Matthew Funke - EVP, CFO & Principal Accounting Officer Greg Steffens - President, CEO & Director.

Andrew Liesch - Sandler O'Neill + Partners.

Good afternoon, and welcome to the Southern Missouri Bancorp, Inc. quarterly earnings call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Matt Funke, please go ahead..

Thank you, Brandon. Good afternoon, everyone. This is Matt Funke, CFO of Southern Missouri Bancorp. The purpose of this call is to review the information and data presented in our quarterly earnings release dated Monday, January 22, 2018, and to take your questions.

We may make certain forward-looking statements during today's call, and we'd refer you to our cautionary statement regarding forward-looking statements contained in the press release. Thank you all for joining us. I'll begin by reviewing the preliminary results highlighted in the quarterly earnings release.

The December quarter, as a reminder, is the second quarter of our 2018 fiscal year. We earned $0.60 diluted in the December quarter, that is up $0.04 from the $0.56 diluted per share that we earned both in the December quarter a year ago and also in the linked September quarter. The September quarter had included somewhat higher onetime expenses.

We have a smaller amount of M&A cost included in this quarter's results.

Of course, the most unusual items in this quarter's results are the negative impact of revaluing our deferred tax asset, that was a $1.1 million hit to after-tax earnings, and then a positive impact from reducing the annual effective tax rate for the company's fiscal year, which ends June 30, which was an offsetting $840,000 improvement to after-tax earnings for a net after-tax impact of $284,000.

The reduction in the federal corporate rate from 35% to 21% means that based on IRS administrative interpretations, we'll pay taxes based on a rate of approximately 28.1% for the current fiscal year.

And so the December quarter had somewhat of a windfall from that reduction because income taxes were approved for the first quarter of the fiscal year at the higher rate. Our effective rate for the quarter was 33% and for the first 6 months of the fiscal year was 30.7%.

Both of those figures are elevated as a result of the income tax provision recognized as necessary to write down the deferred tax asset.

We provided some information in the earnings release as for our outlook for the second half of the fiscal year when we expect the effective rate to be between 24% to 26%, and also for fiscal 2019 when we expect it to drop to 18% to 20%. All of that assuming similar levels of tax-advantaged activity and investment relative to our pretax income.

Moving on to margin. We noted in the earnings release that the amount of discount accretion recognized on acquired loan books was elevated. It was up more than $400,000 from the linked September quarter, and it was up almost $600,000 from the year-ago December quarter. We generally expect that component of net interest income to decline sequentially.

And of course, the capital accretion is new compared to the year-ago period since that acquisition took place in mid-June of 2017. But we also saw an uptick over the linked quarter as a result of a couple of acquired impaired loans, both from Capaha and Peoples, that were resolved during the quarter.

The total between the 2 acquisitions accounted for an additional $860,000 in net interest income, which added about 21 basis points to our reported net interest margin.

In the December quarter of the prior fiscal year, we recorded $267,000 in this component of net interest income, which contributed about 8 basis points to the margin, and the impact in the linked September quarter was $465,000 or a 12 basis point contribution to margin.

So with our margin in the second quarter at 3.87%, again, with 21 basis points of that resulting from the fair value discount accretion in the year-ago period, we were looking at a 3.71% basis with about 8 basis points of impact from the accretion.

So on a core basis, we're looking at about 4 basis points improvement there compared to the linked quarter when we had a 3 79 margin and that 12 basis points of benefit, we'd be looking at about a 1 basis point compression in margin. Moving on down the income statement.

Excluding our securities gains, noninterest income as a percentage of average assets annualized was 71 basis points. That's down two basis points from the same quarter a year ago, and it's down 5 basis points from the September quarter. Gains on secondary market loans sales have not grown proportionately with our balance sheet.

And given -- and the current quarter also was weaker on other loan fees. Deposit service charges did remain strong this quarter. Noninterest expense was up almost 21% compared to the same quarter a year ago, and it was down 2% from the linked quarter as we did see a reduced headcount from the prior quarter.

Not all of those reductions in headcount is planned. We had some vacancies on the lending side of the bank that we'd really prefer to fill.

We also had a negative provision this quarter on our provision for off-balance sheet credit exposures, which gets reported as noninterest expense, and that reduced that category by about $72,000, in line with where we had that same benefit in the same quarter a year ago, and it was compared to roughly 0 in the September quarter.

As a percentage of average assets, noninterest expense decreased to 2.38%, but if you also exclude $84,000 in M&A expenses or intangible amortization, those seasonal swings in provisional off-balance sheet credit exposure, we calculate kind of an operating noninterest expense as a percentage of average asset that is down 5 basis points from the linked quarter and up 2 basis points from the December quarter last year.

Moving over to the balance sheet. We saw a slowdown in asset growth in the December quarter as loan growth was comparable to December -- to the December quarter a year ago. Total assets increased $13 million for the quarter and were up $69 million for the year-to-date.

This included growth in gross loans of almost $4 million for the quarter and more than $56 million for the year-to-date. Compared to December 31 of 2016, so on a 12-month basis, our gross loans are up $245 million.

And if you would back out the $152 million that we picked up from Capaha in June, we'd be looking at $93 million in growth, which would be about a 7.6% annual rate, which is down slightly from a 7.9% rate if you would have looked at that same measure in September of 2017. Deposits were up $37 million in the December quarter.

The December quarter typically is a better quarter for us in terms of deposit growth, and we're up $53 million for the year-to-date. We've seen runoff of traditional brokered deposits in the year-to-date. We're down about $34 million, including both time and non-maturity traditional brokered funding.

Public unit deposits were up $44 million in the year-to-date, with a majority of that due to the seasonal inflows late in the December quarter. And we've also established some new relationships, which have added to that funding source as well.

We generally expect to continue to pick up public unit deposits from our existing relationships into the early part of the March quarter, so it tends to reverse somewhat by the end of the quarter. FHLB advances are down $25 million in the December quarter alone, and for the fiscal year-to-date, they are up $16 million. Nonperforming loans were up.

They were $7.3 million, and in percentage terms, that's 50 basis points on our gross loans. That's up from $2.6 million or 18 basis points on gross loans at September 30, and it's as compared to $5.7 million or 47 basis points on gross loans at December 31 of the prior year.

Nonperforming assets at the end of the quarter were $11 million, up about the same dollar amount as our NPLs and are 62 basis points on total assets. At September 30, NPAs we $6 million even or 34 basis points on total assets, and at December 31 a year ago, they were $9 million or 60 basis points on total assets.

We did provide some description in the earnings release of the situation relative to the one commercial relationship to which most of that increase is attributable, namely that we are working to renegotiate a renewal with the borrower.

But of the $4.7 million total relationship, $3.5 million is a commercial real estate equipment loan, which is covered by a 90% USDA guarantee. And finally, the remainder of that relationship is structured as lines of credit secured by additional commercial real estate receivables on a personal residence.

Net charge-offs for the quarter were 4 basis points annualized. That's unchanged from the same quarter a year ago and it's up from 1 basis point of annualized charged-off in linked quarter.

Provision for loan losses were $642,000 in the current quarter, similar to the amount that we recognized in the December quarter of last year and down from the $868,000 charged in the linked September quarter when loan growth was stronger. The provision represented a charge of 18 basis points annualized on average loans.

That's down from 22 basis points in the December quarter a year ago and up -- and down from 24 basis points in the linked September quarter. The allowance as a percentage of our gross loans is up 3 basis points to 1.15% at December 31.

That's as compared to 1.12% at September 30, and it's down from 1.22%, December 31 in 2016, which would not have included the acquired Capaha bank loans, which are recorded at fair value rather than accounted for with an allowance. That concludes my review of the financial.

And at this time, I'll introduce Greg Steffens, our CEO, to provide his thoughts on our performance..

Thank you, Matt. Overall, I'm going to start with loan growth for the quarter, which totaled $3.4 million, which was slightly below our expectations, and that was due to higher-than-anticipated prepayments and then some slower-than-anticipated fundings of some loans that were working their way through the pipeline.

Loan originations have totaled $260 million -- $268 million for the first 6 months of the fiscal year as compared to $276 million in the same period of the prior year. Loan growth has totaled $55 million or 8% annualized, as Matt indicated earlier.

We believe that we are on pace to achieve our stated targets of 8% to 10% annualized loan growth, and we feel good about these targets. Over the last quarter, the loan portfolio composition really changed little as our CRE balances of various types grew, while our ag operating lines paid down.

To give a brief update on our agricultural portfolio, agro state balances grew modestly over the quarter, while our operating lines were slightly -- were down slightly more than anticipated at $19 million, where we had projected paydowns of $15 million.

Paydowns have been attributed to slightly better-than-expected agricultural results from our customers as their yields exceeded expectations, while pricing was just a little bit below where we had anticipated. Overall, our ag customers appear to have had their best year in the last 3, and we're pleased with what we're seeing in the ag portfolio.

We anticipate ag balances to drop modestly over the March quarter before beginning to draw significantly higher in the June quarter. When we look at our loan pipeline, it remains strong at $97 million, which is significantly higher than the $41 million outstanding 1 year ago at 12/31/16.

And based on our pipeline, we would anticipate better-than-historical growth in the March quarter, but we also do anticipate slightly higher-than-normal prepayments in our CRE portfolio. When we look at the composition of our loan pipeline, it's diverse over a variety of loan types and it's spread out over our footprint as well. Moving on to deposits.

Deposit growth for the quarter was $37 million, and it's been $53 million for the fiscal year-to-date. We're pleased with this growth as we were able to reduce our brokered CDs by $38 million over the same period.

We're also pleased with our level of non-maturity deposit growth, which has grown $74 million or 8%, which is well above our projected levels. Our East and South regions continue to lead in deposit growth, and our non-maturity deposit growth has been nearly split evenly between retail and public unit accounts.

Deposit growth will likely slow over the rest of our fiscal year due to -- in part to seasonal factors. Non-maturity deposit growth is expected to slightly exceed our 8% to 10% annualized growth targets. Moving on to M&A.

Our Capaha partnership continues to go well as our anticipated cost savings have largely been realized while we've been able to achieve both loan and deposit growth out of the acquired locations. Overall, we're very pleased with the acquisition to date, and it's meeting or exceeding our internal estimates.

We are also planning to complete our acquisition of Southern Missouri Bank shares in mid-February, and we're planning to convert systems in mid-March. We have received approval of the Federal Reserve and from their shareholders as well. We continue to review other potential partnerships.

Since our last conference call, we have decided not to pursue a few potentially larger opportunities at this time due to several factors including whether they fit culturally or their geographic footprint meets our expansion needs, and we're also exhibiting a certain amount of caution regarding the amount of growth that we could potentially absorb in a short period of time.

However, we continue to evaluate opportunities of various sizes, and we are also seeing fewer opportunities than at our last conference call, due in part to what we feel is some of the impact of the recent tax reform. And that concludes my comments..

All right. Brandon, at this time, if you would remind folks how they can queue for questions..

[Operator Instructions]. Our first question comes from Andrew Liesch with Sandler O'Neill..

Question on the margin outlook here going forward. Just curious if this latest rate hike, what you expect. And what you might be seeing in your markets related to loan yield, but then also with deposit pricing..

Let me take that in reverse order, Andrew. I'd say, on the deposit side, we're seeing some more aggressive pricing on the certificates pricing. Non-maturity, which is really where we've tried to focus on growth over the last several years, is more limited. And so we're hopeful that we'll be able to slow down the increase in cost of fund.

On the loan side, Greg, do you want to tackle that one or?.

On the loan side, we're seeing increases in loan rates that are coming through the pipeline. It's usually a 30- to 60-day lag between rate movements and before the loans close. We are seeing upward pricing but it is trailing a little bit where we would like it to be.

We continue to see significant competition as some of the smaller players in the market continue to drag their feet on repricing up even though the yield curve has moved up quite a bit across the slope of the yield curve..

Got you. And then, just going to some of your prepared comments, a couple of follow-up questions there, Greg, you're expecting higher prepays than normal in the commercial real estate portfolio here this quarter. Just curious what's driving that.

Is it refinancings by other companies? By other banks? Maybe offering terms and conditions that you're not comfortable with? Just curious what's driving your expectation for higher prepays..

We've had several larger customers that have ended up selling off some of their CRE that they have. And so we're anticipating some prepayment activity from that as well as then there are some people that are moving from being floating rate to locking in some longer-term rates at some rates that we chose not to match..

Got you. And then, one final comment here.

I think you've mentioned that maybe seeing few opportunities on M&A related to tax reform, is this from some targets or prospective targets wanting to go it alone because they're paying a lower tax rate? Or is it with pricing, what they think they deserve a better multiple?.

I think there's a variety of factors, and we're not really sure what all of them are, but some of them definitely are that they feel like they weren't going to necessarily receive the value of what their higher earnings will be going forward with the tax reform, and they're not certain that the market has fully factored in the anticipated higher earnings that they might have relative to stock if you are giving them stock in a cash and stock transaction..

[Operator Instructions]. It appears there are no more questions. So this concludes our question-and-answer session. I would like to turn the conference back over to Matt Funke for any closing remarks..

Okay. Thanks, again, Brandon, and thank you, everyone, for your interest in the company. We'll be looking to speak with you again here in about three months, and appreciate your interest. Thank you..

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