Southern Missouri Bancorp, Inc. (SMBC) Q3 2023 Earnings Report, Transcript and Summary

Hello, everyone, and welcome to the Southern Missouri Bancorp Quarterly Earnings Conference Call. My name is Daisy, and I'll be coordinating your call today. [Operator Instructions] I would now like to hand the call over to your host, Lora Daves, the CFO of Southern Missouri Bancorp to begin. Lora, please go ahead.

Thank you, Daisy. Good morning, everyone. This is Lora Daves, CFO for Southern Missouri Bancorp. Thank you for joining us. The purpose of this call is to review the information and data presented in our quarterly earnings release dated Monday, May 1st, 2023, 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. I'm joined on the call today by Greg Steffens, our Chairman and CEO and by Matt Funke, President and Chief Administrative Officer. Matt will lead off our conversation today with some highlights from our most recent quarter and fiscal year. Matt?

Thank you, Lora, and good morning, everyone. This is Matt Funke. Thanks for joining us. We'd like to touch first on our completed merger with Citizens Bancshares and Citizens Bank & Trust. We completed the legal merger in late January and the operational merger five weeks later at the end of February. We're pleased to be participating in the life of these new communities and we look forward to serving their financial needs. Of course, the merger had a lot of impact on this quarter's income statement and on our balance sheet. Our onetime costs look to be tracking in line with our modeling. Loan portfolio marks were in line with expectations as was the day one provision for credit losses under CECL. These nonrecurring charges accounted for $10.3 million pretax and are estimated to have reduced diluted EPS by $0.73, inclusive of those charges, our EPS declined to $0.22 for the March quarter, that figure compares to $1.26 from the linked December quarter and to $1.03 from the March 2022 quarter, which also included merger-related charges, although they were significantly smaller. Net interest margin for the quarter was $3.48, that was unchanged from the year ago period and up from $3.45 for the second quarter of fiscal 2023, the linked quarter. Net interest income from loan discount accretion and deposit amortization relating to the company's acquisitions resulted in a 14 basis point increase to the net interest margin compared to six basis points contributed in the second quarter of fiscal '23, the linked quarter and six basis points in the one year ago period also. Net interest income resulting from accelerated accretion of deferred origination fees on PPP loans had no impact to the net interest margin this quarter compared to less than one basis point in the linked quarter and as compared to two basis points in the third quarter one year ago. Our average interest earning cash and cash equivalent balances increased compared to the linked quarter as a result of the Citizens merger and they declined from the year ago period as loan growth outpaced deposit growth over the intervening quarters prior to the merger. Our net interest income for the quarter was $33.8 million, an increase of $8.7 million or 34.5% as compared to the same period of the prior fiscal year. With no change in our reported margin, the increase was attributable simply to the increase in the average balance of interest earning assets. On the balance sheet, our gross loan balances increased $485 million during the third quarter with Citizens contributing $447 million of that net of fair value adjustments. Compared to March of 2022, gross loans were up $867 million. The investment portfolio was up $198 million over the quarter, primarily attributable to the Citizens merger, while cash and equivalents increased $60 million. Deposit balances increased by almost $750 million in the third quarter with Citizens contributing $851 million and deposits are up $900 million compared to March 31st of the prior year. FHLB borrowings decreased $16.5 million compared to the linked quarter end, as the company utilized cash acquired in the Citizens merger. There were no overnight borrowings or short-term repo balances at March 31st. I'll hand it over now to Greg for some additional discussion.

Thanks, Matt, and good morning, everyone. I'd like to say again how pleased we are to have completed our merger with Citizens and how key we believe our continued service to the communities in that footprint will be for our continued success. The merger brings with us a very talented team of bankers and I personally enjoyed getting to know many of them over the last several months and look forward to what we'll be able to accomplish together. Of course, in our industry, liquidity and quality of deposits have been forefront in the mind of many people over the last several months and we are glad to have merged with the strong deposit franchise and bolstered our balance sheet with modest dilution in tangible book value. We did see increases in adversely classified loans and nonperformers this quarter, but continue to feel really good about our overall credit profile and borrower performance. Even though the upticks are mostly attributable to the Citizens portfolio, we do feel really good about the acquired credit quality from Citizens as well. Adversely classified loans were $47 million or 1.35% of total loans at March 31st compared to $38 million at December 31st. Citizens accounted for most of the increase. Watch and special mention credits totaled a combined $44 million at March 31st, up from $29 million at December 31st, and these balances would have been down a little bit outside of the Citizens merger. Nonperforming loans were $7.4 million or 0.21% of gross loans at 3/31, up almost $3 million and five basis points from 12/31. A little more than half of the increase was attributable to Citizens. Foreclosed property was also up $3.4 million, but the majority of that attributable to Citizens. Loans past due 30 days or more were lower over the quarter at 21 basis points on average loans, as strong performance in our legacy group offset a modestly higher past due ratio for the acquired book. This was an increase of nine basis points from 12/31, the linked quarter and an increase of four basis points compared to the very low levels from one year ago. We have seen a handful of SBA loans from a prior merger with modest unguaranteed balances that have experienced credit stress and we reserved a modest amount of additional ACL on those loans. We noted in recent calls that we hold a couple of hotel loans that we've been monitoring very closely since the pandemic and with the expiration of the payment modifications we'd allowed for a period of time. These continued to improve over the last quarter paying as agreed, but not quite at the pace that we had been projecting and we did set aside a modest amount of additional ACL as a result. Agricultural loan balances have relatively little impact from the Citizens merger, although we do look to expand that activity in the rural areas of the markets there. From December 31st, ag production and other loans to farmers increased $2 million during the quarter and are up almost $24 million compared to this time last year with Citizens contributing a little bit more than $10 million to both. Ag real estate balances were up $7 million over the quarter and up $28 million compared to March of last year, with Citizens accounting for the quarterly growth. Our agricultural customers are off to a good start in 2023 with good capital positions and more planning progress than where we were at this time last year. However, they do anticipate continued cost pressures in operations this year. Our renewals included conservative underwriting for those expenses compared to projected commodity prices and stress scenarios. We do anticipate some additional borrowing needs in 2023 to carry these increased costs and have worked proactively with borrowers to address that through the renewal process. With the exception of cotton, our other crops financed include corn, soybeans and rice and are generally seeing prices move modestly higher from where we conducted our underwriting. Good pricing available on soybeans has led some borrowers to lock that in pricing and even considered diverting some cotton and rice acreage to soybeans, reversing prior expectations. Last year, crops carried to harvest consisted of 30% corn, 25% soybeans, 20% rice, 20% cotton and 5% other crops, including popcorn, peanuts and sorghum. Lora, would you provide some additional details on our financial performance, please?

Thank you, Greg. Going into a little more detail on some of the items. Thinking through our net interest margin year-over-year we report no change in margin as we're steady at 3.48%, but we do have some additional benefit this quarter from holding the Citizens book for a couple of months and recognizing discount accretion. In total, from all recent acquisitions that benefits margin by 14 basis points. A year ago, discount accretion plus SBA origination fee accretion benefited us nine basis points. On a core basis, we had assessed that margin is down about five basis points. Compared to the December quarter, when we had six basis points of benefit from discount accretion, included in the reported margin of 3.45%, that would indicate we're also down about five basis points. But the drop from a 92-day quarter to a 90-day quarter accounts for all of that. And we actually have been up a couple of basis points sequentially if we adjusted for that. Compared to the December quarter, we view our core asset yield as increasing 22 basis points resulting from higher securities and loan yields, including the securities book that we brought over at current market yields from the Citizen acquisition, while our cost of funds was up 20 basis points. Net interest income was up $1.4 million or 28.1% as compared to the year ago period, attributable to our inclusion of Citizens results since January 20th. Compared to the linked quarter, we're up $828,000 or 15.2%. We did note in prior calls that the linked December quarter had a little more than $300,000 in gain on sale of fixed assets while the year ago March quarter had little more than $150,000 in nonrecurring wealth management income, so the comps would look a little better adjusted for those items. Noninterest expense was up $10.2 million compared to the year ago quarter, including $3.3 million we identified as nonrecurring merger charges this year compared to $1.1 million in similar charges in the year ago period. Compared to the linked December quarter, noninterest expense is up $9.4 million and that quarter included a little more than $600,000 in nonrecurring merger expenses. Outside the nonrecurring items, primary drivers of the core increase is compensation, occupancy, data processing, legal and professional and intangible amortization. Our net charge-offs moved back down during the quarter, dropping to one basis point on average loans and are holding the trailing 12-month figure to two basis points. Our provision for credit losses or PCL totaled $10.1 million for the quarter as compared to $1.6 million in the same quarter a year ago and $1.1 million in the linked December quarter. Of that, $7 million was attributable to the Citizens merger as we booked an allowance for the loans not designated as purchase credit deteriorated or PCD loans and for credit commitments. The remaining PCL attributable to our legacy operations was split between about $1.9 million attributable to outstanding loans and $1.1 million attributable to credit commitments. Greg mentioned the additional allowance or ACL that we consider attributable to a couple of specific pools that we had considered to have higher than normal risk, and those were less than $1 million in total. We also recorded a modest increase in qualitative adjustments based on industry trends. With that, our ACL at March 31st was $45.7 million or 1.31% of gross loans and 618% of nonperforming loans and compare that to $37.5 million or 1.25% of gross loans and 783% of nonperforming at December 31st. Our tangible common equity ratio increased 42 basis points during the quarter due to the intangible created with the merger. Our accumulated other comprehensive loss on the AFS portfolio declined from $18.8 million at December 31st to $18.1 million at March 31st. Our tangible book value per share declined from $32.91 at December 31st to $31.46 at March 31st, also reflecting the intangible from the merger. Matt, would you like to have other comments?

Thanks, Lora. Our legacy loan growth of about $38 million during the quarter was led by our West region centered in Springfield, Missouri and our South region was a very close second. Our East region, which includes much of our ag activity saw further declines in loan balances this quarter, but should begin to see some seasonal rebound in the June quarter. Our outlook for organic loan growth remains relatively moderated at this time outside of the seasonal book, although we do report an uptick in the pipeline for loans to fund in 90 days at $164 million at March 31st up from $122 million a quarter earlier and down from $182 million reported at this time last year. Our nonowner CRE concentration at the bank level was approximately 334% of regulatory capital at March 31st down six percentage points compared to December 31st and up from 310% one year ago. Our volume of loan originations was approximately $212 million in the March quarter down from $281 million in the December quarter. In the March quarter a year ago, we originated $268 million. The leading categories this quarter were commercial construction, single-family residential, primarily nonowner-occupied, multifamily residential real estate and commercial, but construction was the only one in that group to expand much quarter-over-quarter. Last quarter, we had utilized brokered CDs to lay off an overnight borrowing position that resulted from strong loan growth in the June and September quarters. This quarter, we saw small broker deposit outflows, of course, offset with the Citizens growth. Public funding -- public unit funding exclusive of Citizens declined, primarily due to rate shopping on some excess balances accumulated in operating accounts. Overall, we saw a decline of a little more than 2% from the December 31st balances, inclusive of Citizens deposits at that time. Three months ago, we were hopeful that as the Fed was anticipated to slow its pace of increases, we might see a slowing in the pace of increases to bank cost of funds, but we now expect competition for deposits to remain stronger in the near term and to continue to pressure bank's cost of funds even if the Fed would pause in the next quarter. Greg, any closing thoughts?

Yes. Thanks, Matt. In addition to the immediate benefits of additional liquidity and an asset-sensitive balance sheet from combining Citizens balance sheet and ours, we're really looking forward to the long-term opportunities in these markets, both in Metro Kansas City and St. Joe as well as the more rural markets as well for both deposits and loans. We're going to concentrate on the integration and meeting customer expectations in the merger process, and we're really looking forward to the opportunity to grow a good franchise. With that being said, we expect to have plenty on our plate for the time being, and we do not expect to be looking for new M&A opportunities in the near term. From a cost savings basis, we expect most of our cost savings to be achieved by the end of the June quarter, and we're well on our way to our internal projections for cost savings. Lora?

Thank you, Greg. At this time, Daisy, we're ready to take questions from our participants. So if you would please remind folks how they may queue for questions at this time.

Thank you. [Operator Instructions] Our first question today comes from Kelly Motta from KBW. Kelly, please go ahead. Your line is open.

Hi. Thanks for much for the question. Good morning, everyone. I think maybe starting off with the commentary on cost saves. And I appreciate the commentary that you're well on your way for achieving your internal projections for the Citizens deal. Can you remind us on the cost save front, what has been done so far as well as kind of what's left to be realized in terms of the dollar amount of cost save to be recognized and where those are being driven by?

In terms of dollars, that's hard for me to respond to it immediately, we had estimated 65%, I'm sorry, 35%. They were running, I think, about $6.5 million per quarter on their income statement. We're probably 75% of the way through picking those up at this point, but that would be in April.

Got it. Understood. And then this deal came at a time when liquidity was ever more valuable. So it seems very well timed. Just wanted to get a sense of -- I know cash balances are higher than they were pre-quarter, if this is a good level or if these are going to continue to be worked down from here as well as a sense of the liquidity, got your borrowings down. But on the flip side of the balance sheet, your -- how you anticipate funding growth from here? Is it through deposits or potentially using additional borrowings?

So from a seasonal aspect, we would expect the June quarter to be a little less positive for deposits, a little more positive on the loan side. That continues through September typically for us. So over that period of time, we would expect probably cash to move down, we would love to rely as fully as we could on core deposits. We do anticipate that growth to be tough over the next, over the near term, let's say. And would not be surprised if we do have some wholesale reliance in the next year.

Great. And then also kind of sticking with the point of margin, what are -- what is new loan production coming on at and where you see -- still seeing good risk-adjusted returns in this market?

We're seeing a lot of our loan production coming in, in and around the 7% number depending on term and repricing characteristics on up towards the 8% mark. But overall, I would anticipate a little north of 7%. And again, this is a normally a good growth quarter for us as our seasonality of our agricultural portfolio is drawn, that type of thing. So we definitely would plan on sub loan growth this quarter.

Great. And a final question for me. Everybody has been hyper focused on office loans. Can you remind us what your exposure is to office CRE? Any characteristics of that portfolio as well as any other kind of higher focused portfolios, say, I know you've had some hotel loans you've been watching?

We have a very limited exposure to office space. We have less than $20 million in loans secured by office properties of the loans that we have in office. They're predominantly smaller in size, and not big office space, and that's just not an area that we have had much exposure to. Most of the office exposure we have was picked up by the Citizens merger. Prior to that, we had less than $10 million. The portfolios that we're paying closest attention to, you mentioned the hospitality. We have roughly $80 million of hospitality loans, of which they're performing as agreed, and we've seen upticks in their performance. We have the two classified relationships I mentioned earlier that we provided a little more for in the ACL, but they're paying as agreed and their occupancy trends are moving positively. Other portfolios that we're monitoring our strip centers, our single-tenant buildings that we have not secured via discounters. We're really not seeing really any negative performance trends in any of those portfolios. A lot of our strip centers, a lot of that are in more rural communities. And we're not relying on very many large tenants in a lot of our strip centers and that portfolio has been performing very well.

Thank you. I appreciate all the color. I'll step back.

Thanks, Kelly.

Thanks, Kelly.

Thank you. [Operator Instructions] Our next question is from Andrew Liesch from Piper Sandler. Andrew, please go ahead. Your line is open.

Thanks. Good morning, everyone. Just want to circle back kind of -- here.

Good morning, Andrew.

Good morning.

Good. It sounds like expenses here are kind of trending as expected with Citizens, but was there anything outside from the legacy Southern Bank expense base that might have caused expenses to be a little bit higher this quarter.

Nothing particularly noteworthy. There's always a little bit of seasonality in our March quarter as we have compensation adjustments work through that hits our payroll taxes that hits our paid time-off accruals and things like that, a little bit additional legal expense on some miscellaneous stuff, not particularly related to the merger that we wouldn't have identified in that, that should not be recurring. But it's not to the level that we would go into a lot of detail about it.

Got it. So it seems like you take out the merger expenses, your $23.4 million, maybe some of the seasonal costs drop out here this quarter and then you get the cost saves from the deal. So this maybe just a high mark going forward is $23.4 million?

Well that total number, I hope, is a high mark. And the other side of what you're talking through there, though, we wouldn't have had their expense structure in for most of the month of January.

For the full quarter, yes, right. Got it. Okay. And then it sounds like you're getting some good yields on the loans, but the margin held in a little bit better than I was expecting. This balance sheet from Citizen is certainly helpful. Obviously, some discount accretion in there, but I mean, 3.48% in the quarter, [3.35%] (ph) of discount accretion. How do you guys think it trends from here?

We're hopeful that it can stabilize. We're keeping a close eye on the cost of funds and what we're going to have to pay for deposits to retain. We certainly timed the acquisition well with the high level of adjustable rate securities, short duration. So we're hopeful that can offset, but I don't have any specific guidance for you on anything other than continued cost of funds pressure.

Andrew, our crystal ball isn't the best on what's going to happen with competition on deposit pricing and how the new world operates with liquidity premiums.

Certainly. No, it's tough. I can recognize that and appreciate it. So but thanks for taking the questions here. I will step back.

Thank you. [Operator Instructions]

Thank you, Daisy. If no further questions then we appreciate everyone's participation and questions for today's call and thank you very much for joining us.

Thank you, everyone, for joining today's call. You may now disconnect your lines and have a lovely day.