SBFG - NASDAQ

Good morning, and welcome to the SB Financial Fourth Quarter 2023 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 Mekus with SB Financial. Please go ahead, Sarah.

Thank you, and good morning, everyone. I'd like to remind you that this conference call is being broadcast live over the Internet and will be archived and available on our website at ir.yourstatebank.com. Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; and Steve Walz, Chief Lending Officer. Today's presentation may contain forward-looking information. Cautionary statements about this information, as well as reconciliations of non-GAAP financial measures are included in today's earnings release materials, as well as our SEC filings. These materials are available on our website, and we encourage participants to refer to them for a complete discussion of risk factors and forward-looking statements. These statements speak only as of the date made, and SB Financial undertakes no obligation to update them. I'll now turn the call over to Mr. Klein.

Thank you, Sarah, and good morning, everyone. Thank you for joining us. Highlights for our fourth quarter include net income of $3.9 million, up from both the linked and prior year quarters as total operating revenue with higher non-interest income and net interest income increased profitability. Pretax pre-provision return on average assets of 1.43% compared to the prior quarter of just 96 basis points with return on tangible common equity of 16.6%. Total interest income of $15.1 million was up $2.2 million or 16.9% from the prior year and up $330,000 or 8.9% annualized from the linked quarter. Loan balances were higher from the linked quarter by $11.2 million and have now increased $38.1 million or 4% over the prior year quarter. We had annual growth in five of our markets with Fort Wayne increasing 40% and Columbus increasing 8% and collectively representing the bulk of our loan growth. Total deposits were off by $15.1 million or 5.6% annualized compared to the linked quarter and were down 1.5% compared to the prior year. However, deposit costs did increased by $3 million to $4.4 million or 205%. Deposit costs rose from 0.53% in the prior year to 1.62% in 2023 as DDA balances migrated to higher cost instruments. Loan-to-deposit ratio increased to 93.5%, which is solidly back in our historical level of the mid to low 90s and higher by nearly 5 basis points from the prior year. As part of our commitment to operational excellence that includes asset quality, we continue to demonstrate top-tier performance. Our time-tested approach has led to a reduction in total non-accruing loans now standing at $2.8 million, a decrease from the $3.3 million from the linked quarter. This improvement reflects a robust annual decline of 23.5%, bringing the ratio of non-accruing loans to total loans to a peer-leading 28 basis points and non-performing assets declining to $3.3 million or 25 basis points of total assets. Our diligent oversight across all loan categories have been particularly evident in the residential real estate portfolio, which has seen a 44% decrease in non-performing assets compared to the prior year, declining from $3 million to just $1.7 million. Operational liquidity remained relevant at nearly $500 million and continued to be quite strong at 35% of total assets. Expenses this quarter were slightly lower than the previous quarter at $10.4 million compared to $10.5 million, reflecting a careful management of costs that included a reduction in FTE this quarter, and overall, a reduction of 17 for the entire year. Mortgage origination volume were lower than the linked and prior year quarters did deliver a very high level of sold volume at more traditional levels around the 80% to 84% mark. Capital levels remained strong with Tier 1 leverage of 11%, common equity Tier 1 13.5% and total risk-based capital of 14.7%. Customer deposits below the FDIC insured threshold were nearly 80% of total deposits. And when we exclude any collateralized deposits, that level increases to 85%. In fact, our average deposit account now stands at just $26,500. We continue to work to diversify our sources of revenue, and organic balance sheet growth to deliver more scale and scope, remain [influent] with our clients, no matter the communication channel and hold peer-leading asset quality content. First, revenue diversity. The mortgage business line continues to experience significant pressure. This quarter, we saw mortgage originations declined to approximately $40 million and sold 84% or $33 million and brought our 2023 origination volume to just $216 million. For the full-year, we sold $161 million or 75%. Interestingly, our full-year volume of the $216 million I mentioned, $180 million or 83% was from purchase contracts that materially resulted in all new households. Despite the headwinds we encountered this year in our fee-based business lines, quarterly non-interest income expanded. Our $5.5 million this quarter was up slightly compared to the prior year and the linked quarter or 37% of total revenue. For the full-year, our total operating revenue eclipsed the $57 million mark with non-interest income of $18 million or 31% of total revenue, just below our historical average of 37%. Our Title Insurance business, Peak Title experienced a 31% decline in revenue for the year, which was in line with the residential volume we had compared to 2022. We continue to work to integrate Peak into not only other community banks in our markets, but also as a supplement to commercial real estate activities for State Bank clients. In fact, throughout 2023, at State Bank, we were able to capture 80% of the refinance business for our commercial clients and just 13% of the State Bank CRE purchase contracts. In doing so, we referred over $437,000 in revenue in 2023 to our affiliate Peak. As I mentioned last quarter, we intend to raise the bar for the level of revenue from refinances and purchase contracts coming to Peak to 50% in 2024, be it residential or commercial. Year-to-date, third quarter 2023, State Bank referred 30% of Peak's revenue and through this quarter, 26%, but clearly is more work to be done here. Moving on to Wealth Management. Our total assets under management increased $24 million from the linked quarter as the markets were generally all positive. This business line is contributing annualized revenue of approximately $3.7 million and is well in line with prior quarters. We also just added another financial adviser in the greater Northeast Indiana, Fort Wayne market. And now with the backroom fully staffed, we are prepared to grow new relationships and expand on existing ones. We feel strongly that joint calling efforts with this business line in conjunction with commercial and our private banking teams are clearly the best path to overall achievement of our growth goals. Secondly, more scale. Loan growth has now been positive for our last eight quarters, albeit well below our historical growth levels of over 8% annually. Headwinds, getting back to the average have been higher marginal cost of funds requiring higher loan rate at inception, investor expectations and an overall slowing economy. With largely higher fixed cost to produce our balance sheet growth given our 14-county footprint and our market leadership model, it's critical that we devise initiatives region by region by region to develop and deliver organic loan growth that are all well in line with expectations for the coming year. We expect to return to our historical growth rate in 2024. Deposit levels were fairly flat for the quarter and the year, while the change in mix and incremental cost reduced margins. Likewise, liquidity remained relatively stable throughout the quarter as we focused on deposit stability. Overall, asset yields increased 104 basis points this year, while liquidity costs increased 114 basis points, and Tony will give more detail on that mix. Third, more scope. We closed just under 500,000 SBA loans in the quarter and for all of 2023, originations totaled $9 million. This level of production was not only below our anticipated target for the year, but it's certainly less than we feel we are capable of and falls well below the objectives we have established for this highly profitable sector. With something better than a soft landing economic scenario for 2024, we expect to return to our pre-pandemic levels of production of nearly $15 million and well into the top quartile of SBA producers throughout the United States that do SBA lending. Referrals and among our staff and business lines continue to drive deeper relationships. In fact, for the quarter, we delivered a total of 274 referrals, 148 close for $14.9 million. For the year, we handed off a total of nearly 1,400 referrals with 761 closing for approximately $85 million in total business. Many banks talk about interdepartmental referrals, but we do now. We have the business clients, we have the staff and the reward system to deliver them. Rewards for both the person referring as well as the person receiving the referral, know what the job to be done is, and we always keep the client at the center of the conversation. Sales force and sales training, as we discussed last quarter continued to accelerate. Operational excellence. Operating expense resulting production levels and fee-based business lines and associated expenses were all down slightly in the quarter. As a result, our efficiency ratio increased to 73.5% and ironically, positions us well to improve our efficiency ratio with better production and expansion of asset on our balance sheet. All that said, we successfully managed to keep our expenses in line with a more efficient run rate, achieving close to the $10 million mark per quarter. As we move forward, we will continue to build upon these strategies to further optimize our financial performance and maintaining a prudent balance between cost, revenue and net income, given all of the market dynamics. And finally, asset quality. Our top tier asset quality continues to provide earnings inertia. Provision expense was a credit of $74,000 for the quarter due to unfunded commitments and was just $315,000 for the full-year. Charge-offs were again low this quarter at just $4,000 and now $92,000 for the entire year, which equates to just one basis point of total loans. Our reserve coverage of nonperforming loans now stands at a healthy 560% and well positions us to confront economic uncertainties. Additionally, we also experienced a significant reduction in delinquencies to just 15 basis points and arriving at now an all-time low for our company. And now Tony will provide us a little more detail on the quarter. Tony?

Thanks, Mark, and again, good morning, everyone. Again, for the quarter, we had GAAP net income of $3.9 million with EPS of $0.57 per share. As we look at the income statement this quarter, our total margin showed an increase in the linked quarter, but we experienced a decline compared to the same quarter last year. This occurred despite a solid increase in our interest income, which grew 17%. The key factor in this mixed picture is a substantial rise in funding costs, which have notably impacted our overall margin. These trends highlight the complexities of our current financial environment where higher operational costs are balancing out our revenue gains. Our margin ended the quarter two basis higher from the September quarter, but down from the prior year fourth quarter. Throughout the past year, we have observed a gradual stabilization in our margin. The trend over the last four quarters has shown a noteworthy progression from declines of 25, 20 and seven basis points, respectively, to a recent uptick of two basis points. This indicates a positive shift in our financial performance. Looking ahead to 2024, we remain optimistic and anticipate a steady, albeit slow improvement in our margin. Our strategies are aligned to capitalize on our market opportunities and continue this positive trend. In addition to the ongoing shift in the mix of assets away from securities to loans, increases and asset pricing have driven earning asset yields higher in every quarter this year. And they are higher by 62 basis points compared to the fourth quarter of 2022. Loan yields have increased by the same level as new volume and contractual repricing have stayed consistent to market movements in the rate curve. With approximately $170 million or 17% of our loan portfolio repricing higher over the next 12 months, we are optimistic that margins will continue to show improvement in the coming quarters, particularly as the yield curve flattens and then hopefully steepens reducing funding costs. This quarter, our margin betas have followed the pattern for the last half of 2023 in that our funding betas are exceeding the repricing betas on our earning assets. Specifically, the deposit and total cost of funding betas were both in excess of 100%. These are significantly higher than the loan and earning asset bases. For the full-year, the earning asset and total funding betas are just slightly upside down. Cycle to date from December of 2021, our earning asset beta of 33 is slightly higher compared to the funding cost beta of 30. We are especially pleased with how we have managed funding costs over the entire term of this rate cycle. Our level of fee income to average assets remained even to both the linked and prior year quarter at 1.7%. And as Mark pointed out, at the 37% level relative to total revenue. We track our coverage of noninterest expense to assets by noninterest income to assets every quarter. In a perfect world, driving that coverage to zero is ideal, but we understand extremely difficult. This quarter at a negative 1.5% is part of an improving trend in this metric for this calendar year as we have adjusted operating expense to reflect lower levels of fee income, especially in the mortgage business line. For the full-year, our operating expenses totaled $42 million, which was slightly below our full-year 2022 expense level, underscoring our commitment to stringent expense management. In the fourth quarter of this year, we continue to focus on reducing operating expenses, aligning with our ongoing strategy to enhance operational efficiency. Compensation and benefits as a percentage of total expense were 54.5% this quarter, down from 55.3% in the fourth quarter of 2022, with compensation for employees decreasing 5.7% annually, reflecting lower commission levels and reductions in staffing. Now let me turn to the balance sheet. Total size of our balance sheet experienced a slight increase from the linked quarter due to increases in available-for-sale securities and loans with loans held for sale and other assets declining. Securities as a percentage of total assets remained stable this quarter as they are now 16.4% of total assets. This compares to 16% and 17.9% for the linked and prior year quarters. Regular amortization of the portfolio reduced principal by $27 million in 2024, which we will redirect into funding anticipated higher yielding loan growth. The decline in rates this quarter improved the valuation of our mortgage servicing rights, which stood at 132 basis points. The servicing rights balance remained steady at $13.9 million, with the portfolio now at $1.37 billion, up slightly to the prior year. We continue to have very strong capital levels, as Mark highlighted, our common equity Tier 1 ratio stands at 13.5%. And even with adjusting for AOCI, the level remains robust at 10%. Tangible book value per share is higher by 133 basis points compared to the prior year. And when we adjust for the impairment, our tangible book value per share would be $19.42 per share, up 6.2% from year-end 2022. This quarter, we repurchased 53,000 shares at an average price of $13.91, 75% of book value and just 93% of our tangible book. Loan loss allowance was stable in the quarter reflective of both minimal provision and charge-offs. Due to the increase in loan balances, our reserve loans decreased slightly to 1.58% when compared to the linked quarter. But compared to the prior year, we have increased our reserve percentage by 14 basis points. Criticized and classified loans were relatively stable compared to the linked quarter, standing now at $9 million, a decrease of $3.5 million or 28% from the prior year. And as I wrap up my comments, just a reminder when we adjust our pretax pre-provision earnings for all of 2023, reflecting the elimination of servicing rights impairment, performance would be higher than last year by $1.05 million or 7.5%. I'll now turn the call back over to Mark.

Thank you, Tony. Once again, we continue our consistent pattern of raising our common dividend with our announcement this week of a $0.135 per share common shareholder dividend. And now for the full-year, $0.520 per share nearly $3.6 million. The total dividend payout ratio for this year is approximately now 30% with a common dividend yield of nearly 3.4%. And as Tony mentioned, our share buyback, which for the year now totals $3.5 million continued to be the best use of our earned capital. As I close our webcast for the third quarter and now here at year-end, I reiterate our intent to lever our presence deeper into our low-share, high-growth markets in 2024 to deliver organic balance sheet growth and efficiency improvement and with it, sustainable EPS performance and ultimately transforming to shareholder value. And now I'll turn it back over to Sarah for any questions we might have from our guests.

Thank you. We're now ready for our first question.

Thank you. [Operator Instructions] Today's first question comes from Brian Martin with Janney Montgomery. Please go ahead.

Hey. Good morning, guys.

Good morning, Brian.

Good morning, Brian.

Hey. Just maybe start, Tony, you gave a little bit of color or maybe Mark, whomever, just on the mortgage outlook. I think you talked about some of your kind of outlook. But just in terms of volume and kind of margins, just kind of how are you thinking about as far as I don't know if you're adding, yes, I guess what you've done on the talent side or – but can you just give any kind of put some guideposts around how you're thinking about 2024?

Yes, sure. We've obviously – we think that the bulge in the yield curve will settle in something less than 4% on the 10-year, which maybe at the 3%, 3.25% might give us a little inertia there. But currently budgeting something above that 300, 350 mark for next year. We have discussed many times that our sweet spot is $500 million plus or minus. Our Indy group now is producing somewhere near the $100 million, which is going to be accretive to that Columbus Group. And so this coming year, we're going to get a little more intentional with our leadership and that we're going to expand the base of MLOs to get our number back up there where, we feel we have some efficiencies to be realized in our sweet spot of something near that 500 mark. But as far as game wise, we know we need to be selling more. We need to be at that 80% to 85% level brand to get our gains that we want. And now we're working more diligently through sales force to make sure that we're identifying all the services we can for those households that we’ve worked really hard to get. So Tony, on the margin piece?

Yes. Brian, I think if we look at the fourth quarter that we just completed, kind of that 84% level of sales I think is in line with what we're going to expect going forward. We're actually seeing a fairly nice level of pipeline out of the beginning of this year, a little bit higher than I even anticipated. So I think that kind of 300 to 350, as Mark kind of guided a little bit. I think it's imminently doable as we look out the next 12 months. We are committed and we've added people in the Toledo market. We continue to look for people in the Indiana market. So I think those are going to kind of get us from what was a very, very tough year in 2023, up to kind of that level in 2024.

Okay. And the gain on sale margin, Tony, I guess can you kind of hold it where it's at today? Is that, or did you say that maybe I missed it? Or is it just kind of in that range?

Yes. We were solidly at 220 to 225 throughout all of 2023. I don't really see that moving very much. I mean pricing is still tight, you don't have the ability to move maneuver as much as you have in the past. The hedge was pretty successful for us during this year kind of maintaining that level. So I'm comfortable with that 225 level kind of move going forward.

Okay. And then just the last two for me, and I'll step back. Can you give a little color on just the margin? And I guess, in particular, if we do see a lower rate environment, just kind of how the puts and takes of it, maybe you have some flatness stability in the first half of this year and then go into a lower rate environment. Can you just talk about the margin outlook there and what the puts and takes are? And then just your outlook for organic loan growth would be the two that I had, and I'll step back.

Yes. I think I'll start on margin and then turn it back on the loan side. I think as we talked about, we were up kind of two basis points. I do think margins going to stable to be slightly higher as we look out every quarter in 2024. We've got about $140 million of variable rate that's going to reprice, call it anywhere between contractually 100 to 175 basis points throughout the year. We've got another $30 million of fixed that's going to mature, which will roll into a, call it, another 100 to 150 basis points as we refinance those with calls on that product. So I think contractually, we've got a pretty good level of gain. We've got probably $50 million of overnight funding exposure that if rates come down, call it, 50 to 75 basis points would be an median improvement to margin. And we have been deliberate to really shorten our level of retail, call it, term funding to kind of get shorter on the curve coming down from 15 months, call it, 12 months ago to 12 months, six months ago to kind of nine months now. So I do think the latter half of the year where we anticipate two to three rate decreases in our budget for 2024 will drive margin a little bit better. So loan growth. Mark?

Yes. Just high level, Steve Walz is here, our gentlemen in charge of lending. But at a high level, Brian, we currently always have high expectations. That's clear. But we would certainly like to get back to something near our historical level of loan growth in that middle to high single-digit kind of thing. But we know that we're going to have to price competitively. I don't think we have to take a lot of duration risk. But clearly, the marginal cost funding is a bit troublesome because we have to get more in the C&I like we've talked about before. But we clearly have some intentional strategies to maybe take a few less basis points that stand a little bit, but expanding the balance sheet enough to make up and improve the total revenue level. Fair statement, Steve.

Yes. Certainly, Mark, as you both reiterated earlier, we expect to get back into that mid to high single-digit loan growth, Brian. We've got a number of initiatives. We've got some good activity on that, particularly on the commercial side, seeing a little more utilization of those lines of credit as businesses optimism has returned a little bit. Some of that stable, hard to believe we're seeing stabilization of interest rates after the past year. But some of that stabilization has encouraged confidence on that side, we're seeing the activity pick up, and we look forward to that continuing in 2024.

Okay. Thanks for taking the questions guys.

Thanks, Brian.

Thanks, Brian.

Thanks.

Our next question comes from Nina Burns with Jan Scott. Please go ahead.

Hi. This is Nina Burns. I was on with Brian Martin, but he actually asked and answered the questions that I had as well. So thank you.

Thanks for joining.

Thank you.

Thank you. And as there's no further questions, I'll now turn the call back to Mark Klein for closing remarks.

Once again, thanks, everyone, for joining. We look forward to delivering our first quarter results in April. And until then, goodbye.