Good morning and welcome to the SB Financial third quarter 2019 earnings conference call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded.

I would now like to turn the conference over to Carol Robbins. Please go ahead..

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 www.yoursbfinancial.com, under Investor Relations.

Joining me today are Mark Klein, Chairman, President and CEO, Tony Cosentino, Chief Financial Officer and Jon Gathman, Senior 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. I will now turn the call over to Mr. Klein..

Thank you Carol and good morning everyone. Welcome to our third quarter 2019 conference call and webcast. Our comments today are supplemented by our earnings release we filed last evening. To recap, highlights for the quarter include net income of $3.8 million, up $700,000 or a 21% increase over the prior year quarter.

And for the full year, excluding the $1.4 million OMSR impairment taken in the first half of 2019, the adjusted net income was $9.7 million, up $1 million or 12% over the prior year. Consider our results from the year ago quarter.

We grew diluted earnings per share to $0.48 for an all-time record for core earnings for our company, representing a 23% improvement, expanded total assets $63 million to $1.04 billion, achieved a return on average assets of 1.44%, up 14 basis points, produced mortgage origination volume of a robust $158 million and set a new record for quarterly production.

We delivered new loan balances of $8.9 million, growing our balances to now $823 million, increased deposit $8.6 million to $848 million and continued to maintain our strong asset quality metrics.

As we have discussed in prior quarter, five key initiatives that continue to drive our quest for high performance are the diversity and growth of revenue, more scale through organic growth and potentially M&A, more products and services for and among our existing client base, excellence in our operations and intimacy with our client communications and lastly, the foundation of a well-built company with strong asset quality.

Let's discuss revenue diversity briefly. Net interest income for the balance sheet of $9.1 million provided the bulk of our revenue of $14.4 million or 63%. Our fee-based residential mortgage engine was clearly fully engaged this quarter, as we achieved record originations with $158 million in volume from nearly 700 clients.

The dollar volume was up 66% from the prior year quarter of $95 million and over 60% from the linked quarter of $98 million. We have now originated $308 million this year and we are confident that we will achieve our first $400 million year in total production in 2019.

Non-interest income to total revenue was 37.2% for the third quarter and 31.5% for the full year. The exclusion of the servicing rights impairment from the first half of 2019 would increase our year-to-date fee to revenue percentage to 33.9%.

Our non-interest income of $5.4 million is up $1.2 million or 27.7% from the prior year due to mortgage volume, higher SBA gains and revenue from our title agency. Our Indianapolis mortgage team contributed to our success in the quarter, as they now have three originators engaged in that very affluent market.

Columbus continues to lead our company in the residential arena as their loan eclipsed nearly $100 million volume in total volume for the quarter. Our title agency realized a good fortune of a very dynamic mortgage market and the growing Columbus, Ohio region.

For the quarter, Peak Title had revenue of over $400,000 and we have begun to successfully integrate their services with and into our commercial business line and throughout our entire geographic footprint.

The leadership team with Peak Title is quickly becoming a key part of our company and we anticipate continued record volumes in the coming months. Our SBA production for the quarter came in at $1.8 million. However, as we indicated last month, we had some credits on draws that total SBA sales to come to the $2.8 million mark for the quarter.

Those higher sales generated gains of $328,000 which is up 200% from the prior year quarter. Our residual portfolio, the unguaranteed part, now stands at $12.3 million with a nicely weighted yield of 7.5%. Wealth management assets under our care of $480 4 million represented an increase over the prior year quarter of $72.1 million or 17.5%.

Revenue from this business line is up to nearly $800,000 per quarter and is growing nicely at 10% from the prior year. Including all business lines, we now oversee nearly $2.7 billion in total assets, up over $220 million from the prior year quarter. Our second key initiative, more scale, improving efficiency.

Loan growth for the third quarter was $8.9 million and compared to the prior year we have grown $51.7 million or 6.7%. We have had some pressure to match rates in our commercial real estate portfolio as the regional banks have certainly got more aggressive within this segment.

We have elected to remain disciplined on our pricing and determined that some of the transactions would not be priced appropriately. As a result, we have exited some relationships that have put a bit of pressure on our organic growth.

That said, our loan interest income continued its growth in the quarter to $10.7 million, which is up $1.2 million or 12% from the prior year. Deposit growth continued to be positive for the quarter and year-to-date. As I mentioned, this quarter we grew deposits to $848 million, up $58.5 million or 7.4%.

Third is our strategy to develop deeper relationships. Growth in households and services continued its upward trajectory in the quarter standing nearly 900 households from a year ago and with these over 3,300 products and services.

We continue to expand all aspects of our client and product delivery systems with key groups working on our ATM strategies, our new courier service, digital banking and community outreach.

We expect to implement a dynamic loan profitability solution in the fourth quarter that will further refine our approach to identifying newly coveted relationships and remaining relevant to existing ones. In the third quarter, we continued our commitment to identify needs for each of our clients and to refer those needs to our business partners.

Following up on the $30 million we referred in the first half of 2019, we have covered an additional $17 million in opportunities in this quarter. Operational excellence remains the fourth theme. This quarter, refinance volume accelerated as of our $158 million originated, $35 million or 22% were internal refinances.

This refinance volume impacted our expense amortization. However, the commission structure on these transactions are such that we will realize higher profitability in the coming fourth quarter. The number of actual mortgage closings in the quarter was nearly 700, which is up 27% from the prior year and up 44% from the linked quarter.

We were able to achieve that closing rate while maintaining our operational teams at historical staffing and general expense levels. Expense levels of $9.5 million are up $700,000 from the prior year due to the impact of the title agency, merit increases and higher commission levels due to the mortgage volume.

Non-interest expense to average assets of 3.6% was down slightly from the third quarter of 2018 and our net non-interest expense to average assets improved to a negative 1.6% compared to the prior year of a negative 1.9%. And finally, asset quality. Non-performing assets flat to the linked quarter of 0.44%.

Total past due loans more normalized this quarter at.25%. Net charge-offs for the quarter were $113,000 as we had a few SBA credits that did weaken and our reserve to non-performing coverage remains in the top quartile of our peer group at a robust 207%.

Our asset quality and regimented approach to credit analysis and loan review continued to remain a strength of our company. I will ask Tony to provide a little more insight on our performance this quarter.

Tony?.

Thanks Mark and good morning everyone. As Mark mentioned, we had net income of $3.8 million of $0.48 per diluted share. Adjusted diluted earnings per share for the year is also up at $1.22 compared to the $1.14 for the prior year or a 7% increase.

Earnings per share impacted by a couple of things, the capital raise we completed in the first quarter of 2018 as well as the share buyback plan that we initiated in July of this year. Total operating revenue for the quarter was up 13.3% from the prior year and up 15.2% from the linked quarter.

We had positive operating leverage for the quarter of 1.6 times as revenue rose 13% and expenses were higher by 8%. For the year, when we adjust for the impairment, operating leverage comes in at 1.4 times. Loan sales delivered gains of $3 million from mortgage, small business and agriculture in the quarter.

Our mortgage banking revenue increased from the prior year, despite the significant refinance amortization. And lastly as Mark indicated, we continue to hold our non-performing assets steady with the NPA ratio at quarter end of 44 basis points.

As we break down our third quarter income statement, net interest income was up from the prior year by 6.2% and up 2.6% to the linked quarter. Our average loan yield for the quarter of 5.15% increased by 20 basis points from the prior year and overall earning asset yield was up 23 basis points from the prior year at 4.98%.

In addition to the balance sheet rate impact, mortgage volume via fees has added 28 basis points for the quarterly yield as compared to adding 23 basis points in the prior year quarter. Funding costs however have continued to rise but we have reduced depository and borrowing rates in response to the recent Fed rate reductions.

The rate on interest-bearing liabilities came in at 1.33% for the quarter, which was up 33 basis points from the prior year but up just five basis points from the linked quarter. Net interest margin at 3.93% was down three basis points from the prior year.

For the full year, our margin was 3.87%, down nine basis points from the first nine months of 2018. Total interest expense costs have risen by 44% from the prior year due to higher borrowing costs, loan growth and the increased competitive nature of deposit rates.

Total non-interest income of $5.4 million was up from the prior year by 27.7% due to the higher mortgage volume, SBA gains, title agency revenue and the higher returns we have achieved in wealth management.

As Mark indicated, we had a strong contribution from our newly acquired title agency with revenue for the quarter of $400,000 and it was reflective of our efforts to integrate the business line into the rest of our company. Total mortgage sales were $125.4 million for the quarter, which was also up from the prior year and the linked quarter.

For the quarter, our sold percentage was nearly 80%, which is trending closer to our historical averages. Total gains on sale came in at $2.5 million, which was 2.0% on our sold volume. Our servicing portfolio now stands at $1.15 billion providing revenue for the quarter of $710,000 and is on pace to deliver $2.8 million in total revenue in 2019.

This servicing portfolio has increased by $87 million or 8.1% from the prior year.

Market value of those mortgage servicing rights declined just slightly this quarter as the calculated fair value of 95 basis points was down 22 and three basis points from the prior year and linked quarters, respectively, but did not result in a servicing rights impairment.

However, substantially higher level of refinancing did increase our normal servicing amortization by over 123%, as amortization costs were $700,000 for the quarter. At September 30, our mortgage servicing rights were $10.4 million, which were down $700,000 or 6.1% from the third quarter of 2018.

Our total impairment remaining now stands at $1.6 million. Operating expenses for the quarter were $9.5 million, up $700,000 or 8.1% from the prior year and were also up $400,000 or 4.3% from the linked quarter. The quarter included our title agency expense of $300,000 and higher mortgage commissions from the additional $45 million in mortgage volume.

Total headcount, adjusted for the title agency, was down slightly from the prior year due to higher vacancy levels. Efficiency ratio for the quarter was well improved from the prior year, reflective of our 13% revenue increase.

As we turn to the balance sheet, loan outstandings at September 30 stood at $823.4 million, which was 79% of the total assets of the company. We had loan growth of $51.7 million and asset growth of $63.6 million from the prior year and were up $8.9 million and $13.6 million, respectively from the linked quarter.

Compared to the prior year, our loan book grew in all but one segment, led by commercial at $25.3 million, followed by residential real estate with $21 million. On the deposit side, we were up from the prior year by $63.6 million, a 6.5% growth rate and up from the linked quarter by $13.6 million.

We continue to utilize our balance sheet very efficiently as our loan to deposit ratio improved slightly from the linked quarter to 97.1%. We had lowered deposit rates in response to the recent Fed rate decreases and thus far our balances are holding relatively flat.

Looking at our capital position, we finished the quarter at $134.2 million, which is up $7.1 million or 5.6% from the prior year. We continued our share buyback in the quarter, with 173,000 shares repurchased and we have approximately 225,000 remaining on our current share buyback authorization.

Regarding asset quality, total non-performing assets now stand at $4.6 million or 44 basis points. The total level of these non-performing assets is up $0.1 million from the linked quarter. Included in our non-performing asset level is $800,000 in accruing restructured credits.

These restructured loans elevate our non-performing level by eight basis points and absent those, total non-performing asset ratio would be just 36 basis points. Provision expense for the quarter was $300,000, up $300,000 from the prior year and up just slightly from the linked quarter.

We did have loan losses in the quarter of $113,000 or five basis points due to a few SBA credits. Our absolute level of loan loss allowance at $8.5 million is up slightly from the prior year and due to loan growth, our allowance to total loans percentage has declined from 1.1% in the prior year to 1.03% currently.

This allowance level still places us above the median of our peer group and our coverage ratio to non-performing is in the top quartile of that peer group. We now have NPL coverage with our allowance of 207% compared to 256% at September 2018. I will now turn the call back over to Mark..

Thanks Tony. Clearly, this quarter was aided by the substantial increase in our volume in the mortgage business line as we have reported. However, given the weakness in mortgage activity in the first part of 2019, we are actually right on our 2019 budget expectations through nine months.

I am extremely proud of our sales and support teams as they have worked diligently to handle this excess capacity and to drive our services deeper into our clients throughout the footprint. Abby Waters and her team at Peak Title achieved record volumes in the quarter and we are quite pleased with the integration of this complementary business line.

We continue to seek partners like Peak that will enable us to grow our organizations both inside and outside our market areas. As we have begun to plan for 2020 we acknowledge the headwinds that are facing the financial services industry.

However, we continue to remain optimistic about our future and growth potential as our pipelines are strong and the consumer is healthy with higher disposable income and fairly constrained debt load.

Organic balance sheet growth and potential M&A opportunities, coupled with industry disruption in our current market should inure to our benefit in the coming months and quarters. And I will now turn the call back over to Carol for potential questions-and-answers.

Carol?.

Thank you. Sarah, we are now ready for any questions, if there are any..

[Operator Instructions]. Our first question comes from Brian Martin with Janney Montgomery. Please go ahead..

Hi. Good morning guys..

Good morning Brian..

How are you doing?.

Hi Mark and Tony. Could you talk a little bit about, I think you mentioned just starting out loan growth, maybe just being a bit more competitive in your market and letting a credits walk. Just how you are thinking about the coming quarters and just payoff activity, just your outlook? It sounds like the pipelines are good.

So just sustaining the current level of loan growth or just how you view that?.

Yes. Just from a high level, Brian, we continue to be optimistic about our ability to grow. We have certainly got some great individuals that are leading those markets. We have boots on the ground.

We have just kind of from a pricing perspective, we realized that actually remaining disciplined in our pricing might continue to benefit us in the coming months and quarters as opposed to just fielding all request at face value. That said, we don't mind median level growth in that arena.

But again, we want to continue to grow and continue to improve our efficiency, albeit with the margin that we can incrementally expand versus contract. So Jon Gathman is with us and I know Jon sees a lot of credits that we opt out of, not only we do not do but maybe not modify our rates maybe as robustly as we did a year ago..

Yes. I would just add to what Mark said. We are talking about two or three particular relationships. Two of the three in particular were highly price-sensitive and frankly that's how we got those relationships. That said, the competition we are seeing is not just low rates but it's longer durations.

With the rate curve flat, pricing exclusively off of a treasury curve or something like that is going to lead you to some, what we feel, are bad conclusions as we look out three, five, seven, 10 years.

So again, as Mark said, we are maintaining that discipline in those couple cases that we were willing to redeploy that money elsewhere where we thought we could get better duration and better rate..

Okay. And the pipeline today, is it pretty similar to where it was at the end of last quarter? Or just how are things standing in there? It sounds like they are pretty good..

Yes. I would say that. I would say it's pretty similar to last quarter, still very strong. We feel very good about it. So again, these rates that we are talking about haven't had an adverse impact into our pipeline..

And Brian, this is Tony. I would just say to add on to Jon's comments, while we do have, I think, a very good pipeline, I think we are still going to see some downward pressure in CRE in the fourth quarter. Things we know about today. So I think we will grind our way through to a little bit of growth.

But I wouldn't expect it to be historical in the fourth quarter..

And Brian, just to follow-up on Tony's comment. Clearly, we recognized the job to be done that we need to continue to make more calls and particularly on C&I, just because of the competitive nature that we have seen on the CRE.

So we understand that CRE is the places that you can move the needle on the balance sheet, but C&I is what we have continued to focus on in the spirit of generating more deposit to fund incrementally higher loans..

Okay.

And how is the SBA trends that are pretty positive at this point?.

Yes. Just a couple of comments. We got into that business line in a very robust way four or five years ago. And again, our posture on that has been to make good credit better. But recently, we have had a couple that Jon can speak to that just didn't perform as expected. But generally speaking, we like the business line.

We are going deeper into it because there are clearly opportunities out there, albeit in an environment where many competitors have begun to do longer duration, lower rate loans without SBA. So that takes more work and more prospecting.

Jon?.

No. That's absolutely correct. I think we have some work to do here in the fourth quarter as we prepare for the first quarter which we are really working for at this point anyway. But as Mark said, we had a little bit of weakness in two very small credits that we have already primarily worked through here quickly.

But overall, the portfolio continues to perform well. And as Mark said, we need to continue to push that business line forward and we have high expectations for it..

Okay. And then how about just jumping to mortgage for a minute. I mean, obviously a really strong quarter and it sounds as though fourth quarter is shaping up to be pretty similar, as strong.

But when you think about 2020, Mark, I guess maybe just I guess, is your expectation to dust your 2019 numbers? Or is that pretty difficulty? I guess just kind of trying to gauge whether it's going to more of a headwinds or maybe if it could be down next year, given the strong performance, particularly in 3Q and then maybe go into fourth quarter?.

Yes. Well clearly, Brian, as you know and we all know, the markets clearly, for us, is going to be driven by the level of long term interest rates. But that said, we are built for the $400 million to $500 million strategic level that we have talked about for a number of years, it has been that $500 million level.

And now with the addition of Indianapolis and three producers there and incrementally continuing to work to build out our existing footprint with a team or two and potentially a strategy to expand organically at the holding company level to take a bigger bite out of that mortgage business line, albeit maybe with some more nontraditional kind saleable kind of products, we continue to be optimistic about that.

We have done it fairly well. We think we know what we are doing. We have been built for it. We have the backroom that's established for us.

And I think we are going to continue to move that business line along and with it continue to expand households and move those service for households to a higher level because the number of new rooftops in our traditional market, as we have discussed, Brian, with you for some time, is limited, albeit without Columbus and Annapolis and Fort Wayne and Findlay, those kinds of robust markets.

So we need to go deeper in the households to continue to grow the franchise and we continued work on that and we continue to come up with strategies to make that process more robust. But continuing on the current trends and continuing to push it higher continues to be the focus..

Okay. So you wouldn't rule out mortgage being a greater number next year, Mark? I guess at this point, it sounds as though. I mean I am not seeing you are calling for that.

But you are definitively saying it should be lower based on the strength in the second half in 2019 here?.

Yes. Again, looking at the overall turns in the Midwest and the fact that builders have begun to identify more opportunities for expansion in the single-family household, we see some of it as we speak.

This is the first quarter that we can go on record in saying that we have financed a small development which it hasn't been, Brian, in the course of our conversation for, I don't know, five to seven years. And it's in a very robust market with great potential and on the fringes of our existing footprint. So we are excited about the opportunities.

We have got great people and a great staff and of course in a 3.5% unemployment market, you know that the challenges continue to arise with regard to developing staff and retaining staff and talent on all fronts. But we are committed to that business line. And again, our intent is to push it on up to the strategic level of $500 million-plus..

Got you. Okay. That's great color, Mark. Thanks. And you mentioned in your prepared remarks something about, maybe I missed it, just refinance activity and maybe that being a benefit of 4Q. I guess maybe I missed what you said there.

So just if you could clarify that?.

I am sorry, Brian. I missed your question. You cut out on me there..

Yes. I think you said in your prepared remarks about you are talking about refinance activity and then we have it adding a bit to profitability in 4Q. I guess just I missed kind of what you said there..

Yes. Go ahead, Tony..

Yes. Brian, just to clean that up. Our commission structure is such that internal refinances are paid at a lower commission rate than what would be a normal mortgage origination volume. And you know, we saw the bulk of our internal refinances happen in the September timeframe. And we are going to see that continue into the fourth quarter.

So I am just saying, our level of volume will be such but our commission structure, because of how it's structured, will be lower. The cost will be lower, so profitability will be higher in that business line..

And that said, Tony, to add on to that, we do have, Brian, a fairly robust pipeline of construction projects and in the same token those expenses are recognized upfront and then revenue comes later when they are sold. So I think that will add some fuel to the fire as well in the fourth quarter..

Got you. Okay. Perfect. And then maybe just jumping on the margin for a minute.

Tony, just kind of your thought on that if we get some rate decreases here, just kind of how big picture you see the margin unfolding? I guess maybe under the scenario, if we were able to get, if we did get three cuts the next three Fed meetings, just kind of how do you view the margin under a scenario like that, I guess, if we that does come to pass?.

Well, I think three cuts and that is what we are anticipating and budgeting for. We will have downward pressure on our margins. There is no question about that. It starts to accelerate on the interest income side, obviously, as we get below those floors that we have had established and we just don't have a lot of room on the funding side.

I think as we look at interest expense costs, in Q1 we were up 87%, Q2 we were up 77%, this quarter we are up 44% on a year-over-year basis. By Q4, we are going to be up, call it, 10% on an annualized basis.

So funding costs, I think, will stabilize but we are just not going to be able to pick up enough to offset three rate cuts on the interest income side. And I don't we are going to be able to grow fast enough to outpace that margin pressure.

So I would anticipate the same kind of level of year-over-year margin decline that we had in Q3, probably in Q4 and Q1..

Which, I think, Tony, that's really the impetus for the diligent loan pricing..

Yes..

Is that we want to remain steadfast in our approach to the maintenance of our margin and how we are pricing and the incremental cost of funding which continues to ratchet up a bit..

Okay.

And so just to clarify, Tony, just for each rate cut you get, I guess can you give some quantification on what you think that does to the margin? I mean how much of a haircut to the margin at each 25 basis points as you kind of look at it today?.

Yes. It's about $350,000 to $400,000 on the interest income side. Thus far, we have been able to successfully offset about half of that on the funding cost side. I would expect to continue that pace going forward about a 50% offset on the funding side. But that will give a little tougher as we get into further rate cuts..

And some operational efficiencies which, Brian, we are looking at as we speak on a number of fonts to be able to again continue to drive the bottomline north..

Got you. And it sounds like you think, from your comments, Tony, that deposit cost or funding cost peak in the fourth quarter here.

Does that maybe stabilize thereafter? Is that kind of how you are thinking about it?.

Yes. Based upon our projections as we have today..

Okay. Perfect. And then just the last couple, just on the buyback, Tony, I guess or Mark. Just some good progress so far. I guess the expectation is that you would complete that? I just don't recall the time.

Was it by year-end? Or I guess could it bleed into next year? Is that how we are thinking about it?.

Yes. We have got 225,000 remaining on our current authorization. Given our valuations, I wouldn't see us not extending or re-upping authorization after we have finished the current authorization. We are doing between, I don't know, 50,000 to 75,000 shares buyback a month. So best case scenario, we achieve it at all by the end of the year.

It might bleed a bit into Q1. But I would think certainly by February we are fully completed by the current authorization..

Perfect. Okay.

And just any comments on just M&A discussions? What's happening in your marketplace on that front?.

Yes. Just real high-level, Brian, we continue to look at several options. We keep those open and on the table. And we are confident that as we discussed with our investors who were good enough provide us with $30 million of capital, we are optimistic that we are going to be able to deploy that at least marginally and prudently soon..

Okay.

And the primary focus, I know you mentioned in your remarks, Mark, just kind of both traditional bank M&A and then other fee income type of sources, both are still kind of on the table as you look at it today?.

Yes. It would be an and versus an or..

Yes. Okay. All right.

And then maybe just remind me, just on the conversion of the preferred, kind of the timing of that and how that's going to unfold, it's maybe more Tony?.

Sure. We are going to have an announcement here shortly that we will give to the marketplace. We are going to convert those right around the Christmas holiday, per the agreement. And those will convert to common prior to year-end of this year.

So you know, we have had about 70,000 shares early convert and I suspect we will have a bit more of those in between now and the actual full call date which we are still getting the exact eight date in the next week or so..

Okay. I think that's it for me guys. I will step back. I appreciate the time and congrats on a nice quarter..

Yes. Thanks for joining..

Thanks Brian..

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Klein, Chairman, President and CEO for any closing remarks..

Yes. Once again, thanks everyone for joining. We look forward to reporting on our results for the full year in January and that will be forthcoming. And we appreciate you joining in our conference call and webcast today. Thank you and good bye..

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