Civista Bancshares, Inc. (CIVB) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon. Welcome to the Civista Bancshares First Quarter 2020 Earnings Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mr. Dennis Shaffer, President and CEO. Please go ahead.

Good afternoon. This is Dennis Shaffer, and I would like to thank you for joining us for our first quarter 2020 earnings call. I am joined today by Rich Dutton, SVP of the company and Chief Operating Officer of the bank; Chuck Parcher, SVP of the company and Chief Lending Officer of the bank; and other members of our executive team. 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 the 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 www.civb.com. Again, welcome to Civista Bancshares first quarter 2020 earnings call. At the conclusion of my remarks, we will take any questions you may have. Before we get into the results of the quarter, I would like to take a moment to acknowledge the health care providers, first responders, essential workers and everyone on the front lines of this battle we find ourselves in. I would also like to acknowledge the way our Civista team has risen to the challenge by assisting retail and small business customers across our footprint. We began this year expecting one of our biggest challenges would be the uncertain interest rate environment and the pressure it would place on our margin. The COVID-19 pandemic has introduced additional challenges that the banking industry could not have anticipated. Civista is meeting these challenges from a position of excellent asset quality, strong capital levels and a diverse revenue stream. While the length and the depth of economic uncertainty across our footprint and the country is unclear, I am confident in our ability to meet these challenges from a position of strength. This morning, we reported net income of $7.8 million or $0.47 per diluted share. This is a direct result of our strong net interest margin, our continued focus on growing and diversifying noninterest income streams and our disciplined approach in managing the company. Our continued ability to generate core earnings allow our Board of Directors to approve our quarterly dividend during the first quarter of $0.11 per share, which represents a dividend payout ratio of 23%. 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 of time. Our return on average assets was 1.22% for the quarter compared to 1.37% for the linked quarter, and our return on average equity was 9.47% for the quarter compared to 9.44% for the linked quarter. Net interest income increased $893,000 or 4.2% over the linked quarter, and $396,000 or 1.8% year-over-year. Given the changes that were occurring in the interest rate environment, our net interest margin remained strong at 4.10%, compared to 4.18% for the linked quarter and 4.45% year-over-year. The increase in net interest income is a result of an increase in average earning assets, partially offset by a decrease in average yield. Additionally, our cost of interest-bearing liabilities decreased compared to the linked quarter and increased year-over-year. Interest income increased $481,000 or 2% over the linked quarter, and $418,000 or 1.7% year-over-year. During the first quarter, the noninterest-bearing deposits related to our tax refund processing program averaged over $311 million, which allowed us to pay down $84.5 million in FHLB borrowings that were outstanding at year-end. Also included in our margin are 15 basis points of accretion in the quarter compared to 14 basis points for the linked quarter, and 22 basis points year-over-year. As part of our normal ALCO process, we periodically model nonparallel shifts in interest rates. Given the recent drop in the Fed's target rate, we reran those models to see what the impact of a 150 basis point decline in rates might have on our margin. That modeling indicates a 35 basis point contraction in our margin. To put this in perspective, during 2019, the Fed cut their target rate 50 basis points over a 10-month period, and our margin, excluding accretion, contracted 9 basis points. During the quarter, noninterest income increased $1.2 million or 22.2% in comparison to the fourth quarter of 2019, and increased $592,000 or 9.4% year-over-year. One of the largest drivers of the increase is mortgage banking. Our first quarter gains represent a $496,000 or 150% increase over the previous year, as the strong mortgage demand that we saw during the previous quarter continued. During the quarter, we sold $18.9 million more mortgage loans than the first quarter of 2019. The average premium on the sale of loans also increased 34 basis points. Service charge revenue declined by $194,000 or 11.7% compared to our linked quarter, and is comparable to our first quarter of last year. As expected, interchange revenue declined $149,000 or 15.2% compared to the linked quarter with the post-holiday season decline in debit card activity. Our interchange revenue was comparable to our first quarter of last year. Wealth management revenue increased $69,000 or 7.4% compared to the linked quarter, and $159,000 or 18.8% year-over-year, as the assets under management declined by 14.1% to $495.4 million. This was during a period when the S&P 500 index declined 20%. While we continue to view the expansion of these services across our footprint as an opportunity to diversify and grow noninterest income, our fees are primarily based on the value of our clients' portfolios and are impacted by the greater economy. Our income tax refund processing program continues to be an important contributor to our noninterest income, and is concentrated in the first and second quarters of each year. Income from that program during the first quarter was $1.9 million. That was a reduction of $300,000 from the prior year, which is in line with what we indicated during our previous call. Swap fees increased $108,000 compared to the linked quarter, and $265,000 year-over-year, as commercial borrowers took advantage of the interest rate environment to lock in lower rates. Noninterest expense increased $728,000 or 4.3% compared to the linked quarter, and $1.4 million or 8.6% year-over-year. In both cases, the increases are primarily the result of increased compensation expense. While our headcount remained stable when comparing linked quarters, it did increase by 22 FTEs or 5% from the first quarter of 2019. Our average merit increases, which occur each year in April, averaged 3% in 2019 and account for $186,000 of the year-over-year increase, and our employee health insurance for 2020 increased by 9%, which accounts for $131,000 of the year-over-year increase. Our efficiency ratio was 60.7%, compared to 62.9% for the linked quarter and 58% year-over-year. Our loan portfolio grew by $34.2 million, or at an annualized rate of 8%, with the majority of the growth coming from both owner and nonowner-occupied commercial real estate and real estate construction loans. While we saw growth in virtually every market, the Cleveland, Columbus and Cincinnati MSAs continue to be strong drivers of our growth. We were pleased with loan production across our footprint during the first quarter. Looking forward to the rest of the year, it will be difficult to project how our loan portfolio will grow until we begin to see some normalization of our market. Our growth and essentially our entire portfolio comes from organic production. 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. 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 asset. Furthermore, there is no one industry that represents concentration risk. That said, as a percentage of total loans, 7.04% of our portfolio is in guest lodging, 2.01% in restaurants, 2.85% in entertainment and recreation. In a broad sense, 19.03% of our portfolio is in retail, with 4.03% of that mixed retail office, 2.3% mixed retail residential, and the remaining 12.7% being strictly retail. We have no exposure to what we call big-box retail. On the funding side. Our deposits increased $313.2 million or 18.7% since the beginning of the year. The primary driver for the increase was deposits related to our tax refund program, which increased $307.5 million during the quarter. As I mentioned in discussing our margin, we manage our wholesale funding in anticipation of the free funding we take in during the tax refund processing season. We used the tax funds to pay down wholesale funding and other short-term borrowings. Our nonperforming loans were $8.6 million at the end of the first quarter compared to $9.1 million at the end of 2019, which represents a 0.33% of total asset. The ratio of our allowance for loan losses to loans increased to 0.97% from year-end, which was 0.86%. While our allowance for loan losses to nonperforming loans also increased to 197.97% 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 and make further adjustments as our model dictates in future quarters. Given the uncertainty currently being driven by COVID-19 and its impact on the economy, we did make adjustments to qualitative factors in our allowance for loan loss model. As a result, we recorded a $2.1 million provision expense for the quarter. We were fortunate to meet the guidelines for the delayed implementation of CECL, and we'll not be required to adopt it until 2023. We did repurchase 646,703 shares of our common stock during the quarter for $11 million, ending the quarter with tangible common equity ratio of 9.82% compared to 11.08% at December 31, 2019. The extra $311 million of liquidity that our income tax refund processing business generated during the quarter reduced our tangible common equity ratio by 140% -- or 1.4%. The statement is often made that capital is king. We have performed some stress tests on our capital and feel that we are in a strong position. In spite of the challenges of our current environment, we are pleased with another quarter fueled by solid core earnings. The COVID-19 pandemic has had a rippling effect across the nationwide economy. In Ohio, though, we are currently in a stay at home order until at least May 1. Many of our employees have been working in either split operations or from home, and our branches have been at a drive-up-only status for some time. And Civista, we have a long history of working with our customers in good times and in challenging times. That philosophy has served us well over time, and is still prevalent today. We have been assisting our customers through payment deferrals, SBA PPP loans and other accommodations. To date, we have 432 loans totaling $262 million that have been modified as part of our COVID-19 relief effort. Nearly 90% of those loans are receiving a 90-day deferral of both principal and interest. All these deferrals meet the requirements to not be treated as troubled debt restructurings. Through the first round of the SBA payment protection program, we processed and received approval for 1,271 loans, totaling nearly $187 million. While this will provide us with approximately $7 million in fee income, the more important statistic is that it allows approximately 26,500 employees to keep their jobs. We will continue to prudently work with our customers to help them where we can. We feel that is part of being a community bank. As the slogan says, we are all in this together. While the next few months will undoubtedly test the banking industry in the larger business world, Civista is entering this period with excellent asset quality, strong capital levels and a diverse revenue stream. Thank you for your attention this afternoon, and now we'll be happy to address any questions that you may have.

[Operator Instructions] Our first question is from Nick Cucharale from Piper Sandler.

So I wanted to start with the loan modifications here. I appreciate the additional disclosure this quarter. More of a clarification, there's obviously a lot of uncertainty given that pandemic. But of the $411 million in deferral request since March 31, is it your expectation that substantially all of these requests are granted?

Yes. I would -- yes, we kind of took the stance. We're going to give most of our customers that 90-day kind of carte blanche on that, Nick, and then review it at the end of 90 days to see where they stand and what we're going to do from there. So we're pretty much set up to do that.

Nick, it's Rich. The only thing I'd add to that is that they have to be current in order for us to do that.

And all of the ones we have modified to date have been current.

Yes. Okay. Great. And then secondly, on the noninterest-bearing deposits, they got the typical boost from the tax business, as you mentioned. Just looking at the end-of-period numbers, that looks to be about $308 million this quarter versus $189 million in the first quarter of '19, is this a structural change in the business or more of just a timing issue?

Fairly timing issue, Nick. You really -- I don't see a full-on change in this tax season from the last tax season. Again, the taxpayers is taking advantage of that program, both of them file early once the money clicks. And it happens with the extension of the tax season, if you will, to July. It really shouldn't have much of any impact on our cash flow from that program.

Okay. I appreciate the color. And then in terms of the NIM, the 30 -- Dennis, the 35 basis points of contraction you were referring to, I just wanted to gauge what the time period was there?

Nick, this is Rich. And what we did as we went back and looked at where we were sitting in the first quarter, we said, okay, let's take 150 basis points contraction in the lowest and do the nonparallel shift, and that came in again at about a 35 basis point contraction. And that would be, if at all, happened at once and instantaneous.

Okay. And then the accretion income has been relatively steady since you changed your modeling assumptions a few quarters ago, how are you thinking about the NIM in the coming quarters?

Again, I think for the balance of this year, at 15 basis points a quarter is probably what we expect. And again, the only wildcard would be prepayments. But again, I think it's been 14, 15 basis points for the last 2 or 3 quarters, and that's kind of what we see over the next 2 or 3, for sure.

Okay. But referring to the core margin, what is your outlook for that?

Okay. I'm sorry, I answered the wrong question. But I did a pretty good job.

You did. You did.

So if we ended the quarter at -- I got to flip to a different page.

[ 4 10 ]?

Yes. So if it was [ 4 10 ] for the quarter. I think over the balance of the year, something approaching 30 basis points of contraction is not out of the realm.

Okay. And that's point-to-point from the first quarter to the fourth quarter, you're saying?

Correct. Yes. Yes.

Okay. Great. And then lastly, and then I'll jump out. I see you were pretty active on the buyback this quarter and exhausted the repurchase program shortly after quarter end. Is it your expectation that you'll re-up the authorization? Or is it more of a wait-and-see approach?

It is our expectation that we do re-up it. That being said, that I think that there'll probably be a suspension there for a period of time, until we get a better handle on the overall credit portfolio. We want to get some comfort level and see -- get a clearer picture as to what's going on with the economy. Right now, as businesses still being shut, we don't know how long that's going to last or what impact these relief programs are going to have. So I do expect it, though, to be -- to re-up it, but there's going to be probably a pause until we have that comfort level with, one, the economy; and two, the credits in our portfolio.

Our next question is from Michael Perito from KBW.

Thanks for the time this quarter with always the extra disclosures. I did want to ask on the credit side. The hotel and restaurant exposure that you outlined, Dennis, how much of that is going to be in deferral by your estimation in the next week or so? I mean, is it a majority? Or how does that look at this point?

I'll let Chuck answer, but I would assume it would...

I would tell you the majority for sure. As we're looking through it, yes, I don't have an exact percentage on that, but it is going -- it is the majority as I look through the list.

And are you guys making any assumptions at this point? Or any specific reserves against that portfolio as it seems to be kind of particularly stressed, even if there's some type of recovery? I mean, there's still kind of questions as to how fast those guys will be able to return to some type of normal operating period. What are you guys thinking at this point in that regard?

Yes, Paul Stark's on the line, and I'll have Paul give his thoughts and I've got a couple of thoughts. But go ahead, Paul.

Yes. The answer is that I think it's really early to tell. And some of that's going to depend on the financial reserves that the sponsors have to keep this moving. But I think our assumption is it will be a little bit longer build-back period. What we did is, we didn't set -- we ran a couple of different scenarios. But right now, given the deferrals and the cash that's being put out there, we did -- we just increased our Q factors for that as opposed to trying to make any specific allocations. As we get more information over the next 90 days, we'll be better positioned to do that.

Mike, most of our provision expense was really -- we just adjusted the qualitative factors surrounding the economy itself. So as Paul said, I think we'll gain a little bit more clarity as we go along here and we see what opens and what doesn't.

Okay. So the majority of -- the whole reserve build rather in the first quarter was really general reserve build? And I guess, what were some of the economic assumptions that you guys made to drive those qualitative changes?

Well, I think some of them were businesses that have -- they don't have any income. There's no income for businesses. Businesses have additional expense related to the COVID-19. The unemployment rate is extremely high. And then the amount of payment deferrals or the requests that were coming in for relief. I think those were really the 4 driving factors behind that.

As well as lack of personal travel because of closing down and people being homebound.

Right.

Are you guys able -- just as a reason for the question is we're trying to compare kind of what your reserve trajectory, how it compares to ours. Are you guys able to share some of the GDP and unemployment assumptions that you guys leverage in making those decisions?

I don't -- I can tell you right now, these are general allocations based on the overall numbers. We've got some localized information. But I don't think it's that precise given the huge influx. And most of these people went from standard revenue in good years to pretty much a significant drop in revenue and a lot of restaurants with no revenue. So again, I don't think we have our normal pattern. So I think as we look at the risk and how these people would be stressed, we decided it would be better to try to estimate less than -- I mean, if you go back and take a look at unemployment and the losses that you could derive out of that in the past under normal scenarios, that's pretty predictable. Unfortunately, given where you are today, it's really a lot harder to do. So yes, it was difficult as we went into there, but I don't think we're in a position to really spell that out. It's more of a -- well, it was an estimate.

Yes. The reserve build was, Mike, was about 8x what it was a year ago. So again, just so much uncertainty around where that number needed to be. But we felt that was pretty appropriate for the first quarter, given that we were -- the stay at home orders had only been in effect 2 to 3 weeks.

Yes. No, that's fair. Okay. And moving on, just one last question, just on -- any thought -- on expenses, rather, any thoughts, Dennis or Rich, on kind of expenses in the near-term here? I mean my guess is there's some elevated personnel and stuff like that type cost, especially with the stress the PPP lending is putting on the franchise? But any thoughts on kind of where the near-term expense trajectory could go in the second quarter? And I guess I'll just leave it there.

Yes, Mike, this is Rich. So if our noninterest expense for the first quarter was about $17.8 million, part of our normal business process is that we do merit increases April 1. So you can add about a $200,000 number to that, and that gets you to $18 million. That's the only thing I know for sure. Again, I think we've got some elevated expenses relevant to COVID. We've got some expenses that are going the other way, because, obviously, nobody is traveling anywhere and lodging is not -- we're not spending the night anywhere. Somewhere probably between 18 and -- 18, 3 or 4 is kind of what we've modeled. But boy, I mean, you're going to hear unsure, I think, a lot -- on a lot of these calls, and that's kind of where we're at right now.

Mike, the PPP stuff, we didn't really incur a lot of additional expense to process those loans. So we've really used people from our retail section because we had closed some of the branches and stuff and really across all of our business lines. So we didn't really incur a ton of additional expense from the PPP loans. The mortgage volume is pretty high, so we have added some processors. We've added those in the last year or something. So you'll see that -- the full year effect of that moving forward, but our mortgage volume is nearly double from where it was before or so.

I was going to say, once we find out what the exact forgiveness rules are, there probably will be some small incremental expense because people will be working on the loan portfolio, but that should be covered by the revenue that we're taking in from PPP.

Our next question is from Russell Gunther from D.A. Davidson.

I just wanted to follow-up on your comments with regard to internal stress tests that you've been running. You said your -- it gives you comfort in the capital position, which certainly seems in excess. But if you could just share some of the related assumptions that you're performing and perhaps what you consider or model there with regard to potential stress loss rates within those hotel and restaurant segment?

Well, on the -- when we ran and when we've been doing our capital plan stress test, we really looked back at the last recession, took the amount of charge-offs that we had during that time. And over a 4-year period that we had incurred about $54 million in losses. We really doubled that and assumed that we were still paying a dividend, assumed that there was some loan growth, really -- and we did it over a 2-year period, we condensed the period of time. And that really showed that we could keep a capital level, a Tier 1 level above 8%, so it could -- so we could sustain about $110 million of losses and our Tier 1 capital would still be above 8%. So that's double the losses that we had during the last economic recession condensed under a shorter period of time, without us really pulling some levers that you would typically pull. You may slow loan growth. You may furlough employees. You may cease your dividend, and we didn't really -- we assumed that, that was all still taking place. And obviously, if losses build, there's levers you're going to pull. So we felt pretty comfortable about that.

I appreciate the comments there, guys. And then kind of a ticky-tacky question, but the loan loss reserve is at 97 basis points today, if you consider marks taken in prior deals, is there much of a lift to that? Where would that number stand?

It's about 17 basis points, the credit mark from our last -- really our last acquisition that we did about 18 months ago. So the credit mark on that has about 17 basis points. Paul, do you have anything you want to add on that?

Well, no, if you're talking about future, I think the -- we don't know yet. I mean, we really are going through -- we started the process of assessing on a credit-by-credit basis. And I think everybody is going to be impacted differently on that. But if we find that this is prolonged, I'm not sure what the definition of temporary is anymore. But basically as we look forward, we may have to increase that depending on what we see.

Yes. So the credit mark on that last acquisition, it was about 17 bps, which takes us -- with the 97, we're 114 or so. We do expect provision to be elevated may be moving forward, but -- or at this elevated level that we're at today, unless -- but again, because of all the uncertainty, we just don't know yet.

Understood. And then last question I had, guys, is there much in the way of overlap between the roughly $400 million of deferrals and the $187 million of PPP?

Yes. This is Chuck, Russell. Yes, I would say that the bulk of it is probably overlapping, to be honest. We kind of took the -- we took the -- taking care of our customer-first model on the PPP program. So we really got through almost all of our clients that asked for it in that first wave. And I would tell you that I don't have a cross-reference totally, but I would tell you, it's pretty close to -- most of the people who took deferral took the PPP loan.

Our next question is from Kevin Swanson from Hovde Group.

Most of my questions are answered, I just want to throw one more out there. Obviously, prior to COVID, you guys had a nice growth plan, it was working well. Obviously, right now, the stance has kind of changed a little bit to sustaining businesses and helping the community. But how do you think about positioning for offense as the tide starts to turn?

This is Chuck, Kevin. And it's been interesting as we went through this PPP program, we've actually -- because we were so successful in implementing it, we have started to see some nice loan demand and some nice customer relation piece of that from actually beating the, I would call, the regionals and the national guys to the punch. And even as we're looking into the second wave, we've picked up -- even more people have asked us to implement it for them as compared to their normal banks. The other thing that I think that I've got -- I feel good about looking forward is, right now, the CMBS market seems to be a little bit in disarray, some loan to values, et cetera, have been pushed down. We're seeing a few of our really successful projects that probably would have went out to that marketplace and have been taken off our books, coming to us and asking for some 10-year swap money and leaving them on balance sheet, which I think will help us growth-wise through the balance of the year as well. Now hard to predict what total demand is going to be looking forward 90 days from now as we come out of the other side of this, but I'm still optimistic that we'll have some growth looking forward.

Okay. Great. And maybe just a follow-up to that. Obviously, I appreciate some of the uncertainties that remain. Have you thought about any changes to credit structure and underwriting, given what we've learned so far from the impact? And maybe on some of the growth that you guys are seeing?

We have. We've talked quite a bit about it. And I guess I'll let Paul start to jump in as well. But obviously, we're working on -- everything I touched differently. Obviously, we're not going to be jumping into the hotel market anytime soon or anything like that. But Paul, you want to talk a little bit about what we're looking at going forward?

I think the immediate need is to really have a -- I mean, we're looking at every deal as they come through. And so the biggest issue really is understanding any of these projects or customers as to what kind of impact they've had, what kind of liquidity they have, which is ever more important as well as do they have a plan and a strategy to work their way through this thing. There's still a lot of customers out there who have not been affected too much, and -- but there's also some projects out there that I think when they first came to us, we're expecting more of a normalized environment. So we've been very cautious as we approach those things. So in terms of wholesale underwriting changes, I don't think we've made any. I think it's really focusing on deal-by-deal at this point in time.

Just to reiterate what Chuck said, too, the hotels, restaurants, those would all be tough deal we wouldn't be looking at today.

Yes. The one thing that was interesting through this, Kevin, I know some other banks have seen different results, we have not seen really any excessive draws on any of our lines of credit. Nobody has come in, in any type of panic and try to draw our commercial lines up or our home equity lines up. Those balances have been pretty flat from the start of this announcement of the pandemic.

[Operator Instructions] Our next question is from Scott Beury from Boenning and Scattergood.

All the detail regarding your COVID-related programs, and most of my questions have already been answered, I just was curious to kind of see if you had any guidance regarding the tax rate? I know that it dipped down a little bit this quarter below kind of your prior guidance, but I just wanted to see what the impact would be there regarding the CARES Act and what you expect going forward?

Sure, Scott. This is Rich. And really, I don't know that the CARES Act had a whole lot of bearing on our effective rate. It was a whole lot more to do with the elevated provision and then the percentage of kind of tax preference revenue that we generate regularly. So I think going forward, we've been kind of running at about a 16% effective tax rate. Todd and Mike and I have been talking about it. And given what we think we're going to do for the rest of the year, probably 16% is the high end of what we would guide you to, but probably a 14% or 15% effective rate is probably not a bad rate. And I'd have lost money if you'd asked me that a quarter ago.

This concludes our question-and-answer session. I would now like to turn the conference back to Dennis Shaffer for closing remarks.

Thank you. Well, in closing, I just want to thank everyone for listening in, thank those who participated on the call. Again, we are very pleased with our first quarter results. The balance of 2020 will likely be a challenge. We know that. We do look forward to meeting those challenges and to talking to you again in a few months to share our second quarter results. So thank you for your time today.

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