Good day and welcome to the SB Financial Second Quarter 2018 Financial Results Conference Call. All participants will be in listen-only mode. [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 Melissa Martin. 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 Group undertakes no obligation to update any forward-looking statement 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, Melissa and good morning everyone. Nice to have you all with us. Welcome to our second quarter 2018 webcast. Our comments this morning are supplemented by the earnings release that we filed yesterday. Briefly, highlights for the quarter include net income $3.1 million, a 34% improvement over the prior year quarter, representing a return average assets of 1.35% or 23.9% increase. Diluted EPS for the quarter $0.40 per share, representing an 8% improvement over the prior-year quarter. Trailing 12 months EPS now stands at a $1.82, a 26% improvement over the prior year of a $1.44. Operating revenue expanded over $1.2 million or 11%. Loan balances expanded over $46 million or 6.4% from a linked quarter and nearly $102 million or 15.6% from the year ago quarter. Deposits likewise grew just slightly from the linked quarter, but nearly $46 million or 6.5% from the year ago quarter. Expenses and support were down from the linked quarter but up 9.9% from the prior year. Mortgage origination volume was up $51 million or 87% from the linked quarter to $109.5 million and up nearly $12 million or 12% from the year ago quarter. Asset quality, a common theme with our company continues to be one of our competitive strengths. SBA loan volume finally slowed a bit from our strong first quarter, but we still originated nearly $1 million in our activity reflect strength in each of our higher growth markets. We continue on our steady course to deliver our five key strategic initiatives we've discussed them every quarter. It's all about the revenue diversity, organic growth to deliver scale and efficiency, a broader product set in not only new households, but existing ones as well, world-class operational excellence and of course the top tier asset quality that we've mentioned quarter…

Thanks Mark, and good morning, everyone. As Mark has previously highlighted, we had net income of $3.1 million or $0.40 per diluted EPS for the quarter. That EPS of $0.40 was up $0.03 or 8% from the prior year and up $0.05 or 14% from the linked quarter. Of course, any comparative is impacted by the addition of the 1.67 million new common shares from February as well as a reduction in our federal tax rate, coming down from 32.1% in 2017 to 18.4% currently. So some highlights for the quarter, operating revenue up 10.9% from the prior year and up 6.1% from the linked quarter. Loan growth was up $101.7 million from June 2017 or 15.6%. Loan sales delivered gains of $2.2 million for mortgage, small business and agriculture. Our mortgage volume of $109.5 million was 11.9% higher than in the second quarter of 2017 and lastly as Mark indicated, we continue to reduce our nonperforming ratio, which is now down to 34 basis point. As we break down further the second quarter income statement beginning with our margin and despite the headwinds of a flattening yield curve, net interest income was up from the prior year by 21% and up 9.4% from the linked quarter. End of period loan balances from the prior year were up $102 million, an increase of 15.6%. Our average loan yield for the quarter of 4.97% increased by 46 basis points from the prior year. Overall, our earning asset yield was up 54 basis points in the prior year. In addition to the balance sheet impact, the three rate increases have driven yields certainly higher. With 70% of our loans of a variable nature, we will continue to see higher loan yields on average, but not necessarily at the same pace that we…

Thank you Tony, it was a great quarter for our company. A strong one for our company on many fronts, double-digit profit improvement driven by top line revenue expansion of nearly 11% representing as Tony had mentioned, then I'd certainly mentioned the $100 million and organic balance sheet growth year-over-year, year-over quarter and more normalized level of residential real estate production at the $109 million and of course the market-leading asset quality. Clearly together the results reflect our deliver commitment to grow and diversify our revenue as we add scale to improve our efficiency. As we move into the second half of the year, we remain optimistic that the earnings momentum we have seen in the first half will continue. That said it will surely not come without added pressure as Tony indicated on the liability side of the balance sheet, that will most certainly effect overall cost of funding. With our nearly 100% loan-to-deposit ratio, we will be selective on the lending opportunities to optimize revenue and margin. Finally, we remain steadfast. Our focus to continue to deliver our stakeholders, a high-performing company with strong regional leadership, insightful business line leaders, serving geographically diverse markets and an economy that remains fairly resilient, albeit one that is entering one of the longest expansions of all time. And I'll turn the call back to Melissa for any questions from our investment community. Melissa.

Thank you, Mark. Operator, we are now ready for our first question.

We will now begin the question-and-answer session. [Operator Instructions]

While we are waiting for questions to assemble, I would like to remind you that today’s call will be accessible on our website at www.yoursbfinancial.com under Investor Relations.

The first question comes from -- we have Brian Martin with FIG Partners. Please go ahead.

Hey, good morning guys.

Good morning.

Maybe I just wanted to start with if maybe as Tony or Mark, I guess maybe Tony on the margin, if maybe you could just reconcile Tony, just kind of a gap up in margins from first quarter to second quarter. I guess, certainly you kind of outlined some of it. It seems like mortgage fees were part of it, but just trying to understand that and then just in the context of your commentary about funding costs and how you are expecting them to continue to rise, just how to think about margin prospectively given Mark's comments about trying to maximize profitability, but just reconciling the margin and just kind of your outlook on how you're thinking about it prospectively.

Sure, happy to. This is Tony. Thanks Brian for the question. I would say it certainly was a bit of a unique quarter that we had an oversized level of loan growth, $46 million, kind of 2 to 2.5 times a normal sized quarterly level of loan growth. And I would also say the fact that we've not yet realized all of the funding increases that I think will be evident when we get to the next quarters margin levels, I think these two factors certainly allow their balance sheet to move to the 100% loan to deposit level, which we've traditionally been kind of mid to low 90s. I think that oversized a bit the impact on margin and certainly we can't discount going up $51 million in mortgage loan originations from Q1 to Q2. Had a significant impact on certainly loan fees, that has a somewhat impact on our margin level. So, I would say those are the three factors that got us to the higher level above four margin for Q2 and I think we would come back to maybe a more normalized that 385 type level as we look forward, because funding cost certainly in the latter half of the quarter, we begin to see those evident throughout our markets.

Brian, this is Mark. Just one comment, your marginal cost funding as we have seen is well into the 1 to 1.5 and so we've certainly been cognizant of that as we price loan demand. So, we're going to be very prudent on the loan funding side to keep that net interest income expanding, albeit with a larger bottom line, maybe a bit of leakage on the ROA, but clearly improvement in net income as well as ROE, but it's clearly moving up and we're on the forefront with a 100% loan to deposit. So we're right in line of sight.

Right. Okay and just kind of a strategy and funding going forward. I guess are there as far as how you found this given the loan-to-deposit ratio and the critical nature to kind of match the loan growth with deposit, what specifically I guess maybe you mentioned a couple of things in the call, but I guess what are you doing on the deposit side to accommodate that loan growth?

Right, great question and clearly our conversations on funding loans is certainly more robust when it comes to the deposit side requiring those deposit accounts with loan funding is certainly the beginning. We also have restructured as I mentioned our entire retail network, which would place another eight individuals that would have been generally managing or overseeing those retail offices, that now have been relegated to the next layer of management in those retail offices, which has allowed us to put those eight individuals literally every day on the street, talking with existing commercial clients, existing small business clients, as well as prospective ones. So we've clearly changed the game. We've clearly put the shoe on the other foot relative to the balance sheet and we think we might be able to move the needle and continue to expand the balance sheet and improve efficiency and the scale. So that's how are doing it, albeit again with some key products that right now we're reaching out to our private client base and advising them of our new products that are currently at about the 185 level and bringing a larger portion of their deposit into that relationship with us. So we're using it not only to expand current relationships, but also establish some new ones.

Got you. Okay. That's helpful. And maybe just if one of you could just talk a little bit about the loan growth and I think you gave a little bit of color and maybe I missed it where geographically it came from, but you know I guess and then just have based on what you saw this quarter, but cognizant of the profitability you're going to maximize or at least book to in the next couple of quarters, how we think about loan growth, the balance just kind of longer term, however you guys, how you can frame it a little bit just what the pipeline looks like.

Okay. Thanks Brian. Again structurally we're built for growth as I've mentioned a number of times with our -- Jon can make some comments here, but with our brand 17, high-level individuals in very diverse geographic markets. We expect that growth and we're going to have to look at alternative funding, should the deposit machine slowdown. But, Jon I know you feel literally 90% of all those requests, the rest are loan committee, and I think we're feeling pretty good about now, where and we've come from and what we've done but where we're going.

I do. We began the year with a bit of a pivot and changed some of our weightings and incentives and different things, more to C&I growth model, not that we're still not growing CRE as Tony went through in the call, but we've seen some very nice C&I projects come on board here in '18 and in the pipeline here for the remainder of the year. The pipeline remains strong. We have a number of projects that are drawing up here in the second and third quarter. So again it's all about pivoting and looking at that loan growth a little more strategically. We have the benefit as Mark said of being structured for growth, you know little bit more strategic about where we deploy our capital and our funding to get those deposits and those C&I credits that are going to tend to come more concentrated in the deposit world.

You know what Brian, one follow-up comment is that, as you well know three years ago we developed a specific focused SBA strategy and the $40 million or so, that we've done in SBA and sold off 75%, much like Freddie Mac loans has certainly given us ability to garner our additional relationships and marginally some higher-yielding variable rate balances on our balance sheet. So, that's been a great addition to our product set and delivery channels throughout all of our market and we intend to remain significantly relevant in that space.

I got you. And the loan growth at least on the residential side, which kind of lead the quarter, my guess is that it's probably some of the variable rate loans, and the mortgage side were kept retained as opposed to being sold I guess. Is that a trend I guess you guys would expect to continue? If you kind of cap out that, it's talking about how strategically what you want to grow. Means does that change going forward or just how to think about that, that component of the loan book relative to the others, which clearly are focused on.

Thanks Brian, well clearly, we like the net interest margin that comes with putting those loans on the book, albeit them variable. Tony and I talked about this earlier that the mortgage machine that we have going, given the flatness of the yield curve has driven some of those through the variable end of the curve. And we will be talking about how much we have in this, relative to booking more of those given our 100% loan-to-deposit ratio. So, our private client group is very robust on that end. Those $0.5 million to $1 million mortgage loans and some of our low share high-growth Metropolitan markets. So it's pulling is by inertia into that field and we need to continue to consciously determine how did we price that to make sure we get what we want. But we've enjoyed it so far. We like the relationship we gather as a result of that private client relationship, and so far, we've been able to fund it, but we're going to get more selectively as I mentioned. Tony, you might have additional comment.

Yeah, I would just say to add on to that, we had historically been kind of a mid-80s to high-80s percentage of sale of our mortgage origination product, given the type of product we have and the relative slope of yield curve and really this quarter and a little bit in Q1, we've seen a real dramatic shift of our clientele into the variable rate product. And the profile of that client certainly in this quarter was much more private client oriented, medical professionals, very high-profile of the client that we like and we don't mind having that on our portfolio. Our still residential real estate is still only mid-20s right now in terms of a percentage. So, we're not overly concerned, but certainly we don't want to be 100% residential real estate bank.

Right, okay. So, you're comfortable having it go a bit higher and maybe you cap that at some point, but at least somewhere it's at there now there is still room to take it higher.

Yes it certainly -- certainly on the agenda to continue to discuss Brian and we've liked it as I mentioned so far, but I think a bit of conversation internally about that would certainly pay dividends and give us some more conscious approach to that particular delivery channel.

Okay. Perfect and then maybe if you can just give a little thought on just -- on the mortgage business and just kind of if anything is changed with your outlook. I get certainly if we think about that, how we think about what the production is versus kind of what we are -- what you guys are selling into the secondary market, that's kind of shifted to that, that lower range. How we think about that going forward and then just any comments or if does it look like the gain and sale margin was down a touch the quarter from first to second quarter, just are we thinking differently about that as you go forward.

Brian, just one comment. Yeah, as I've mentioned for 10 years, mortgage banking is something that we really like. We obviously have to get it right in the midst of regulatory reform. So we know that, that can give the best of banks angst at times. And certainly something that we continue to have to deal with on an ongoing basis, but we love the opportunity to not only gather some non-interest income, but clearly that 7,300 households that have like 1.5 to 1.6 service per household. We have a great opportunity to continue to expand our reach in all of our markets via that household with one, two, three, four services. So from my perspective, where I sit, it's a great business line that we're going to lever through the retail network to gather more scale. As far as the gains, Tony has done a great job with a couple of other professionals and organizations to widen that margin and hedge and I think Tony that's evident in our take on each mortgage loan.

Yeah, I think that's right and I think Brian as we look forward in the mortgage business, I think the end of '17 and Q1 was really an anomaly, and it really was inventory-driven and some people just taking a breather on the market. Our pipeline is extremely strong as we sit here today. I would expect a similar result in Q3 that we've had in Q2, both in terms of level of origination roughly as well as the level of sales volume. We're seeing that portfolio of product be very strong and the type of clientele that we're getting, be very strong in that private client arena.

Okay, so you think the 72%, I guess the sale post origination this quarter Tony, keep it at a lower level or you think it would tend to gravitate back up toward that, you talked about historic that 80% type of range, just so I understand kind of what you -- at least how you're thinking about it?

Yeah, I'd be surprised that we get back in the 80% level certainly in the next couple of quarters based upon the pipeline I'm seeing.

Well, Tony and the yield curve is driving people to the short end, Brian as you all know, but if we're going to continue the price consciously and make sure that we get what we want and in light of the challenges we have on the other side of the balance sheet.

Yeah. Okay. So this level we are at today is kind of more realistic, give or take little fluctuation and then just kind of the gain on sale margin, Tony, I guess any -- it's kind of decreased. It's similar to what it was a year ago. It's down linked quarter, just kind of in this broad range, it's just kind of you guess you feel like that's at least going to hold in there. Is that holding there pretty good. No but…

No I would not say it will have a significant change from where we are in that kind of mid 2.5 to 2.75 type range would be that level.

Okay. Fair enough. And I guess just from an SBA standpoint and I guess like you said a little bit of a downtick this quarter, just how are you thinking, how does that pipeline look and I have heard some -- at least one other bank that we're seeing more customers do that in the traditional market as opposed to taking the guarantee on this. Are you guys seeing any change in I guess competition in that market or just how does your pipeline look or any commentary you can offer on that.

No, this is Jon. No our pipeline remains very, very strong. I think the second quarter to first quarter comparison is more a function of the outstanding first quarter we had. The second quarter was down a bit, but the pipeline there was very, very strong. We have a couple of large SBA. We have one USDA loan in there that falls into that same category. So, I'm optimistic about the third quarter and the pipeline moving forward. We have not changed our strategy. We continue, to answer your question, we don't see any pressure necessarily to change those loans to the portfolio. We've targeted -- we've targeted specific market in that SBA and it tends to be business acquisition, development, doctors, professional and that market remains as it was. We have key business development officers. In fact, we continue to deploy as Mark said earlier, new in Toledo and soon to be in Fort Wayne that we really think will drive that towards higher level here in remainder of 2018 and 2019

Brian, just one comment. all things being constant, given all the calls we make with our 17-plus individuals that are making probably 200 calls a month, where we would've again, certainly not a new approach, but where we might have walked away from a credit that needed some help, such an SBA guarantee. Now we have that opportunity to keep that client with us, expand that relationship and make some great fee-based income that as we've always said is going to supplement the mortgage business line as rates increase marginally. So, we feel we've got both ends of the curve covered and we really like our prospects in that SBA space, particularly with our deployed BDO's who do nothing, but SBA lending. We think we have the model right? We think we've got the markets and we certainly are supportive of a three-plus GDP that is expanding our opportunities.

Right and did you guys -- did I miss it or did you guys say that you also added someone or you're looking at someone this quarter. I guess -- did I miss that?

We added somebody in Toledo in the second quarter and we're tentatively adding somebody that's accepted, but hasn't yet joined us here in the third quarter in Fort Wayne.

Fort Wayne, okay. All right. That's good. All right and then just one question back to the margin. This is a variable rate component of the loan portfolio and what, what amount of the loan book is re-pricing today with rate increases. You are pretty close to thereafter with the rate increases.

Well, yeah I'd say a couple of things there. We're about 70/30 variable to fix in terms of the entire portfolio. Now again that doesn't necessarily mean that's going to re-price every time. We're about a quarter of a million to 300,000 on every Fed rate rise on 25 basis points roughly right now. That gets wider as you get further away because we certainly do have floors that that people get away from. So, I would say we're probably 40% of our portfolio is probably an immediate reaction to any kind of rate rise, whether that be LIBOR based or prime based.

Yeah. Okay. That's what I heard. I thought you said 75%, but I know not all that moves right away, so okay. Maybe just last one or two for me was, just on the expenses, it looked like things were pretty clean this quarter. Anything unusual in the expense line, outside of the volatility that goes with the mortgage unit, a pretty clean quarter on the expense side. Would you guys characterize and just how you're thinking about that the outlook there. Are you still making investments in the franchise to kind of keep that rate -- that expense run rate kind of tending to trickle up a bit.

Well, again from our new found as we reported the first quarter of the year with our newfound tax initiatives -- incentives, we have borne some additional expenses from some of our staff as everyone would certainly contain the market. The employment market has continued to tighten. That has begged some additional increases and some incentive components that we've continued to realize. Be that as it may, our expenses are clearly up, but we keep a keen eye on that operating leverage that was still positive this last quarter and we clearly have a lot of room to run. As I mentioned in our last quarter Brain, when you look at our 30 million to 35 million average portfolio of our commercial person with a number of people we have on staff, we're clearly poised for continued rise and improvement in our efficiency as those portfolios expand. And again we sell off those SBA, but those are real time gains that we would like when we build the balance sheet. We've got certainly a lot more room to run on that net interest income. So they're up, but all those trades that we have made in the last five-plus years have been good trades and we contend that through those fee-based business lines, they're continuing to provide us initial profitability and initial inertia that's going to take us to a higher level.

Yeah. Okay. That's helpful and maybe just any update if there is any on just you talked about the capital and the benefit as far as M&A goes and just how you're thinking about that as you go forward, I guess it seems like there is opportunities in your market, you got the capital now, better currency. And I guess just kind of wondering how things are trending there? Are there other discussions or it just seems like they've, just I guess some color on that.

Well as we've certainly seen -- certainly strengthening in our currency, which is giving us opportunities to have those discussions. That said, we need to close our 2018 compliance examination. We have some issues that we're currently discussing with our regulators that we certainly expect a timely resolution to. But that said, we don't have anything on the platter that is eminent, but we have had those conversations and we continue to rank opportunities that would fit not only geographically for us, but fit nicely from a balance sheet perspective that would certainly help our 100% loan to deposit. So those deposit-rich entities that have their own challenges, because obviously they're deposit rich because they haven't grown the other side of the balance sheet, would fit nicely with our company. So, we continue to have those conversations -- we continue to use our capital judiciously. Organic growth we think is very wise for all of our stakeholders, but certainly we keep a keen eye on the opportunities that are out there on the M&A side.

Yeah. Okay. And the tax rate I guess no change to kind of it looks it's been lower than kind of at least I was thinking, is that you expect that to kind of trend a bit higher from kind of a current level, I think it was around 18% this quarter, kind of blended rate for the year let's call it 18.5%, just as you think about that going forward, does it trend a bit higher from the current levels or is this level pretty sustainable.

Yeah, hi Brian. This is Tony again. Yeah, we had a couple of some stock compensation items as well as some tax-free investments that were a bit higher this quarter. I would tend to be more comfortable with the tax rate going forward the high 19s type level.

High 19s, okay. All right and I think that's it. I appreciate you taking all the questions and I'll step back if there's someone else who has one.

Thanks Brian. Nice to chat with you.

See you, Brian.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Klein for any closing remarks. Please go ahead.

Once again, thank you all for joining. We're proud of the result we delivered. We thank you for your confidence in what we're attempting to accomplish here at SB Financial and we certainly look forward to chatting with you again in October for the third quarter results of 2018. Thanks for joining and have a great day.

Thank you.

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