Earnings Call Transcript - SMBC Q3 2022

Operator, Operator

Hello and welcome to the Southern Missouri Bancorp Quarterly Earnings Conference Call. My name is Alex and I will be coordinating the call today. I will now hand over to your host, Matt Funke, CFO for Southern Missouri. Over to you, Matt.

Matt Funke, CFO

Thank you, Alex. Good morning, everyone. This is Matt Funke, CFO with Southern Missouri Bancorp. Thanks for joining us today. The purpose of the call is to review the information and data presented in our quarterly earnings release dated Monday, April 25th, 2022, 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 President and CEO. Greg will lead off our conversation and give commentary on our current operations, lending activity, and credit quality measures. Greg.

Greg Steffens, CEO

Thank you, Matt, and good morning, everyone. This is Greg Steffens. Thank you, and we appreciate you joining us today. First item I would like to note is that we completed our merger with Fortune Financial Corporation locations in the St. Louis Metropolitan area in late February. We completed system conversions on that same weekend, and operations have been running smoothly since the acquisition. As for our COVID update, as in most of the U.S., our market areas saw a rapid decline in reporting cases of COVID and hospitalizations beginning in February and dropped to the lowest levels since the beginning of the pandemic. Scheduled team members have not been an issue with COVID for the last several months, which has been a welcome relief. We do note that there are a few areas of the country where new variants may be pushing infection rates in the wrong direction. But it's hard to imagine that we would see another wave or anything in our areas that would result in any significant mitigation efforts that would affect our business activity or our customers. Our borrowers' credit performance remained strong. We noted in January that we were working with two hotel industry relationship loans totaling just under $24 million with business models that were particularly impacted by the pandemic. We've seen improvement as hoped for on the performance on those properties, and one has returned to scheduled principal and interest payments. The second, comprised of three loans, has not yet moved to principal and interest, and we've moved it to substandard as a result of that. We do expect they return to principal and interest payments by the end of the June quarter on those credits. And we expect continued improvement in occupancy as the calendar year progresses for both properties. Non-performing loans moved modestly higher in the March quarter, up about $900,000, which was primarily due to a handful of loans acquired in the merger. Adversely classified loans increased by around $12 million primarily due to the relationship noted above and totaled $27.7 million a year ago; adversely classified assets totaled $20.8 million. Watch and special mention credits totaled a combined $45 million at March 31st, up $9.5 million this quarter, due primarily to a single construction loan in the line tech industry, offset by the migration, the special mention substandard hotel loan discussed earlier. We don't anticipate any issues on the construction note; the downgrade was just primarily due to unanticipated delays in the completion of the project. Watch and special mentioned loans totaled $64.5 million a year earlier, so they've declined substantially. Past due loans were modestly higher but remain at very low historical levels at $4.4 million, with loans past due 30 days representing 17 basis points of our total loans. This was up from 14 basis points last quarter but is down from 20 basis points or $4.3 million a year ago. Turning to our agricultural portfolio, agricultural production and other loans to farmers were down $13 million in the quarter and up $1.1 million compared to the same time last year. While agricultural real estate balances were up $6 million over the quarter and $20 million compared to the same period last year. We noted on the last quarter's earnings call that our farm customers had a strong 2022 with good yields and pricing, and that's translated into expected payment performance and line management. Renewals for 2022 are completed for the most part, as most of our relationships have been renewed and most of our customers are beginning the year with very strong working capital positions. Input costs have increased substantially for our farm customers, with fuel costs and other input costs growing as the season has gotten underway. Our lenders are visiting with our borrowers and checking on where they are with locking in their crop production and sales prices for this year, with commodity prices having already moved, offsetting most or all of the costs of higher input costs. Most of the crops that we finance have increased in price by 20% or more compared to where we completed our underwriting, and these increases have more than offset the costs of our crops. One unknown is what impact the hostilities in Ukraine or the resolution could create for the commodity markets. We have seen some delays in planning for the 2022 season due to spring rains, as we're falling a little behind anticipated schedules on a historical basis. We do expect that some of our corn acreage, which carries higher input costs than our other common crops, may be diverted to soybeans or cotton if crop conditions don't improve. If the wet weather continues, we could see more soybeans and cotton. We've financed a limited amount of livestock overall, but increasing grain costs, feedlot bottlenecks, and supply chain issues affecting deliveries are all stressing these borrowers more so than our row crop farmers, to the extent any are affected to the point that stresses are working capital positions. We will look to be utilizing the guaranteed loan product programs. PPP forgiveness continued in the March quarter and we made good progress on the remaining balances for those loans we originated, with our originative balances outstanding dropping from $11.5 million to $4.2 million, which comprises only 10 loans. We also picked up a small amount of PPP loans that remain outstanding from the Fortune acquisition, and those totals were down to $2.4 million on 22 loans at March 31st. We expect to make further progress in the June quarter. Accelerated fee recognition continued to decline in the March quarter and at present, we have $100,000 in deferred fees remaining on those PPP loans. Matt, would you provide us with an update on our financial results?

Matt Funke, CFO

Thanks, Greg. We did earn $1.30 diluted in the March quarter, which marks the third quarter of our fiscal year. The net figure is down $0.32 from the linked December quarter, and we're also down $0.24 from the $1.27 diluted that we earned in the March 2021 quarter. Items primarily contributing to the decline include $1.1 million in non-recurring, non-interest expense attributable to the merger, and $2 million in provision for credit losses needed to fund the allowance for credit losses per loan balances outstanding, as well as for off-balance-sheet credit exposures. Also, there was a significant drop in the accretion of deferred loan origination fees from PPP loans, as Greg mentioned. In the year-ago quarter, we had a modest negative provision, and we would have done the same in the current quarter except for the provision required for the acquired non-PCD loans from the merger. Our net interest margin in the March quarter was 3.48%, which included about 6 basis points of contribution from fair value discount accretion on acquired loan portfolios, which was about $448,000 in dollar terms. However, PPP loan balances and forgiveness repayments dwindled, as did the accelerated accretion of deferred origination fees on those loans, dropping to $180,000, which contributed just two basis points to the margin. A year ago, the margin was 3.68%. We had 10 basis points from fair value accretion, and PPP forgiveness contributed 18 basis points. So on what we see as a core basis, our margin was down less than one basis point year over year, from March 2022 to March 2021. We see our core loan yield dropping 22 basis points over that period while our core cost of deposits was down 17 basis points, and our cost of funds was down 19 basis points. Average cash balances are modestly higher in the current quarter compared to the year ago, but securities yields are a little better, helping to offset that pressure. In total, excluding PPP or accretion of fair value discounts on acquired loans, our earning asset yield was down 17 basis points. In the linked December quarter, we had a margin of 3.77%, which included a similar benefit from fair value discount accretion, and we had significantly more recognition of PPP origination fees, contributing 13 basis points in the December quarter. So on what we see as a core sequential basis, we're seeing a decrease of about 19 basis points. About 8.5 of those basis points are attributable to higher cash balances, while 7.5 are due to the drop in the quarter from a 90-day quarter to a 92-day quarter in December. Core loan yields dropped about three basis points when we adjust for the day count difference in the quarters, and that accounts for most of the remaining decline while our cost of funds was unchanged. Non-interest income was up $380,000 compared to the year-ago period. That's attributable to wealth management and insurance increases due in large part to the Fortune merger, a non-recurring $152,000, and assistance from our broker-dealer to help us bring on new advisors. Loan fees and deposit service charges are up compared to the year-ago period, but secondary market residential originations continued to fall compared to that year-ago period, down about 71% in dollar terms. Compared to the linked quarter, non-interest income was down as we had an unusually strong quarter in December from wealth management. We also had a gain on our exit from a renewable energy tax credit, partially offset by a fixed asset loss. Deposit service charges, which are usually somewhat seasonal, dropped a bit from December to March, and secondary market residential income declined sequentially as well. Non-interest expense was up $3.2 million compared to the year-ago quarter, including that $1.1 million in M&A charges, mostly data processing and legal. Other increases were attributable mostly to compensation, which was up $1.5 million year-over-year, and occupancy was up just over $400,000. Our annual compensation increases are generally completed effective in January and would have added about 7.5% to our payroll as we continue to see competitive pressure there. Four contained members were on our payroll for about five weeks, and in addition to base salary, that group will introduce more volatility as they have a higher percentage of their team members participating on a commission basis. Our payroll tax reset with the calendar year-end always influences our compensation expense in the March quarter. And we also had modest severance charges in transition assistance to those wealth management reps from Fortune. We accrued for PTO at the new higher base rate of pay. We also saw benefit expenses increase in line with an 8% increase in average headcount. Occupancy increased year-over-year due to the inclusion of the Fortune locations for part of the quarter, as well as the trend increase we've seen due to relocations and remodels. Compared to the linked quarter, non-interest expense was up $1.7 million, mostly due to items that we already commented on, and partially offset by lower foreclosed property charges in the quarter. The company again had very low net charge-offs in the March quarter, little change from the last several. Our trailing 12-month figure is now less than $100,000, which is less than one basis point on our average loans. Loan growth slowed a bit in the March quarter along with continued positive credit metrics and projections for the economic factors that drive our CSO calculation. We would have had a net release of allowance for credit losses except for the provision required in the Fortune acquisition. In the last 12 months, we've recorded a total negative provision of $1.4 million, and outside of Fortune, that would have totaled approximately $3.4 million negative. Due to the additional loans and what would have been a negative provision otherwise, our allowance as a percentage of gross loans dropped seven basis points from the linked quarter to 1.29% at March 31st. On the balance sheet, gross loan balances were up $222 million in the March quarter. Backing out the Fortune merger, this would have been about $19.5 million in core growth. I say core, but that's actually net of PPP balances, which declined by a little more than $7 million. Compared to March 31st a year ago, gross balances were up $443 million, just over 20%. Fortune added $202 million while PPP balances declined $96 million over those 12 months. So if we adjusted for both those items, our annual rate of growth over the last 12 months would be a little more than 15%. The investment portfolio added $20 million over the quarter while cash and equivalents increased almost $70 million quarter-end to quarter-end. Fortune added cash to our holdings but no material investments for the portfolio. Deposits had another strong quarter with $303 million in growth. Backing out the Fortune merger, we would have recorded $84 million; brokered funding was up $11 million, which is attributable to Fortune. While public unit deposits in total were up $40 million, which also included about $11 million from Fortune. We also saw other public unit inflows and we expect those to continue in the coming quarters. In the current quarter, time deposit balances outside of the Fortune merger dropped about $5 million. Over the last 12 months, time deposits are down $39 million outside of acquisitions and brokered funding. Non-maturity deposits, meanwhile, are up $291 million outside of acquisitions and brokered funds, and that includes just under $100 million in public unit funds. FHLB borrowings were up $6.4 million as advances assumed from Fortune were partially offset by repayment of a small amount of term advances. We also assumed $7.5 million of subordinated debt from Fortune; that note is callable in 2026 and matures in 2031. Our tangible equity ratio decreased by about 71 basis points during the quarter, reflecting the merger and a decline in the company's accumulated other comprehensive income, which was partially offset by earnings retention that modestly outpaced our asset growth aside from the acquisition. The AOCI decline contributed about 20 basis points to the reduction in the equity ratio. Greg, final comments.

Greg Steffens, CEO

Thanks, Matt. As expected, our loan growth tapered off during the March quarter following a very strong September and December quarter. Excluding the loans acquired with Fortune, we saw a strong growth this quarter in our residential and multifamily real estate portfolio; however, construction balances did decline during the quarter. Activity in our West region, centered in Springfield, Missouri, led the way again in the current quarter and has shown very strong growth over the last 12 months. Our east and south regions saw relatively little change in the current quarter, but above those shown, very good growth rates over the last 12 months. We expect loan growth to continue in the June quarter, which historically has been one of our best two quarters of the year. Our pipeline for loans to fund in 90 days was $181 million on March 31st, up from $158 million at 12/31, as compared to $146 million we reported a year ago. As I mentioned, we had modest paydowns in the March quarter, and that should reverse in the current quarter. The impact from PPP forgiveness should be immaterial. Our non-owner occupied CRE concentration did rise during the quarter and totaled approximately 304% of regulatory capital at 331, up 16 percentage points compared to December 31st, and as compared to 262% one year ago. Fortune's concentration was the biggest factor in the increase as the loans they added outpaced the new capital that we issued in the merger, and they had a higher CRE concentration upon acquisition. Our volume per loan originations was about $268 million during the March quarter, down about $68 million from the December quarter. In the same quarter a year ago, we originated $251 million in loans, which was substantially elevated by PPP originations. Our December and March quarters are usually our best for deposit growth, and on a core basis, this sparse quarter was above average, though much slower than the linked December quarter. The Fortune merger added about $218 million, with a limited amount of public unit or brokered funds on a core basis. Time deposit balances continued to stabilize this quarter, with balances little changed over the last six months. Public inflows have made up about 35% of our deposit growth in the fiscal year to date. Guidance from our depositories continues to expect inflows for the rest of our fiscal year. Our east region is leading in non-maturity deposit growth outside of public units, while the west region leads in total non-maturity growth, including public units. Our cash balances have continued to move higher in the March quarter, and we expect them to remain elevated for the upcoming quarter. Loan growth is expected to improve in the June quarter, and the ability to earn better investment yields has convinced us to begin putting a modest amount of cash to work in the investment portfolio. Although we want to do so at a measured pace over a period of time. Our expectation is that public unit balances will now follow the normal pattern this year, which would entail drawing down over the June quarter. Finally, we continue to work to fully integrate the team members and locations from our partnership. We are also continuing to look at other opportunities in the marketplace, and as always, we want to take advantage of any opportunities when they become available while maintaining disciplined pricing and evaluation. Matt.

Matt Funke, CFO

All right. Thank you, Greg. At this time, Alex, we're ready to take questions from our participants. So, if you could please remind them how they can queue for questions.

Operator, Operator

Thank you. Our first question for today comes from Andrew Liesch of Piper Sandler. Andrew, your line is now open.

Andrew Liesch, Analyst

Thanks. Hi, everyone. Good morning.

Matt Funke, CFO

Good morning, Andrew.

Greg Steffens, CEO

Good morning.

Andrew Liesch, Analyst

Got two questions on the margin here. So obviously, the deal added a lot of cash, rates are higher. Sounds like you want to put some of that to work in the securities book. Loan growth is going to improve here. How should we look at it on a core basis? The trend seems to be up from this 3.38 level or so just from those dynamics alone. But then there are rate hikes on top of that that should be beneficial. So how are you guys looking at the margin for the next couple of quarters?

Matt Funke, CFO

Thanks. Some of it is going to be driven by how fast the Fed ultimately goes. We think these next couple of quarters, as the Fed maybe moves a hundred to 150 basis points, we are generally positive to stable or a little bit positive there. Beyond that, it becomes a little cloudy, influenced by deposit competition more so. Anything further you'd say, Greg?

Greg Steffens, CEO

And then just somehow the shape of the yield curve is going to change as the Fed continues to raise rates. What happens to the other parts of the yield curve and the loans that we'd be putting on the portfolio at that time?

Matt Funke, CFO

Just given where the March quarter usually comes in, with the day count issue and everything, we would expect the reported numbers to look a little better as we look at it on a core basis. We'd expect maybe just marginal improvement there.

Andrew Liesch, Analyst

Got it. Okay. That's helpful. And then the cost saves related to Fortune, with the conversion done, how are those tracking? Are they all going to be in the run rate to start your next fiscal year, or will there be any spillover in July?

Matt Funke, CFO

I don't think there'll be anything significant from the data processing side. I think we should have most of that cleared up by July. I think that would be at that point.

Greg Steffens, CEO

We've been progressing well on the numbers and we're within our target ranges. We estimated there's still going to be some hangover this quarter of just some different items, but we're pleased with where we're coming at.

Andrew Liesch, Analyst

Got it. That makes sense. Then I remember part of Fortune's business was SBA loan sales. How has that business been tracking since the deal closed? And how is the outlook for that progressing so far this quarter?

Greg Steffens, CEO

Their pipeline of loans that are for the SBA is tracking ahead of what our internal estimates were upon the acquisition, and everything seems to be tracking in line at the present time.

Andrew Liesch, Analyst

Great. All right, that covers my questions. I'll step back. Thanks.

Matt Funke, CFO

Thank you, Andrew.

Operator, Operator

As a reminder, our next question is from Allina Hagen from KBW. Allina, your line is now open.

Allina Hagen, Analyst

Hi, everyone. Good morning. Thanks for the question. I'm subbing in for Kelly today. So just thinking about loan growth, I know you highlighted that it is expected to continue in June and the pipeline is looking good. How should we think about loan growth looking out for the rest of 2022 and some of the drivers behind that?

Greg Steffens, CEO

Well, can you tell us how much demand we're going to have from customers after rates go higher? Right now our pipeline is really strong, and we're now looking at it compared to where we were a year ago. I think we have some pretty strong tailwinds behind us for the present quarter and so the June quarter early growth looks optimistic. Historically, the September quarter does pretty well, as we have a lot more ad draws and advances. So I think we'll have some line draws during the September quarter. As you get further out in the course of the year, I think a lot of it's going to depend upon how successful the Fed is with some of their goals of taming inflation and what impact that's going to have on borrower activity. I would expect the latter part of the year to show slower loan growth than what we historically have seen. Matt, do you have any?

Matt Funke, CFO

Yeah, I think what we're hearing from the origination side is maybe a little bit of pessimism about whether we can keep up the rates from last year. We will see a little bit of a benefit probably from prepays slowing compared to where they were in 2020 and 2021.

Greg Steffens, CEO

Then we're seeing some good signs from the Fortune acquisition on lending activity from the team members acquired there, and that should have a positive impact on overall portfolio balances in the latter part of the year. They're continuing to adapt to our lending practices.

Allina Hagen, Analyst

Great, that's helpful. Thank you. And I guess jumping around a little bit, now with Fortune closed, what is your appetite for M&A looking forward? And if you do have an appetite, how are conversations progressing and all that? Thanks.

Greg Steffens, CEO

Well, we definitely have an appetite. We are always in the process of talking and discussing with other people. With Fortune behind us, we would like to find the right partnership to put in place. So we always have the conversations going and now we're just hopeful that they will reach a positive conclusion.

Allina Hagen, Analyst

Great. Thank you, that's helpful. I'll step back.

Greg Steffens, CEO

Thank you.

Operator, Operator

Thank you. We have no further questions. So I will hand back to Matt Funke for any closing remarks.

Matt Funke, CFO

Okay. Thank you again, Alex. And thank you everyone for joining us. We appreciate your interest as always, and we'll speak with you again in about three months. Have a good day.

Operator, Operator

Thank you for joining today's call. You may now disconnect.