we paid off all overnight borrowings. In total, the cost of liabilities increased 38 basis points to 3.11%. In comparison, our yield on average earning assets was up only 15 basis points in the same period. As our asset repricing lags the impact of higher rates more than our liabilities, we continue to see some net interest margin pressure through the quarter, which resulted in the net interest margin for the month of December being modestly lower than the quarter average. The monthly compression has slowed as a significant percentage of the CD portfolio now rolling over each month has already been impacted by higher rates offered in periods following the sharp move higher in short-term rates. Also, we have reduced special deposit rates offered, as we balance availability of liquidity and near-term loan growth expectations as we have seen an inflection point in the competitive landscape for deposits. Looking at our liabilities that are repricing in comparison to our earning assets, we could continue to see some additional pressure. With this coming spring, we are optimistic that we should see our margin's low point if deposit competition does not re-escalate. The reduced day count in the March quarter will have a small negative impact on quarterly net interest income. Lastly, on the net interest margin and net interest income, we are liability sensitive. If the FOMC does start cutting rates this year, we would expect to be a net beneficiary of those cuts, especially if the slope of the yield curve would normalize somewhat. Noninterest income had some noise in the quarter from the loss trade we executed, with the resulting loss of $682,000. Excluding this, noninterest income would have been up almost 16% as compared to the year-ago period, primarily due to the Citizens merger in fiscal 3Q and up 8% compared to the linked September quarter. For the linked quarter, the increase was from several categories of loan fees and other noninterest income increased as a result of a settlement of legal fees settled in the bank's favor with total impact of $85,000. This was partially offset by lower wealth and trust management income. Although not impacting the quarterly comparison, we will continue to have a drag on year-over-year comparisons due to NSF policy changes we adopted in July 2023, our first fiscal quarter, on how we assess fees for some items that resulted in a reduction of fee income. Noninterest expense was up 35.3% compared to the year-ago quarter due to the larger expense base with the addition of the Citizens, and up 0.6% compared to the linked quarter. In comparison to the linked quarter, the bank benefited from having no material merger charges. Last quarter, we had about $134,000 mostly in our other expense line. That benefit was more than offset by higher compensation and benefits from an increased head count and the associated expenses with higher FTE. We would expect to see another quarterly increase in compensation expense in the March quarter as annual merit increases and cost-of-living adjustments take effect. As indicated on the last earnings call, we had a slight uptick in occupancy expense as we relocated personnel to better positioned offices in our Kansas City market. As Greg mentioned, credit remains benign, but we did see an uptick in net charge-offs for the quarter to 10 basis points annualized, still a very solid performance by comparison to historical industry figures. About half of these charge-offs were related to one real estate relationship from the Citizens merger. Our provision for credit losses was $900,000 in the quarter as compared to $1.1 million in the same period for the prior year, and in line with the linked quarter. Our allowance for credit losses at December 31, 2023, was $50.1 million or 1.34% of gross loans and 846% of nonperforming loans, as compared to an ACL of $49.1 million or 1.33% of gross loans and 856% of nonperforming loans at September 30, 2023, the linked quarter. The current period provision for credit losses was the result of a $1.9 million provision attributable to the ACL for loan balances outstanding, partially offset by a recovery of $1 million and a provision attributable to allowance for off-balance sheet credit exposure. This was due to construction draws reducing the available credit and increasing our on-balance-sheet exposure. Our assessment of the economic outlook was little changed. Despite some of the challenges over the last few quarters, as the bank navigated this higher interest rate environment impacting our margin, slowing the overall economy and resulting in lower loan originations and secondary market fees, we feel optimistic about margin and overall earnings for the June quarter and beyond if we remain in a benign credit environment. Greg, any closing thoughts?

Thanks, Stefan. We're now a year past our merger with Citizens Bancshares and 11 months past the systems conversion. We remain focused on core deposit retention in those markets and elsewhere and have seen steady improvements over the quarters in how we're integrating those team members into our operations and procedures, and our team is doing a great job. We have achieved the cost savings we'd anticipated at the merger, and from here forward, we are looking to expand in our metro markets. As Stefan noted, we are also looking to recruit community bankers in some of our new markets, so there could be modest incremental upticks in noninterest expense. We are 100% committed to providing our excellent services in the more rural and middle-market communities we added through the Citizens merger, in addition to the Kansas City metro area. We're not currently actively pursuing additional merger opportunities. That being said, continued regulatory and macroeconomic factors pressuring other banks could eventually lead to an uptick in potential interested partners.

Thank you, Greg. At this time, Kathy, we're ready to take questions from our participants. So if you would please remind folks how they may queue for questions at this time.

Operator Instructions. So our first question comes from the line of Kelly Motta of KBW.

I think, maybe starting out, you noted that you repositioned a small portion of your securities book during the quarter. Just wondering the timing of it within the December quarter as well as appetite for, at the margin, potentially doing another piece as we look ahead?

We completed the repositioning of those securities in mid- to late-December. So we didn't see much of an impact in the December results at all from the securities transaction, and we would anticipate that we're going to continue to evaluate whether we do a little more.

Kelly, it's pretty limited as to the dollar amount of securities that we have at a low enough yield where it makes a lot of sense to do more. But there is a little bit additional that we could clean up there.

Got it, appreciate it. And then, I think when we last spoke last quarter at this time, you were looking for mid-single-digit loan growth. It seems like near term, the ag seasonality might be slow, but you noted you expect to pick up in the summer. Just wondering: is mid-single-digits for the full fiscal year still something that you think is a reasonable expectation?

Yes. I think going forward, we would anticipate somewhere between 3% to 5% annual growth. So if you look at our 12/31 figures, we'd look at another 3% to 5% over the course of calendar year '24.

Got it. Appreciate it. Maybe one or two more from me. On the deposit side, it looks like some of the growth was from public deposits. Can you remind us, any seasonality with that? And as we look ahead, you mentioned that margin month-over-month trends appear to be stabilizing, which is good. Just kind of where incrementally you're adding on the rate at which you're adding new deposits? And do you think in order to get a stabilization in the cost, does it take a rate cut? Or provided that we are done with rate hikes, would you still expect a stabilization in funding costs?

So on the public units, yes, we did have some dollars come in this quarter. We would expect some of those to go back out. It's always a little tricky to know exactly how that will play out. We do have some new public unit customers from our merger that was just at a year ago now, so we're not 100% familiar with what their flows would be. But definitely, some of that growth would wash back out in the March quarter. Margin overall, we have reduced our CD specials a little bit. Some savings products are really stable, but where we look at how much in CDs has already absorbed the higher pricing, we really feel pretty good that we're past an inflection point on the pace of those increases, and really ought to see—as long as rates stay here or move lower—that we ought to see a decrease in the uptick on cost of funds.

Our next question comes from the line of Andrew Liesch of Piper Sandler.

I guess this might be related to the public funds question, but cash balances were a little bit elevated at year-end. I'm just curious: is that what drove that? And any plans for these funds or for this cash going forward?

Yes, we would expect, obviously, to use some of that to fund outflows on any of those seasonal deposits. Some of it would fund our seasonal ag book as we move through the first half of calendar '24; some of it is just we did a little better than we had anticipated in the second half of calendar '23 with deposit specials. So we're pulling the reins back a little bit on that. It wouldn't surprise us if we have some deposit outflows as some of those specials reprice again. But we do have some brokered funding that long term, we wouldn't like to maintain at the same levels we are. And then Stefan and Greg both noted, we would look to be incrementally a little more optimistic about loan growth as we get into the middle of calendar '24.

Got it. All right. That's helpful. And then Stefan, did you quantify what each 25 basis point reduction in the Fed funds rate could do to the margin? I'm sorry if I missed that, if you did?

No, I didn't quantify 25 basis points. But on a big picture, 100 basis points on a static balance sheet would be about a mid-single-digit benefit to net interest income. And with our sort of budgeted growth, it would be about a low single-digit benefit.

As there are no additional questions waiting at this time, I'd like to hand the conference back over to Southern Missouri Bancorp's CFO, Stefan Chkautovich, for closing remarks.

Thanks, Kathy, and thanks, everyone, for joining us. Appreciate your interest in the company and speak again in about three months. Have a good day.

Everybody, have a good day.

Ladies and gentlemen, thank you for joining us for today's call. Have a great rest of your day. You may now disconnect your lines.