Earnings Call Transcript - SMBC Q1 2021

Operator, Operator

Good day and welcome to the Southern Missouri Bancorp, Inc. quarterly earnings conference call. Please note that this event is being recorded. I would now like to turn the conference over to Matt Funke. Please go ahead, sir.

Matthew Funke, CFO

Thank you, Chuck, and good afternoon, everyone. This is Matt Funke, CFO with Southern Missouri Bancorp. The purpose of this call is to review the information and data we presented in our quarterly earnings release dated Monday, October 26, 2020, 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 is going to provide a quick update on the bank's operations in the continuing pandemic environment.

Greg Steffens, President and CEO

Thank you, Matt, and good afternoon, everyone. Thanks for joining us today, and we're going to provide a brief update on our operations as we continue to deal with COVID-19. We're pleased to report that our communities are continuing to work to get back towards normal. Although we are currently seeing increasing virus cases and hospitalizations, we currently have very few restrictions on actual activity in most of our markets. Schools remain open. And we're hoping that the spread is brought under control soon before significant activity restrictions will be required. While we've had a few situations where some of our team members were affected by the virus and we have needed to temporarily close a facility or move to drive-through-only service for a period of time, all of our facilities remain open for business at this time. We have focused a good deal of our earnings release on the loan payment deferrals and interest-only modifications that we began to make as early as March, as provided under the CARES Act without TDR designations and with the encouragement of our regulators. Those loans over the last few months have made substantial progress towards resuming amortizing payments, and we are continuing to see that in October. We've seen a significant reduction since June 30 levels when we had $380 million in such modifications, and we were below $94 million at September 30, and we expect a substantial majority of that to move back to contractual terms by the end of October. And most importantly, loans that are in full deferral were down to less than $10 million at September 30 from $141 million at June 30. On PPP, we have funded very few loans since our last call and have submitted a relatively small number of forgiveness applications to the SBA, and they've approved and funded only a handful of those. Balances are basically flat at $134 million. Also, I want to touch on credit quality. Our nonperforming loans were little changed and remained at good levels at quarter end, as we saw just a few basis points of increase in past dues and classified loans. Classified loans were up about $0.5 million at the end of the quarter at $25 million, and past due loans were up by a similar amount at $7 million. We have provided a detailed breakdown of our loan portfolio at the back of our earnings release. I would encourage you to review that. We remain very pleased with the underlying performance of our loans in our current environment. We continue to work closely with the borrowers in our hotel portfolio, and we did downgrade several loans in the June quarter due to poor occupancy during the pandemic, and some of those loans were in more urban areas and continue to struggle. Our restaurant and multi-tenant retail portfolios continued to perform better than we could have anticipated at the outset of the pandemic, and we remain guardedly optimistic about those loan portfolios. Now for agricultural portfolio update. Our borrowers are generally in the harvest season and making good progress. Agricultural real estate balances were down a little bit over $3 million over the quarter, while ag production loans to our farmers increased by $21 million, which is a little bit stronger than our seasonal draws over the past several years. Our lenders are reporting average to higher yields on most of our crops, with their fall crop progress reports. Corn yield reports are averaging from 175 to 210 bushels an acre with some reports up to 250 bushels an acre on better, more productive ground. Rice producers are reporting yields in the 175-bushel range, and hybrid varieties are going for up to 200 bushels an acre. Producers are reporting early soybeans, yielding around 60 bushels an acre and with some longer season varieties ranging from 70 to 80 bushels an acre. Cotton producers are reporting some lower yields in comparison to previous years, coming in around the 1,200 pound an acre range, with more productive land coming in at 1,300 to 1,400 pounds an acre. For a few of our farmers who still farm non-irrigated land, they've reported much higher-than-average yields on their crops such as soybeans and corn compared to what they normally do. Overall, our crop mix ended up being 30% soybeans, 25% corn, 25% cotton, 15% rice, and then 5% specialty crops, which include primarily popcorn and peanuts. Our rice harvest is approximately 75% complete, with producers expecting to market their price in the $5.25 to $5.40 a bushel range, which, along with improved yields and pricing, should improve their incomes on their crops delivered. Our cotton farmers are approximately 50% complete with their harvest, with producers estimating cotton sales in the $0.60 to $0.62 a pound range, but it's a little early to determine how cotton is going to be graded this season yet. Our corn harvest is 95% complete, with producers reporting sales averaging the $3.75 to $4.15 a bushel range. We're seeing typical harvest season spikes in corn prices at this time that may help some of our people move more bushels to market that aren't fully contracted. Our soybean farmers are approximately 60% complete with their harvest, with several farmers contracting soybeans earlier in the year in the $9.25 to $9.50 range. Overall, we're seeing seasonal spikes for soybean prices that should allow farmers to sell noncontracted beans in the $10 or more range per bushel. In comparison to our price issues for 2020 underwriting, corn prices are trending 11% higher, soybeans are trending 12% higher, rice is about even, and cotton is trending about 14% lower. Overall, with improved pricing on some of our crops, combined with higher-than-anticipated yields, we maintain an optimistic outlook for the majority of our farm customers. Livestock prices are still trending 10% below our underwriting prices for most of our cattle farmers, and they are continuing to hold cattle, hoping to gain additional weigh-in prices before selling to market. As we noted in last quarter's call, many of our cattle farmers had to hold their cattle longer this spring than usual with the pandemic and the livestock markets being closed. But we did see government payment assistance that helped offset a good portion of this problem. Farmers are optimistic that prices will increase through the fall. There is considerable demand for locally-grown beef, with families purchasing cattle for slaughter and processing locally to restock their freezers, helping to improve farm-to-table demand that we're seeing improve as a direct result of the pandemic. We do see lingering instability in the agricultural markets related to the pandemic, but currently expect our farmers will have an average to above-average crop for 2020, and most are expecting a better year than when we spoke 3 months ago. Farmers are also anticipating possible additional assistance and government payments from the USDA later this year or early next, similar to what they received in 2019 from the Market Facilitation Program that would help offset the increased cost of production we're seeing in agriculture relative to commodity prices. FSA is now distributing some CFAP 2 payments to area farmers, but it's too early to determine yet how those payments will impact overall income.

Matthew Funke, CFO

Sure. Thanks, Greg. We earned $1.09 diluted in the September quarter, marking an increase of $0.33 from the linked June quarter and a rise of $0.24 from the $0.85 diluted earned in the September 2019 quarter. The provision for loan losses decreased moderately due to slower loan growth compared to the same period last year, and there were minimal changes in the economic outlook after our July 1 CECL adoption. Noninterest income remained robust, and we experienced a decline in noninterest expense from the elevated levels of last quarter, which included costs associated with the Central Federal acquisition and expenses related to foreclosed properties. Noninterest income showed significant increases compared to the previous year, with gains from secondary market residential loan sales leading the charge. The volume of originations is more than three times that of the same period last year, and the average gain per loan has also improved. We are generating more in mortgage servicing income as the amount under servicing sharply increased, and we created new mortgage servicing rights due to our rise in originations. Compared to a year ago, loans under servicing rose by approximately 30%, exceeding $45 million. If you track our noninterest income and expenses closely, you may notice we have altered how we report debit card expenses by netting them against interchange income instead of showing them solely as noninterest expense. On an adjusted basis compared to last year, debit card income is up just over 10%, reflecting a 9% increase in transactions and a 17% rise in dollar volume. However, we have concerns as the outlook may become more challenging with consumers responding to the ongoing pandemic and diminishing government stimulus. Our deposit service charges, including NSF fees, decreased by about 6% year-over-year, despite a 12% increase per item in NSF charges. Additionally, we benefited from a one-time boost in our wealth management income due to an agreement with a broker-dealer to offer services in a new market, generating around $187,000 in unique income. Noninterest expense rose by 9.3% compared to the same quarter last year but decreased by 13% from the linked quarter, where we had $1.1 million in M&A expenses with no significant charges in the current or prior year periods. In this quarter, we saw $150,000 in nonrecurring items related to the wealth management market expansion. We also posted a provision charge for off-balance sheet credit exposure at $226,000 in the current quarter, compared to a recovery of $146,000 in the same quarter last year and a charge of $132,000 in the linked quarter. Excluding these items, ongoing increases this quarter compared to the June quarter occurred in only a couple of areas: occupancy due to the addition of new facilities and FDIC assessment premiums resulting from an increased assessment base after the Central Federal acquisition alongside a lower leverage capital ratio due to PPP loan growth. We observed reductions in foreclosed property expenses, as we incurred significant losses in that category in the June quarter. Marketing expenses were lower than anticipated because of the timing of marketing department projects, and data processing expenses were also influenced in a way that should not repeat. Compensation and benefits returned to a more typical level outside of the noted nonrecurring item compared to the previous June quarter, where bonus accruals had inflated figures at fiscal year-end. Regarding year-over-year changes in core areas, compensation and occupancy are both up just over 6%, data processing expenses are approximately 20% higher, and deposit insurance cost $200,000 in the current quarter, having been zero last year due to one-time FDIC credits. The net interest margin for the September quarter was 3.73%, including about 6 basis points from fair value discount accretion. A year ago, this margin was 3.81%, with about 10 basis points from fair value accretion. We also benefited from loans returning to accrual status that had been nonaccrual, as well as deferred interest income recognized from those loans. In the linked quarter, we had a margin of 3.75%, benefiting from 6 basis points of fair value discount accretion and another 3 basis points related to loans returning to accrual status. On a sequential basis, we see a slight 2 basis point improvement in our core margin, though this is somewhat related to the 92-day quarter. Adjusted for the number of days, our core basis may actually reflect a decrease of 2 basis points. We're pleased with our margin performance so far but anticipate challenges ahead in matching asset repricing with a lower cost of funds. Our nonperforming balances, including loans and assets, remained stable from the previous quarter, with nonperforming assets at 40 basis points on gross loans and 44 basis points on total assets, both showing improvement from a year ago as we reduced problem loans from the Gideon acquisition in November 2018. We had net charge-offs of just $162,000 over the past 12 months, reflecting a trailing 12-month figure of about 4 basis points. At this time last year, we were running about 2 basis points. Provisioning for the September quarter decreased to $774,000, equating to 14 basis points for the quarter, with the last 12 months seeing provisioning around $6 million or 29 basis points. Our effective tax rate has risen slightly to 21.6% due to higher pretax income alongside a small drop in tax-advantaged investments. On the balance sheet side, gross loan balances increased by $18 million, but net loans rose just $8.5 million because of CECL adoption. We saw a $9.5 million rise in our provision, of which nearly $9 million was due to CECL. Excluding the Central Federal acquisition and PPP loans, we observed a core growth rate of about 5.5% over the past year, down from about 6.5% at the same time last year. The allowance as a percentage of gross loans stood at 1.59% as of September 30, which would be 1.69% if PPP loans were excluded. Deposits experienced a slight decline in the September quarter after two strong quarters in March and June. Public unit deposits fell by $17 million this quarter after rising by about $13 million last quarter. Brokered funding also decreased by a couple of million. Overall, the figures indicate a bit of a retraction of the growth we saw in prior quarters, particularly in time deposits, as there appears to be a shift in preferences towards holding cash in nonmaturity accounts.

Greg Steffens, President and CEO

Thanks, Matt. In terms of loan growth, our pace of growth is relatively slow over this last quarter, and that was roughly in line with our expectations. With PPP loan forgiveness, with it getting started, we're going to anticipate gross declines that are fairly modest over the next quarter, depending upon the speed at which the SBA approves forgiveness. At 9/30, our nonowner-occupied CRE concentration was approximately 270% of regulatory capital, which is down from 280% at June 30, and up from 253% 1 year ago. Our volume of loan originations was lower in the September quarter than where we were in June. The June was artificially inflated by all the PPP lending, but we were up substantially from the same period of the prior year. Our loan pipeline for loans to fund in 90 days was $123 million at September 30, notably higher from where we were at June 30 when it was $87 million, and $102 million compared to a year ago. Our pipeline remains diverse in nature and similar to prior periods, but it does include a little bit more on secondary market production for loans that will be sold after they are closed. Even though our pipeline is larger than where it was last quarter, our expectation is for limited growth in the coming quarter due to the PPP forgiveness, expected seasonal pay downs on our ag operating balances, and increased loan prepayment activity that we're seeing at present. In regard to M&A, we continue to not expect many opportunities over the upcoming months. We do believe that ultimately, disruption will lead to some deals. But for the moment, we aren't hearing the phone ring very often. In an 8-K filing last week and reiterated in our earnings release, we announced that our Board approved a resumption of our stock repurchase plan, originally announced in late 2018. We have around 232,000 shares remaining for repurchase under the plan. Given our current outlook on the credit portfolio and expectation for limited growth and few M&A opportunities, we believe that repurchasing shares near-term at current levels could represent a relatively attractive use of capital. We maintained the quarterly dividend of $0.15 per share for the November quarter as well.

Matthew Funke, CFO

Okay. Thanks, Greg. And Chuck, at this time, we'd like to take any questions that our participants may have. If you wouldn't mind reminding them how to queue for questions, we’ll do so.

Operator, Operator

And our first question will come from Andrew Liesch with Piper Sandler.

Andrew Liesch, Analyst

Greg, in the last quarter's conference call, you mentioned a few hotel loans that you were monitoring for potential weakness. How are those loans currently performing? What is the occupancy rate? Were these among the credits that were downgraded? Please provide any updates on those relationships.

Greg Steffens, President and CEO

We had 3 hotel relationships that we moved to watch list status. They remain in watch list status. The markets where they're at continue to struggle. They cater primarily to the business community and business travel, and they are struggling. They are currently on repayment status. We are monitoring how they are performing and we will make any adjustments as necessary, but we're presently negotiating with those customers.

Andrew Liesch, Analyst

Okay. Beyond the hospitality loans, are there any other areas of the portfolio that are raising concerns for you? Any other targeted areas of worry?

Greg Steffens, President and CEO

We aren't observing much activity. There is one restaurant client facing difficulties; they are making interest-only payments and have significant restrictions on their occupancy, as their space is quite limited. The three hotels are our main area of concern.

Andrew Liesch, Analyst

Got you. Got it. And then, Matt, just on your expense commentary, it sounds like there are a few line items that might have been a little bit below a natural run rate here in the quarter. So pretty safe to assume that you're seeing increase in expenses going as we head into this upcoming quarter?

Matthew Funke, CFO

Yes. We would probably see some of those bounce back to a more normalized level on the items we noted. Nothing huge there. But you probably see a little tick up in the December quarter. And then generally, into the March quarter, we have a little bit of expense build with our new calendar year.

Operator, Operator

Our next question will come from Kelly Motta with KBW.

Kelly Motta, Analyst

I wanted to ask about mortgage revenues, Matt. In your prepared comments, I believe you noted that volumes were 3 times year-over-year. I was just wondering with what you're seeing in your markets, if you expect another couple of quarters of outsized mortgage banking revenues.

Greg Steffens, President and CEO

Kelly, we're seeing that the pipeline right now for what we have for mortgage production is really running pretty similar to where it was last quarter. We would anticipate after the end of the calendar year that some of those balances would start to wind down a little bit. But at present, the pipeline is really maintaining the same level where we were before.

Matthew Funke, CFO

At some point, those refinancing opportunities will disappear. However, currently, it appears we are gaining market share due to the increase in the volume of loans we are servicing. Although Greg mentioned balances, I believe he is referring to the fact that originations will decline as refinancing opportunities diminish.

Kelly Motta, Analyst

Understood. Do you have how much was refi this quarter?

Matthew Funke, CFO

And I don't add that in front of me. I think it's about 2/3, is probably refi.

Greg Steffens, President and CEO

We've been running about 64% refi and 36% purchase.

Kelly Motta, Analyst

Got it. And then maybe if I could turn to credit. You obviously built your loan loss allowance a lot with CECL adoption. I was just wondering if your assumptions include any potential stimulus down the line, and kind of how we should be thinking about if any further reserve build is needed, if conditions kind of stay here without further deterioration.

Matthew Funke, CFO

In the CECL model we are using, we are primarily focusing on GDP expectations by considering insights from the FOMC and several external economists regarding their forecasts for future GDP. Most of these sources seem to anticipate some form of stimulus. However, if those expectations change and the likelihood of stimulus diminishes, we may see a reduction in their GDP forecasts, though I am not certain how to quantify that.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Matt Funke for any closing remarks. Please go ahead, sir.

Matthew Funke, CFO

Okay. Thanks, Chuck, and thank you, everyone, for participating. We appreciate your interest, and we'll talk again in 3 months.

Greg Steffens, President and CEO

Thank you, all.

Operator, Operator

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