Good day, and welcome to the Civista Bancshares Second Quarter 2020 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. .

I would now like to turn the conference over to Dennis Shaffer, President and CEO. Please go ahead, sir. .

Good afternoon. This is Dennis Shaffer, President and CEO of Civista Bancshares, and I would like to thank you for joining us for our second quarter 2020 earnings call.

I'm joined today by Rich Dutton, Senior Vice President of the company; and Chief Operating Officer of the Bank; and Chuck Parcher, Senior Vice President of the company and Chief Lending Officer of the bank; and other members of our executive. .

Before we begin, I would like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of Civista Bancshares, Inc. that involves risks and uncertainties.

Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website.

The company disclaims any obligation to update any forward-looking statements made during the call. .

Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute the most directly comparable GAAP measures. The press release available on our website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

We will record this call and make it available on Civista Bancshares website at civb.com. .

Again, welcome to Civista Bancshares Second Quarter 2020 Earnings Call. I would like to begin by discussing our results, which were issued this morning. At the conclusion of my remarks, we will take any questions that you may have. .

This morning, we reported earnings for the second quarter 2020 of $6.5 million or $0.41 per diluted share and $14.3 million or $0.88 per diluted share for the 6 months ended June 30, 2020. This represents a decrease in net income from 2019 of $2 million for the quarter and $3.7 million for the 6-month period.

The COVID-19 pandemic has had several effects on our balance sheet and income statement during 2020. Our balance sheet has grown as a result of the Paycheck Protection Program, or PPP, makeup of our income statement shifted as well.

The largest change in our income statement is an increase in provision for loan losses due to the economic uncertainty created by COVID-19, stay-at-home orders and increased unemployment. .

Without the increase in provision, our net income would have exceeded 2019 levels. Our strong capital position and continued ability to generate core earnings allowed our Board of Directors to improve our quarterly dividend during the second quarter of $0.11 per share, which represents a dividend payout ratio of 26.8%.

In these uncertain economic times, it is difficult to predict future performance, but our strong capital and liquidity should allow Civista to maintain this dividend level unless we experience a further deterioration in the economy for an extended period. .

Our return on average assets was 0.93% for the quarter and 1.07% year-to-date, while our return on average equity was 7.91% for the quarter and 8.70% year-to-date. Despite the lower interest rate environment, net interest income for the quarter was $22.1 million, which was consistent with the linked quarter and the prior year.

Our net interest margin did contract to 3.61% compared to 4.1% for the linked quarter and 3.84% year-to-date. .

If we remove the impact of the PPP loans we originated that carry a 3.46% yield, our margin would improve by 22 basis points to 3.83% for the quarter and by 12 basis points to 3.96% year-to-date, which are in line with what we modeled at the end of the first quarter. .

During the quarter, noninterest income was consistent with that of our first quarter at $6.9 million and increased $1.8 million or 34.3% over the same quarter in the prior year. During the first 6 months, noninterest income increased $2.3 million or 20.6% over the prior year. Mortgage banking continued to be the largest driver of these increases.

Second quarter gain on sale of mortgage loans were $1.4 million or 173.4% greater than during the linked quarter and $1.7 million or 307.4% greater than the second quarter of the previous year. .

Similarly, the year-to-date gain on sale of mortgage loans was $2.2 million or 248.5% higher than the previous year. During the quarter, we sold $91.5 million in mortgage loans at an average premium of 247 basis points compared to $35.4 million in the linked quarter and $27.9 million in the prior year.

Year-to-date, we sold $126.8 million compared to $44.4 million in the previous year-to-date. Our mortgage pipeline remains very strong. The other significant driver of our noninterest income was swap fee income, which increased $426,000 or 126% from the linked quarter and $749,000 over the prior year's second quarter.

Similarly, swap fee income was $1 million greater year-to-date compared to the same period in 2019. These increases continue to be fueled by the low interest rate environment and by more favorable pricing from our third-party swap debt, which we were able to negotiate late in the first quarter. .

We continue to be disciplined in controlling noninterest expense, which increased only 1.4% for the linked quarter and $2.9 million or 8.7% year-over-year.

In both instances, the only significant fluctuation was in compensation expense, which centered on annual pay increases that go into effect each April, commissions attributable to increased mortgage loan activity, and overtime associated with commercial loan modifications and our participation in the SBA's PPP program.

Our efficiency ratio was 61.7% compared to 60.7% for the linked quarter and 61.2% year-over-year. Excluding PPP loans, our loan portfolio increased $22.3 million during the second quarter and $56.4 million year-to-date. That equates to an annualized growth rate of 5.1% for the quarter and 13.2% year-to-date. .

Our growth came in every commercial category, our loan pipelines are strong, and we have $119.1 million in approved, undrawn construction loans at June 30. While we continue to be pleased with our loan production across our footprint, it is difficult to project how our loan portfolio will grow until we begin to see some normalization in our markets.

Our growth and essentially our entire portfolio comes from organic production. As I have outlined in prior calls, we have no exposure to nationally syndicated loans. We like knowing who our customers are and having the ability to work directly with our borrowers should conditions dictate. .

During last quarter's call, we addressed Civista's participation in the SBA PPP program, I can report that we originated nearly 2,300 loans for $257.6 million. This resulted in $9.8 million in deferred fees that will be earned over the lives of these loans.

However, we are most proud of the fact that we were able to help nearly 2,300 small businesses throughout our footprint and over 36,000 employees that are employed by them. In regard to COVID-19 loan modifications, we took a very proactive approach to the first round of modification.

Essentially calling all of our loan clients that were in good standing, offering the deferral of interest and/or principal payments for 90 days. Year-to-date, we modified 723 commercial loans, totaling $417 million, which represents 25.6% of our commercial loan portfolio.

We are meeting with all of these customers now to determine who will need an additional 90 days of relief. Based on our very preliminary discussions, we anticipate that approximately $150 million of our commercial loan portfolio will need some form of additional relief. .

We believe that we have greatly enhanced our credit underwriting over the last 10 years. Our loan portfolio is diversified throughout our footprint with none of our operating markets holding more than 25% of our assets.

While we do have a concentration in commercial real estate, we do not believe that any single industry represents a significant concentration risk. As a percentage of total loans, net of our PPP loans, 7.05% of our portfolio is in guest lodging, 2.01% in restaurants, 2.75% in entertainment and recreation.

In a broad sense, 18.91% of our portfolio is in retail with 4.07% of that being mixed retail office, 2.25% mixed retail residential and the remaining 12.59% being strictly retail. .

We have no exposure to what we call big box retail. On the funding side, our deposits increased $390.5 million or 23.3% since the beginning of the year. While we saw increases in every deposit category, the most significant increases came in our demand accounts, where the proceeds from the PPP loans were deposited.

In addition, over $85 million of our deposit growth came in personal checking and savings accounts. The increase in deposits allowed us to reduce our reliance on our FHLB advances by $101.5 million or 44.8% since December 31.

In addition, we borrowed $183.7 million from the PPP liquidity facility to assist with funding the PPP loans originated during the quarter. These borrowings carry a low rate of 35 basis points and also provide for advantageous regulatory capital treatment of the PPP loans. .

Our nonperforming loans were $7.8 million at the end of the quarter, a 14.6% decline from year-end, which represented 0.28% of total assets. A ratio of allowance for loan losses to loans increased to 1.01% from year end, which was 0.86%. And note that if we back out the PPP loans, this ratio would have been 1.16%.

Our allowance for loan losses to nonperforming loans also increased to 262.13% at the end of the first quarter from 161.95% at the end of 2019. .

While these reflect very strong credit metrics by historical standards, given the uncertain nature of our current economy, we will continue to monitor our portfolio and the economy making further adjustments to our model -- as our model dictates.

Given the uncertainties associated with the COVID-19 and its impact on the economy, we did adjust the qualitative factors in our allowance for loan loss model. As a result, we have recorded a $3.5 million provision expense for the quarter and a $5.6 million provision expense for the year.

As a reminder, we did meet the guidelines for the delayed implementation of CECL and will not be required to adopt it until 2023. .

In spite of the challenges of the current environment, we are pleased with another quarter fueled by solid core earnings. The COVID-19 pandemic continues to affect our nationwide economy in Ohio, which comprises most of our footprint, we were under a stay-at-home order for much of the second quarter.

This presented challenges to many of our customers and the communities we serve.

I am proud of the way Civista and our employees have met these challenges, I have received many notes of thanks for the way our employees were able to assist our customers as they navigated through the early weeks of the crisis and how we are continuing those efforts today. .

On March 19, due to the COVID-19, we limited our branch lobby services to buy appointment only to help protect the safety of our employees and customers after implementing a number of safety protocols to safeguard against the spread of the virus, we begin reopening our lobbies for walk-in service during limited hours on June 15.

Excluding our retail staff, we currently have approximately 60% of our employees working remotely. The COVID-19 situation remains fluid, and we will continue to monitor and assess the information provided by our local state and federal agencies as we make decisions on how best to operate going forward.

While the next several months, we'll continue to test the banking industry in the larger business world, so this is well positioned with a strong balance sheet, strong capital levels and a diverse revenue stream. .

Thank you for your attention this afternoon, and now we'd be happy to address any questions you may have. .

We will now begin the question-and-answer session. [Operator Instructions] And the first question will come from Nick Cucharale with Piper Sandler. .

So I wanted to make sure I understood the commentary on the loan modifications. It struck me that you guys were especially proactive with your borrowers, which contributed to the mid-20s deferral rates as a percentage of loans when you back out the PPP.

Understanding the environment is uncertain, is your expectation that $431 million number at June 30 comes down meaningfully in the near term?.

Yes, I'll have Chuck elaborate a little bit. But yes, I think I tried to address that a little bit in the commentary. It's very preliminary. We did a bulk of those or probably 2/3 of those modifications by mid-April. So they're just now coming due. So we've run some numbers to kind of project those.

That was the $150 million I was referring to in the comments.

Chuck, you want to -- Chuck or Paul?.

Nick, it's Chuck. We had all of our lenders kind of go out and pull all the customers that took deferrals. And obviously, they continue to come up, and we continue to look at those. But we're looking in that 10% range, as Dennis mentioned, that around $150 million.

And even from that perspective, we've moved a lot of them that took full payment deferral in the first piece to interest-only deferrals in the second piece.

So when you think about that $150 million, I would tell you probably $95 million to $100 million of that's going to be interest-only with the other $50 million to $60 million being full P&I payment deferral. .

Okay. Thank you for clarifying. So you guys had a big quarter for swap fees, as you mentioned in the prepared remarks.

Has customer appetite continued since the end of the quarter?.

Yes. I would tell you, customer appetite is still as strong. Based on the rate environment today, we have tried to widen those margins out some, Nick. We were doing a lot of stuff, pretty big rate reduction in that LIBOR plus [ 2.25%, 2.50% ] range.

We've kind of moved that -- those swap rates up to LIBOR plus [ 3.00% to 3.25% ], it sort of help save our margin. And at the same time, we're also examining whether we're better off putting those on short-term and swaps or putting some balances on the books as far as straights, like a 4%, 5-year fixed or 7-year fixed as compared to that swap fees.

So we're trying to blend that out, but the customer demand to go along is definitely there. .

And Nick, we also have been successful in kind of reinstituting some floors. We've been able to push that up a little bit. And it kind of gone away as rates have gone up.

Now as rates are coming back down, we are implementing a few floors now but when you widen the spreads and you start to put floors in, I think it will slow some demand because all banks haven't adjusted to that. But we're getting our first look at deals. .

This is Chuck again, Nick. The one thing that Dennis mentioned in his commentary, we did renegotiate our swap contract with our provider. So our cut of the swap fee is a little bit higher going forward. .

Okay. Great.

And then can you just help us think about how you're viewing expenses in the near term? And just given the operating environment, do you see any opportunity for some cost savings longer term?.

Nick, this is Rich. I think the run rate of what we did this quarter, while maybe the composition of it might change a little bit. I think that's a pretty good number for the next quarter and probably the next 2. What we're saving on travel. We're spending on janitorial services as we clean up after exposure to the COVID and whatnot.

But I think in terms of big-ticket items. I don't know that anything is going to change dramatically. .

Yes. Nick, I would say that given the fact -- I think it gets increasingly more difficult for banks going forward just given the fact that we're going to be in this lower interest rate environment. We've always been a shop that is focused on revenue, growing the revenue side, which we'll continue to do. But I think we do have to have an organization.

We'll take a harder look at some of our -- some of that noninterest expense. And we're prepared to do that as an organization. But just the environment, we're in the early stages of this thing. So I just think we're going to have to look for every way, both on the revenue and expense side as we go forward. .

That's very helpful. And then just lastly, I see you noted the settlement impacting the ATM interchange line.

Do you have that amount by any chance?.

I'm sorry, could you ask me that question again, Nick?.

Yes, there was a settlement that you mentioned in the earnings release just impacting the ATM interchange line.

Do you have that amount?.

I do. It was $150,000. .

Our next question will come from Michael Schiavone with KBW. .

So can you guys tell us your thoughts on the deployment of the excess liquidity build in the quarter and the trajectory of the NIM for the remainder of the year?.

In terms of excess liquidity, I mean, I guess, again, I don't know how familiar you are with -- Mike, with our balance sheet and the tax program and how those funds flow in, in the first half of the year and out in the second half of the year.

But by June, I think we were down to just $50 million of tax funds as far as liquidity goes, then again, we took that $180-ish million of funding from the SBA's PPP loan facility -- liquidity facility. So those are the big, I guess, liquidity components. I'm not sure if you're alluding to something else.

But in terms of the margin, I think we said at the end of the last quarter, when we modeled it out, we thought that we would have about 30 basis points of compression and if you take out the PPP impact, that's just about what we had. I think we had 28 cases points of compression.

Our balance sheet is pretty asset-sensitive and things reprice pretty quickly. So as long as our loan guys can continue to do the good job that they're doing in terms of holding the line on the asset pricing side, we feel like we've borne the brunt of the compression. It will continue to contract, but nothing like it did in the second quarter. .

Right. Right. We just have so much more than reprices. And again, we had the rate drop near the end of the first quarter. So we have 1/3 of that portfolio. So there will be compression moving forward, as Rich alluded to.

But we also had the PPP money and a lot of that money got deposited into some of our accounts, that money will run -- is running out as we go.

So -- and then I mentioned $87 million of personal deposit growth, some of that is most likely the impact of the COVID-19 because people -- we have these stay-at-home orders in place, and people aren't spending money. I think personal spending in Ohio for the quarter was down 6%, 7%, 8%.

So that's a contributor to some of that buildup of that liquidity. .

Okay. That's a lot of color. That's helpful.

Can you also provide some color on the loan growth pipelines outside of PPP? And what you are expecting for the remainder of the year?.

Chuck and Paul, I'll have Chuck Parcher, Chief Lending Officer; and Paul Stark, Chief Credit Officer, address that. .

Yes. Our pipeline stayed relatively strong throughout the entire time period, Mike. And obviously, we had a little bit of growth or quite a bit of growth in the commercial real estate bucket.

We had quite a few projects that were taking place across, especially our metro regions and those projects continue from a construction perspective, we're just talking about this morning, I think we only had 1 construction project that I'm aware of that actually got stopped during the whole COVID process. So those dollar amounts continue to fund out.

Columbus has been a very hot market for us as far as from a construction area. There's still a lot of demand there, especially on the multifamily side and a need for product. So we can see that to continue going forward. .

Obviously, like everybody else, we've kind of shut down the hotel lending and the restaurant lending, et cetera. But we still feel good about where our pipeline sits looking from here into the next few months anyway. .

And we've got businesses that have flourished during this time. It's general logic, you have about half the businesses that struggle and half of them are just flourishing. .

Well, the unique thing about -- this is Paul Stark. The unique thing about this cycle is the fact that every company is being impacted differently. And there's still a lot of liquidity in particularly in investors, and they're moving forward.

On the other hand, you've got some others that are really struggling to recover from that business disruption and the revenue disruption. So we're looking at each of them separately, but it's amazing how strong parts of it remain. .

I'll say the nice part, Mike, is as I was looking at some of the data, we're getting growth out of every marketplace, which feels really good. We're led a little bit by Columbus so far year-to-date, but we've got growth in Cleveland. We've got growth in that Southeast Indiana, Cincinnati market.

And then we've got growth also in our legacy markets through the center of Ohio. .

[Operator Instructions] Our next question will be from Russell Gunther with D.A. Davidson. .

This is Ryan on for Russell. I just had a quick question on the $9.8 million in deferred fees.

Are you able to provide any thoughts on the recognition of the PPP fees throughout the next couple of quarters?.

Yes. We think most of that will recognize most of that income as points from the forgiveness piece in the fourth -- in quarter -- in first quarter of next year. We will take that in over 24 months.

So I think it equates to about $400,000, maybe around $410,000 a month?.

$410,000 a month. .

$410,000 a month. So -- but we think that most of that we'll recognize in the fourth quarter of this year or first quarter of next year. And we expect the majority of that to be forgiven. Most of our loans, 80% of our loans had an average loan balance of around $120,000 or so.

So there's been talk that anything under maybe $150,000 is a 1-page forgiveness type application, some sort of easy process. So we do expect the bulk of those to be forgiven. .

Got it. And then just one more on the retail portfolio.

Just was curious how those conversations with borrowers have been going in, any more detail you're able to provide on either the coverage ratios or LTVs there?.

As far as growth or as far as asset quality?.

As far as asset quality?.

Okay. So as far as the -- our retail portfolio. We don't have a large consumer portfolio, most of it is HELOCs and residential mortgages. We've been really pleased with the performance of the payment streams on the mortgage portfolio. Our deferrals are less than 100, and a lot of those are going back to payments.

Now it will be interesting to see what happens when the unemployment benefits, the rich unemployment benefits phase out here pretty soon. But thus far, it's been less than 1% deferrals. .

[Operator Instructions] And our next question will come from Kevin Swanson with Hovde Group. .

Just 1 follow-up here on the PPP. Remind me again, the percentage of non-clients you did with PPP.

And then I guess the follow-up to that would be, how are you guys thinking about traction and keeping those clients with the bank? And what do you guys see as kind of an offensive move utilizing that program?.

Kevin, this is Paul. As far as the origination of these, I would say the vast majority of these customers were our customers. And we did take a portion of loans that were not customers as well. But I -- it's kind of hard to -- we didn't really measure that per se. But looking backwards at -- probably 80% were customers, at least.

And then from the standpoint of retention, we did work on that... .

Yes, we've been working really hard on that, to be honest with you, Kevin, this is Chuck. And we put together a list of the target pieces.

And I will tell you, even the noncustomers that we took the bulk of them were referrals from our [ CLI ] sources, our accounting firms, our law firms, or et cetera, they called us and said, "Hey, you guys are doing this very successfully. We can't get these through the regionals.

Can you take care of these clients for us." And because we were able to do that, we did generate quite a bit of goodwill across all our marketplaces.

And we've had quite a bit of success, a, right now, more so on the deposit side than the lending side, but we're working through very quickly and very -- I just looked at one the other day, we just brought a new $4 million client in, based solely on our PPP work, and we've got a lot of those opportunities bubbling up right now, then I probably have a little better idea of what those total numbers will be at the end of the third quarter, to be honest with you.

.

And Kevin, those opportunities, I mean those deposit accounts that they're opening are not just as they open the business deposit account.

We've hooked a lot of those people up with our retail managers or our private bankers, and they are already -- we -- I've gotten a lot of e-mails where people have opened their personal checkings and their money market accounts, CDs, wealth accounts, mortgage loans out of it.

So we have really done a very good job, we know who those customers are, and we immediately -- they were so happy that we were able to get them through the process. And we got 87% of our clients through Round 1 of the PPPs. And there were a whole lot of banks that had that high of a percentage.

But 87% of the applications that we got, we got through Round 1, and people are really happy and I think we've been able to parlay that in into expanding some of these relationships with existing clients and these new clients. .

And I can't emphasize enough the amount of goodwill we generated with the [ CLI ] bases. I mean they would kept saying, "Hey, we've got a client that we really need to get through this.

Even if we couldn't pick that client upfront right away, we built a goodwill there, but we really built a lot of goodwill with all the accounting firms around the state. .

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Dennis Shaffer for any closing remarks. . .

Well in closing, I just want to thank everyone for listening and thank those that participated in the call. Again, given the low interest rate environment and the fact that a lot of the economy was shut down for a good portion of the quarter, I was extremely, extremely pleased with our second quarter results.

The balance of 2020, we know will continue to be a challenge. We do look forward to meeting that challenge. And to talking to all of you again in a few months to share our third quarter results. So thank you for your time today. .

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