SB Financial Group, Inc.

Good morning and welcome to the SB Financial third quarter 2021 conference call and webcast. I would like to inform you that this conference call is being recorded and that all participants are in a 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 Migas with SB Financial. Please go ahead, Sarah.

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, Ernesto Guyton, Chief Technology Innovation Officer, and Steve Walls, 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.

Thank you, Sarah, and good morning, everyone. Welcome to our third quarter conference call and webcast. Briefly, at a high level, overall, we're quite pleased with our quarterly performance as well as our year-to-date results. For the quarter, we realized positive loan growth that has now expanded for two consecutive quarters, grew our operating revenue, improved earning asset yields, and realized negative net charge-offs. Year-to-date, we've expanded both total assets and total deposits by nearly double-digit percentages, achieved positive operating leverage, witnessed a decline in delinquencies to an all-time low, and drove our allowance to non-performing loans to a record 3.5 times. We are certainly pleased with our progress and momentum, but of course not satisfied. Briefly, at a high level for the quarter, net income $4.1 million, yielding an ROA 1.23, pre-tax, pre-provision ROA 1.63, Net interest income of $10 million was up 8.3% from the prior year due to PPP forgiveness, loan growth, and a 35% reduction in interest expense. Loan balances from the linked quarter, excluding PPP effects, were up $21 million or 10% annualized. This follows a similar $22 million increase in the prior quarter. Deposits quarter over quarter continued to increase, $21 million up by $97 million year over year, Expenses down for the prior quarter, flat to the linked quarter. Mortgage origination volume, 153 million, down 24% year-over-year. Key asset quality metrics, including non-performing assets at 42 basis points and delinquent loans of just 35 basis points, were improved both the prior year and linked quarter. And finally, tangible book value, now up to $17.55. 11.6% increase year-over-year, or $1.83. Our five key strategic initiatives remain. We are impassioned by growing and diversifying that revenue, adding more scale organically now, again, post-COVID, and M&A when prudent. More products and services, which would be scope. And, of course, deploying technology and better technology for customized client care and communications. And finally, the foundation of all high-performing companies, we feel, asset quality. First, revenue diversity. This quarter, mortgage volume and loan sale gains were down from prior year, 24% on volume, 51% on gains. For the last 12 months, we delivered $650 million in originations. Our volume continues to be bolstered by our newer PCG fixed rate product, the 15-1 product that we announced the first of this year. And, of course, we underwrite and book in-house at here State Bank. We expect to close nearly $70 million in this product for the year. Non-interest income decreased to $6.6 million from the prior year quarter of $10.4 million, but it's up slightly compared to the linked quarter. Current quarter includes a mortgage servicing recapture of $248,000 compared to a recapture of $326,000 third quarter of last year. Non-interest income remains strong at that 40% mark that's traditional for us and 2% of average assets. Our affiliate peak title contributed over $500,000 of revenue this quarter, and we anticipate a full year of over $2 million, with net income approximately $400 million. Our president, Abby Waters, and her team have made great strides in doubling the revenue of this business line in three short years. We intend to leverage this true complement deeper into our core business lines and across all 14 county footprints. The stock market expansion has certainly assisted our wealth management team to consistently amass assets under management at or above that 600 million mark. This quarter's levels are up by 66 million, or nearly 13% from the prior year, while providing over 959,000 revenue, which is up 14% over the prior year. Year-to-date wealth revenue is up nearly 19% from the prior year. Second, more scale. Loan growth continued to show improvement in the quarter net of PPP paydowns. PPP activities are winding down for our calling officers, and the feeling on the ground in our markets is one of optimism, as we now have pivoted to servicing our clients and addressing their expansion plans. Our recent expansion into the Edgerton Ohio market continues to exceed our expectations. After just four months of operation, we have opened nearly 200 lower-cost core deposit accounts, with balances of $3.7 million, booked loans of over $13 million, and have a pipeline now of loans antipods of nearly $2 million. We continue to believe that capturing market share in our rural markets with our Main Street model that includes both BRICS and CLICS presents us nicely to grow our presence and build long-term franchise value for our company. Deposit levels continue to show growth and strength across all segments, including small business and consumer. Our clients, as I mentioned, have begun to slowly release their liquidity as they gain confidence in a more normal post-COVID world and leverage record levels of liquidity to undertake expansion activities. Third, deeper relationships, more scope. We ended the quarter with $10 million in PPP loans outstanding and essentially all of phase one loans fully forgiven. We're all looking forward to the full forgiveness of the remaining PPP loans yet this year and freeing up our calling officers to return to more normal lending activities, in particular SBA 7A lending that has all but disappeared with the onslaught of PPP and returned to our more traditional levels of $10 to $15 million annually. We have begun internal discussions regarding 2022 budget and business plan and are certainly focused on expanding our presence into growing urban markets of Columbus and Indianapolis. We are confident that our disciplined client calling model and loan prospecting initiatives will yield additional growth opportunities in the coming year. Operational excellence and client care and better communications is our fourth theme. The shift to purchase and construction lending in the mortgage arena accelerated substantially in a quarter, as that volume represented 61% of our total activity. We expect origination volume to remain healthy in the coming quarter and anticipate nearly $600 million in origination for the full year. Our mortgage ecosystem is built for higher production, and the variable here is the number of producers and not necessarily the volume. Expense levels will tend to mirror our mortgage origination volume as we continue to strive to make this business line more variable in operating costs on both the front and the back end. We are in the final stages of implementing a new loan origination and CRM system, and we anticipate operating costs will be elevated a bit in the short term until all operational efficiencies are realized mid-2022. As such, operating leverage for the quarter compared to the prior year is negative. due to the decline in mortgage revenue. However, year-to-date revenue growth of 10.5% is 4.1 times the 2.6 annual expense growth. And finally, before I turn it over to Tony Costantino, our CFO, for more detailed comments, asset quality. We continue to have zero loans in COVID's forbearance, and we feel very positive about the direction of our asset quality. We believe our disciplined approach to Lending during good times, as reflected in our palette of asset quality metrics, has helped us and our client base to withstand the effects of the recent downturn. Our profitability the past seven quarters has also enabled us to continue to build a healthy reserve level to 1.65% of total loans now for a year-over-year increase of 17%. Tony? Thanks, Mark.

Good morning again, everyone. Again, for the quarter, we had gap net income of $4.1 million or $0.58 per diluted share. Some of the highlights for the quarter include total operating revenue down $3 million or 15.3% as mortgage gains due to lower activity and lower gain on sale yields was lower by $4.1 million or 51%. We were able to offset the large mortgage variance with higher wealth and deposit fees, which were up 14% and 11% respectively. Loan sales delivered gains of $4 million from mortgage, small business, and agriculture. And margin revenue was up 8.3% due to the continued decline in funding costs, loan growth, as Mark pointed out, and PPP forgiveness. Now, as we break down further the third quarter income statement, beginning with our margin, average loan yields for the quarter of 4.67% increased by 16 basis points from the prior year and were up six basis points from the linked quarter. Overall, earning asset yields were down 44 basis points compared to the prior year, but were up 27 basis points from the linked quarter. Those loan yields were impacted by the revenue from the PPP portfolio, which were $1.1 million in the quarter compared to $780,000 for the linked quarter and $642,000 in the prior year quarter. We have just $560,000 remaining in unamortized fees. and we fully expect that essentially all of these fees will be realized by December 31 of this year. On the funding side, we again reduced the cost of our interest-bearing liabilities from the prior year. For the quarter, that rate was 44 basis points, which is down from the prior year by 31 basis points and flat to the linked quarter. Net interest margin at 3.21% was down 20 basis points from the prior year but up compared to the link quarter by 27 basis points. Accounting for that improvement from the link quarter were our on-balance sheet loan growth, deployment of liquidity to higher earning assets, and continued aggressive control of interest expense. Total interest expense costs were down 539,000, or 35% from the prior year. When we exclude the impact of PPP fees from both years, the third quarter margin would decline an additional 31 basis points to 2.8%. On a year-to-date basis, our gap margin of 3.12% would be reduced due to the PPP impact by 21 basis points to 2.86%. Total non-interest income was down 3.8 million or 36.2% for the prior year quarter, reflecting the significant decline in mortgage gain on sales. We did continue to see good growth in the wealth arena, as well as customer service fees, as we have pointed out. As we have discussed at length, mortgage gain on sale yields have trended down each quarter since their peak in the fourth quarter of 2020. The gain on sale yield for mortgage sales this quarter was 3.2%, which is a strong historical level, but well off the 4.9% that we realized in the third quarter last year. coupled with the lower levels of sales due to the private client 15-1 strategy Mark mentioned, has made annual comparisons of our mortgage operation challenging. Our traditional servicing portfolio does continue to grow and is now at $1.34 billion and provided revenue for the quarter of $850,000. The market value of our mortgage servicing rights remains steady this quarter with a calculated fair value of 84 basis points. This fair value level was up 18 basis points from the prior year. We now have a servicing rights balance of $11.2 million and remaining temporary impairment of $2 million. We would expect that the increases in market rates and the slowdown in prepayment speeds will continue to increase the value of those servicing rights. As we turn to operating expenses for the full year, which were $33.2 million, they are up $840,000 or 2.6% compared to the prior year first nine months. The prior year did include a $1.2 million one-time charge for merger costs related to the agent merger. And when we adjust for these merger costs, operating expense costs would be up 6.7%. Now, as we turn to the balance sheet, our loan outstandings at September 30th stood at $847 million, which was 63.7% of the total assets of the company. As we have discussed, Deposit levels continue to be above our expectations and have certainly impacted total asset growth. Absent loan growth, we have reallocated cash balances to supplement our investment portfolio that now stands at $254 million and is up $118 million or over 86% from the prior year. As we look at our capital position, we finished the quarter at $144 million, which is up $2.9 million, or 2.1% from September 30th of the prior year. And our equity-to-asset ratio stands at 10.9%. The buyback continued at a brisk pace in the quarter, with 107,000 shares repurchased, at an average price slightly above tangible book value. With our market price just above tangible book value, our shares are well undervalued, in our opinion, and repurchasing aggressively at these prices, we feel, is an effective strategy. Of our $20 million in earnings in the last 12 months, we have allocated over $15 million on the buyback and dividends to our common shareholders. By most metrics, the $300,000 in provision we took for the quarter was fairly aggressive relative to the level of loan growth and especially considering the net recoveries we realized in the quarter. Our mortgage and PPP earnings have allowed us the flexibility to increase reserves as we enter a tougher rate cycle in 2022. In addition to the improvements in NPAs and delinquent loans, our criticized and classified loans are both down nearly 9% from the linked course. And as I conclude my remarks, I want to point out year-to-date net income of $14.9 million is up $5.4 million or 56% compared to the prior year with an anticipated solid fourth quarter yet to report. I will now turn the call back to Mark.

Thank you, Tony. I want to conclude by acknowledging the dividend announcement we made last week of 11.5 cents per share, which equates to a payout ratio of roughly 21% and a dividend yield of approximately 2.4%. Our capital strategy continues to include an appropriate return of capital to our shareholders and an aggressive buyback, as Tony mentioned, of our stock. And I'll turn the call back to Sarah, and we'll open it up for questions. Sarah?

Thank you.

We're now ready for our first question. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. And the first question comes from Evan Liesel of Jannie Montgomery Scott. Please go ahead.

Hey, guys. Yeah, this is Evan on for Brian. Good morning.

Morning. Morning, Evan. Thanks for joining.

Thanks for having me. So I guess to begin with, you guys mentioned, you know, you gave some color on mortgage and just, you know, originations were healthy for the quarter. And I was just curious on the outlook on mortgage production and then also on the gain on sale margins.

Yeah, this is Mark Gavin. Just at a high level, as I mentioned, we've built this thing for not only an owner's income, but in particular mortgage lending. We like that $600 to $650 million number. That's what we're built for. That's what we're looking for. And as I mentioned, the variable here is the number of producers, which we're intent on finding to keep that number robust. So it's not a matter of what we can produce. It's a matter of what we want, and then we build a strategy of MLOs to go get it. So I like that number going into 2022. Certainly going to have some pressure on the downside on refinancings that have begun to decline already. But clearly we've got some nice products and some great markets for construction as well as the purchase market that now is 61% of the volume. So Tony, comments?

Absolutely. Yeah. Evan, I'll just add, you know, we're probably going to end 2021 with, call it, 45% of our volume in refinance. I would expect You know, that's going to trend to probably a 30% number as we look out into 2022 of our total volume. So that'll put some pressure on our origination levels, but as Mark talked about, you know, we want to expand in some other markets, add originators, and move forward on that. Gain on sale, you know, we did 3.2% on a relative basis this quarter, which is down from where it was, you know, off the charts in 2020. um we're we're looking at that probably going to settle in the mid two range as we look out the next you know six quarters or so which i still think historically is a really a relatively pretty strong level of gain on sale awesome that's very helpful and you know just tying to your outlook on that you know i know um

Just on expenses, I know they're kind of closely tied. Is there, with that outlook, is there a way of thinking about expenses moving into 22? Is it, you know, if there's going to be more production or volume, is, you know, is it going to be similar with expenses or how's that going to trend?

Yeah, I think, you know, at the top of the house, I think, you know, mortgage, you know, fortunately, unfortunately drives a great deal of our of our expense side, because we have gone, you know, almost exclusively variable, not only on the origination side, but also a little bit on our backend incentive side. I do think we're going to have, you know, kind of elevated expenses a little bit. We've done a, you know, relative to maybe what we see in the marketplace, we've really filled in a number of holes on the, on the headcount side in the last call it three to four months that we're, open positions for us. And as we look into 22, you know, we've already advertised that we've put in, you know, Encino and Salesforce, which we think will help us from the origination and client expansion capabilities. But in the short term, we're going to have a little bit of elevated expense side on the technology front.

Okay, awesome. Thank you. And then next, I guess I kind of turn to loan growth. You guys had nice annualized loan growth this quarter, and I was just curious on your thoughts on this growth moving forward and just any color on the outlook on loan growth through the pipelines would be very helpful.

Yeah, just a couple comments, and then our new chief lending officer will tell us about the pipeline there a little bit. But generally speaking, Evan, you know, we've always been content with that median level peer growth of, you know, 5% to 7% median level. But, of course, this last quarter we began to accelerate to a 10% annualized pace. So we like that 75 to 100 million number all the time, and we're finally gathering a little different conversation from our clients, from one of building liquidity to one of leveraging now and using that liquidity to expand and take on new projects. So things have been fairly robust. And I'd ask Steve Waltz to give us a little color on the pipeline as we see it across our entire footprint. Steve?

Good morning, Mark. Yeah, good morning, Evan. I would agree with Mark's comments there. We've had several conversations with borrowers who are expressing increased optimism about deploying some of that liquidity. You know, that's absent another COVID curveball, as we all know. But we have clients reaching out to us expressing optimism about their year ahead and interest in borrowing, making us aware, frankly, that we may have some purchases we're interested in, particularly on the equipment side, that when those things become available, when the supply chain normalizes, that we will see some activity. So I think we've got that $90 to $100 million looking out in the pipeline, and fourth quarter, more like $25 million we're looking to fund. But again, feel good about the pipeline as it stands. We have had good conversations with borrowers. We're also, all the PPP loans we did, we had new clients to the bank, obviously, in that case, and we are looking to mine those for opportunities as well to maintain that prudent growth strategy that we've always employed.

Thank you. Yeah, thank you for that, Keller. And then kind of turning with that loan growth to just, you know, this quarter you saw margin expansion, and that was really driven by average earning asset yields improvement, which were, you know, driven by, you know, partially a benefit and your core loan yields. So I'm just curious, you know, you had mostly stable funding costs. I'm just curious on the drivers and margin, like how do you think about these levers moving forward and just where do you see margin playing out over the next couple of quarters?

Yeah. Yeah. Good point. You know, I think, Funding costs we feel has certainly hit the bottom of the curve. You know, we were flat on deposit costs from the linked quarter, and I would suspect that's going to stay in that same range. You know, the majority of the funding that's going to go away, I would suspect, over the next two or three quarters is probably in that zero-cost funding level as those clients, certainly on the business side, start to utilize that. So I don't think we'll see much movement going forward on the funding side. But on the asset side, you know, we were up 10 basis points from the linked quarter if you net out PPP from both quarters. And I think of that, half of it was we had a little bit of a pickup from some non-performing interest on some non-performing loans that paid off in the quarter. So call it five basis points of core NIM expansion all driven by not only loan growth but better yields on both the bond side and the loan side. So I would just expect that level of growth and trend line to continue over the next two to three to four quarters, call it a five to 10 basis point improvement as loans and loan growth start to pick up here based upon our expectations.

And Evan, this is Mark, you know, just a high level comment as everyone knows. And we reported for many quarters now that balance sheet of ours is clearly asset sensitive. So, you know, we've borne the brunt of that on the way down and, We're a bit optimistic that we can potentially move that a bit wider as the yield curve steepens a bit and as we continue to expand our balance sheet. So we've taken a little bit off the table and taken some duration risk on that NGL 15-1 or PCG 15-1 mortgage product, and I think that's done exactly what we wanted. We knew there would be a bit of a slowdown in the commercial arena in 2021. We knew we needed to bolster that with another product, and we came up with that a private client 15 year one, and it's been real nice for us. And the quality of the client and the LTVs have been really good. So we're pretty optimistic on where we find ourselves.

Nice. Awesome. And you guys mentioned, you know, you mentioned PPP revenues netting out, but just an update on that. I think, you know, that grew 360 K in the quarter. You guys remaining, you have what? Is that right?

Yeah, 550 of unamortized fees. I would suspect by the time we get to 1231, we're going to have maybe 20 loans left that are going to go to full kind of maturity payout just because of whatever happened with their understanding of the program, but it's going to be de minimis. So I would suspect the bulk of that 550 is going to go into our earnings in Q4, and we'll really be a totally clean slate on PPP in 2022.

Awesome. Thank you. And then just kind of touching on, you know, liquidity has been in discussion. Just, you know, you guys saw more deposit growth this quarter. How are you guys thinking about, you know, balance sheet and just deposits moving forward?

Well, we like to think, Evan, we're pretty good at what we've done. We've certainly aligned well with our treasure management services, which clean up a lot of the lending issues. that we do in all of our markets. So here we are sitting with an immense amount of liquidity and trying to deploy it in loans, albeit defaulting to the investment portfolio, unfortunately. But that said, we continue to see that everyone is pretty insistent on retaining that liquidity. But we've now, as I mentioned, begun to see a little bit of clients discovering the power of leverage, if you will, that they can take that $100,000 that they had in their checking and now leverage it into $1,000,000 10 to 1 kind of thing at the outside. And so we've begun to have those conversations, which I think has led to the development of a $25 million production in the next 30 to 45 days coming out the pipeline and then having a nice pipeline going into the middle of the fourth quarter. So we don't see that going away. We see individuals spending the money, but profits are good, confidence is high, and we like our positioning taking care of all of our clients. It's been good.

Awesome. Thank you. That's very helpful. And then I think just a couple in-house questions for me. I know you guys mentioned your repurchase program. Just how many, you know, how are you thinking about that moving forward at your current price? Do you... I know you just announced this increased dividend. How are you thinking about this moving forward? Just how many shares do you have left on that, if you could remind me?

Just a comment. Tony will give us all the details. Just at a high level, we talk about the strategy, and we look at the sub-debt we raised at $3, $6, $5, $20 million, which sits at the holding company. But the robust profit that we've realized has enabled us to we think make a good investment decision. We're looking at a potential M&A when you're talking 130% to 140% of tangible book, and we can do our own at 105%. We think it's a pretty merited strategy that we've been able to deploy through profitability. Tony, I'm not sure how much we have left.

Yeah, so we did $106,000, $107,000 in this quarter, which was down a little bit from the linked quarter. We still have $520,000 remaining as we sit here today. And we've done probably $50,000 thus far in the month of October. So I would suspect we're going to be on that pace of $150,000 to $200,000 a quarter. So we'll probably be done with this allocation by June or July of 2022. And I think the board and and all of us feel that at these prices that this is phenomenal use of our capital given our earning stream, and we don't anticipate backing off from our strategy.

And just a closing note there, Evan, we continue to look at all of our capital strategies and how do we make sure that we're recognized for our performance at eight or nine times trailing 12 months. EPS is not terribly rewarding, but we think there's a lot of embedded value there. So, you know, we're going to continue to look at all of our capital strategies to improve market cap and our presence in the market.

Awesome. And, yeah, and to your point on M&A, just, you know, I guess we all know the, you know, the dialogue has picked up in the industry. Have you noticed it pick up in dialogue or have you had any interesting conversations, just anything You know, any color on that would be very helpful as well.

Yeah, we continue, Evan, to have meaningful conversations with individual banks that, you know, would be marginally smaller than us. Certainly nothing on a parity basis at this juncture. But that said, you know, our currency doesn't provide tons of paths to prosperity. But that said, we have certainly plenty of capital to get something done. Um, there's a lot, I think of opportunistic kind of, uh, uh, potentials out there that we continue to talk with. Uh, we're certainly not going to overpay. We've been very disciplined on how we build the franchise organic. We think is the way to prosperity. Uh, but, uh, certainly, um, MNA is kind of a divine kind of a thing. Uh, we continue to look at that. We want to be smart about it. We want to make sure it's a creative to certainly EPS and, and minimal tans of the book value dilution that we would find, uh, a path back to in the three and a half, four to four and a half kind of period on a payback basis. But conversations are good. But as we all know, when we've declined from many, many thousands of banks down to 5,000, performers are clearly left. And so the market is trading at numbers not seen for a long time. So we need to get our currency to where we have a little more opportunity in the market to pay a higher number than what we're currently trading. And we certainly look at those options today as we speak.

Well, awesome. That's it for me, guys. Thanks for taking my questions and a great quarter.

Yeah. Thanks, Evan. Tell Brian we said hello. Talk to you later, Evan.

All right. I will. Sounds good, guys. All right. Later.

Once again, if you would like to ask a question, please press star, then 1. And please wait while we continue to poll for questions. If there are no further questions, I will now turn the call back to Mark Klein.

Thank you, and once again, thank you all for joining us this morning. We certainly look forward to speaking with you in January of our full year and our fourth quarter. Have a great weekend. Thanks for joining. Take care.

The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.