Southern Missouri Bancorp, Inc. (SMBC) Q2 2017 Earnings Report, Transcript and Summary

Good afternoon. Welcome to the Southern Missouri Bancorp Quarterly Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Matt Funke, Chief Financial Officer. Please go ahead.

Thank you, Anita. Good afternoon, everyone. This is Matt Funke, CFO at Southern Missouri Bancorp. The purpose of this call is to review the information and data presented in our quarterly earnings release dated Monday, January 23, 2017, and to take your questions. We may make certain forward-looking statements during today's call, and we refer you to our cautionary statement regarding forward-looking statements contained in the press release. To start out, we want to review the preliminary results highlighted in the quarterly earnings release. The December quarter is the second quarter of our 2017 fiscal year. We earned $0.56, diluted, in the December quarter. That's unchanged from the same quarter a year ago, and it is up $0.06 from the $0.50, diluted, that we earned in the September quarter. The year-ago period included a significant amount of non-recurring benefits, which we'll touch on when we get to non-interest income below. Asset growth slowed during the December quarter following a strong September quarter, with just $22.5 million in asset growth after averaging growth of more than $60 million during the September and June quarters, so that highlights the seasonality in our balance sheet. Gross loans were up $6.6 million for the quarter, but they're up $132 million compared to December 31, 2015. That's an increase of just over 12%. The investment portfolio was also up almost $8 million for the quarter, but it's grown very little over the last 12 months. Deposits were up more than $44 million in the December quarter, with a strong contribution from seasonal public unit deposits. This followed the September quarter, when a $38 million increase in brokered funding accounted for a majority of nearly $47 million in deposit growth. Compared to December of last year, December of 2015, total deposits are up almost $95 million, with that growth including an increase of just over $31 million in time deposits. And again, with the non-reciprocal brokered CDs in the September quarter adding $38 million, that means that we saw a decrease in non-brokered CDs of almost $7 million. Also, we grew our non-maturity deposits by more than $63 million over that same 12-month period. Included in that is $6 million in public unit funding and $10 million in non-reciprocal brokered funding. Moving to the income statement, we are careful to update you quarterly on our fair value discount accretion on loans and fair value premium amortization on time deposits that resulted from the Peoples Bank acquisition, which is now at almost the 2.5 year mark. In the current quarter, that item dropped $267,000 following higher accretion in the June and September quarters of this calendar year. Those higher numbers resulted from resolution of particular purchase credit impaired loans, where we received payoffs that exceeded the loan's carrying value. So we're dropping back down to a pace that would be more in line with expectations. In the year-ago quarter, December of 2015, we recognized accretion of $557,000, and in the linked quarter, the September 2016 quarter, discount accretion provided a benefit to net interest income of $601,000. In the June 2016 quarter, it was $416,000, so dropping off quite a bit there. We expect that to continue as those loans prepay mature. We could see isolated instances where you would have a number pick back up for a quarter as you resolve some of those purchased credit-impaired loans. The net interest margin for the December 2016 quarter was 3.70%, of which 8 basis points was the result of that fair value discount accretion we just mentioned. In the year ago period, margin was 3.88%, of which 18 basis points resulted from fair value discount accretion. So when we strip it away and look at margin on more of a core basis, we think we were down 7 basis points, comparing the December 2016 quarter to the December 2015 quarter, with the core asset yield down 10, core cost of funds down 3. Compared to the linked quarter, when our net interest margin was 3.81% and we had 18 basis points of benefit from purchase accounting, we would consider our core margin to be unchanged. A steeper yield curve, increase in the prime lending rate, should be beneficial to our loan and investment portfolios. Generally on deposit pricing, we're not seeing too much pressure yet on non-maturity deposits, but we are seeing some pressure, as you might expect, on time deposit pricing. Moving on through the income statement, non-interest income as a percentage of average assets on an annualized basis was 73 basis points. That's down 11 basis points from the December 2015 quarter, but we noted in that press release that we had more than $600,000 in non-recurring benefits during that period. That resulted from acquisition of a trust company in which we owned stock and a bank-owned life insurance claim. Outside of those items, non-interest income would have improved by 7 basis points compared to the year-ago period. Compared to the linked September quarter, non-interest income is up 1 basis point. It was a good quarter for our loan fees, including prepayment penalties. It was a good quarter for gains on residential loans sold into the secondary market and for debit card interchange income. On the non-interest expense side, we were up compared to the same quarter a year ago, but we were down compared to the linked quarter. In the linked quarter's results, we reported in the press release that we had $335,000 in expense resulting from the prepayment of the term FHLB advance. As a percentage of average assets, non-interest expense declined 2.35%. If you exclude intangible amortization and seasonal swings in our provision for off-balance-sheet credit exposure, we calculate that our operating non-interest expense as a percent of average assets is down 6 basis points from the year ago quarter and 9 basis points from the linked quarter. Compensation was a little more favorable this quarter, partly due to just some timing differences. Occupancy was stable from the linked quarter, but it's up year over year, as we've seen in the last several quarters. We continue to see increases in point-of-sale and electronic banking costs as we grow our non-maturity deposit accounts and more depositors utilize those services. Of course, on the other side we're reporting benefit from point-of-sale interchange activity. Foreclosed property expenses were lower this quarter compared to the year ago period, but we were up compared to the linked September 2016 quarter. Back to the balance sheet, nonperforming assets at December 31 were $9 million. We were up about $0.75 million from September 30, back to approximately the same level where we ended our fiscal year at June 30. Nonperforming assets, by our definition, is foreclosed and repossessed property, nonaccrual loans, and loans 90 or more days past due. As a percent of total assets, they're back up to 60 basis points, which is about the middle of the range we've seen over the last four quarters. Charge offs were consistent with the prior fiscal year's level, down from the linked quarter. Nonperforming loans are now $5.6 million, or 45 basis points on total loans, which is up 4 basis points from September 30. The allowance as a percentage of gross loans was 1.22% at December 31. That's up 3 basis points from September 30, and it's been relatively stable over the last four quarters. We provisioned $656,000 in the December quarter. That's down from the linked quarter, as loan growth had slowed. In the linked quarter, we provisioned $925,000, and in the year ago period, we provisioned $496,000. We noted in the press release that our effective tax rate was 29.4%, which is lower than the 30.2% we saw in the same period of the prior fiscal year. It's a little less of an improvement than we saw in the linked quarter, when we formed a real estate investment trust at the beginning of the fiscal year, which benefited our effective tax rate. The year ago period, that 30.2%, was a little lower than what we were typically running at that time because it included a tax-advantaged noninterest income item related to bank owned life insurance, which we mentioned earlier. There's no comparable benefit in this period. Our effective tax rate in the December 2016 quarter was a little higher compared to the linked quarter, primarily due to our higher pretax income. That concludes my prepared remarks, and I'll turn it over to Greg Steffens, our CEO, to provide his thoughts on performance and update you on our strategic initiatives.

Thank you, Matt. So far, I'm going to start with some discussion on lending. We're pleased with our year to date loan growth of $74 million, or a little over 6.5%. Our annual target remains to grow between 8% and 10%, and we hope to be at the top end of that range for this fiscal year ending June 30. Growth for our calendar quarter was muted compared to the first quarter, as Matt indicated, at a little over $6 million, with our growth coming across a variety of lending types, including multifamily, nonresidential, commercial, and land loans, offset by some declines in our ag balances of nearly $19 million and construction balances of $10 million. When we look at the year to date with our first six months of our year with our growth of over $74 million, we're looking at growth primarily in multifamily, nonresidential, commercial, and land loans, offset by the declines in ag, nonresidential, and construction loans. If we look at the geography to where our growth has occurred this year, our growth in the southeast Missouri region has been $7 million, while our Arkansas region was $24 million, and our southwest Missouri region was $38 million, as the southwest Missouri market is continuing to lead our production. Southeast Missouri was limited primarily due to our seasonality in our ag portfolio, as the agricultural harvest has proceeded and we are receiving pay downs as farmers are taking their crops to market. Again, our harvest is completed, and our balances in our ag portfolio have declined to approximately $65 million, and compared to $59 million last year at this time. We had forecast that we were going to have pay-downs of $15 million this quarter, where our actual pay-downs were $19 million. So we were fairly close to projections. Overall, our farmers had a very good year for crop production, as our yields were good. However, pricing and marketing will have a large determining factor on how well the individual farmers did. We do not anticipate any material change in the quality of our ag portfolio, and most of the farmers that we booked this year will be renewed for the upcoming year. Our outlook for our agricultural customers this year is slightly better than what it was last year. Our 2017 underwriting is underway and, again, we do plan on renewing most of our ag credits. When we're looking at our loan pipeline, as Matt indicated earlier, it's not quite $41 million versus $55 million at September 30, and $35 million a year ago. Typically, the December quarter end is our low point in our pipeline, and we usually tend to see the pipeline pick up during the March quarter. In part for our loan growth this last quarter, it was again limited, due primarily to ag pay-downs. But when we're looking at current pricing, we're seeing pricing to be a little more competitive at this point than where we were at the September quarter, primarily due to some of the smaller banks in our various regions have not changed their pricing as much when you compare the yield curve today to where the yield curve was last quarter. So we feel like that has had some negative impact on our pipeline. But we are satisfied, again, with our year-to-date growth and feel like our overall loan production growth is going to be at the top end of our range. Our pipeline that we have pending at this time is more concentrated in commercial real estate, but we do feel like there is a good geographic and product type diversity. When we actually look at our loan production over the last quarter, we were down $10 million in loan production from the September quarter to the December quarter, but we were up $17 million from the December quarter of last year. When we look at our secondary market income, it does continue to improve and continues to be above budget. And it did total $513,000 this quarter, or for the first six months of this year, versus $287,000 last year to date. We do anticipate some negativity on income in this level due to the impact of the recent rise in rates, so income's likely to slow from the pace of growth that we did have. We have originated approximately $26 million in secondary market loans this year compared to $16 million last year. Our loan-to-deposit ratio remains high and has averaged 103% this quarter compared to 99% last quarter. So that is something we are closely monitoring, and we are making conscious efforts to paying attention to what we need to do in that arena, and it does have some impact on the type of M&A transactions that we are looking at. When again, we're looking at deposits overall, we've grown $94 million in the first six months of this year, which is 8.2% growth. And again, that growth includes $38 million of CDs that were brokered. We are pleased with our deposit growth. The December quarter's usually one of our strongest quarters for deposit growth, and we again experienced that this year. Our non maturity deposits have grown $55 million, or almost 8% for this year compared to $61 million last year. Public unit deposits represented $17 million of this growth compared to $22 million last year, while non public, non maturity deposit growth was $38 million this year compared to $39 million last year. We continue to focus primarily on our non maturity deposits, and that will continue to be an ongoing focus. When we look at where our growth has come from in non maturity deposits, we are continuing to see the largest amount of our growth in southeast Missouri, followed by southwest Missouri, and then Arkansas. We are also pleased with the amount of new accounts that we're doing in our account retention, as our net new account growth is up 75% year over year for net growth. And this is primarily due to a 13% increase in our new account production over the prior year, while our amount in closed accounts was staying flat. And we're seeing higher openings in each market. As we turn the page and look to M&A, we've recently announced the Capaha transaction, and we are anticipating to close that late in the second quarter. That acquisition will help modestly with some of our deposits, and it has been a great geographic expansion for us, and we feel like the pricing is really good, and we're pleased with the EPS accretion and the tangible book value earn back periods. We do continue to look at other acquisition opportunities, and our calls have continued to be at a steady pace, and we are continuing to look for the right deal. Ideally, we would find another transaction that would be a little more deposit heavy partner, as we would like to address the higher loan to deposit ratios that we do have. We do feel like the recent uptick in bank stock prices has maybe generated a little bit more in potential calling activity, and we're anticipating having several opportunities come up this quarter. When we look at our capital ratios, we are comfortable with our current level of capital, and capital ratios have remained stable over the last quarter. We're comfortable with the pro forma ratios from our merger, and we continue to target having tangible common equity of 7.5% to 8.5%. And that concludes my prepared remarks. Matt?

Anita, if you would, remind folks how they can queue for questions, and let us know if we have any out there.

[Operator Instructions] Our first call is from Andrew Liesch from Sandler O'Neill. Please go ahead.

Just a follow up question on the fee income side. It sounds like there were a lot of different line items that were up this quarter that drove the strength there. Is this $2.7 million a good run rate? It sounds like maybe mortgage banking, or gain on sale, will decline a little bit. But this $2.7 million seems a little high to use as a run rate, but I'm curious what your thoughts are.

Well, as Greg mentioned, we're expecting that might struggle a little bit, going forward, with rates having moved up like they are. Also, our March quarter, we always seem to do a little worse on NSF income, some other general, just slower activity.

Got you. And then Greg mentioned M&A ideal targets have, could help you on the loan-to-deposit ratio. Are there any markets in Missouri or Arkansas that you find particularly appealing that you'd like to expand to?

We really don't want to limit ourselves to one particular spot or another. We really want to take an opportunistic viewpoint and look at what opportunities come up and whether it hits our pricing targets and our earn-back periods and let that drive part of where we want to go. The Cape Girardeau market was a market that we had been interested in for a number of years, and it finally bore fruit this year.

Got you. And then, [indiscernible] mentioned our earn-back targets and things like that for deals? Can you just refresh us what your acquisition criteria are?

We generally want from a tangible book value. We just have not wanted to extend beyond three years. What was your other question?

Oh, like just metrics along those lines, like IRR metrics, things you look for in a deal, and as well as pricing.

Everything's going to vary a little bit based on how good of a strategic opportunity it is. With this Capaha deal being almost 8% accretive in our second fiscal year, we think that's a great return based on the number of shares we're issuing in the deal. Tangible book value earn-back, we're very comfortable with. Greg, anything else you want to…?

Andrew, each transaction brings different things to the table. If somebody is bringing a lot more deposits to the table, you're going to be looking in one arena. If they're bring more earnings, each transaction's different based upon pricing. And to just say, hey, it has to have this numerical return, I think you have to weigh everything in with their balance sheet, and then also the growth opportunities in what you're acquiring, as well as the cost-saving opportunities.

Got you. Very helpful. Thanks much.

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

All right. Thank you again, Anita, and thank you, everyone, for your interest. We'll look forward to visiting with you again in April.

Thank you all, and have a good day.

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