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Q1 2023 SB Financial Group Inc Earnings Call


Anthony V. Cosentino; Executive VP & CFO; SB Financial Group, Inc.

Mark A. Klein; Chairman, President & CEO; SB Financial Group, Inc.

Nina Burns

Sarah S. Mekus; Executive Assistant & Corporate Secretary; The State Bank and Trust Company



Good morning, and welcome to the SB Financial First Quarter 2023 Conference Call and Webcast. I would like to inform you that this conference call is being recorded. (Operator Instructions) We will begin with remarks by management and then open the conference up to the investment community for questions and answers. I will now turn the conference over to Sarah Mekus with SB Financial. Please go ahead, Sarah.

Sarah S. Mekus

Thank you, and 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 Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; and Steve Walz, Chief Lending Officer.
Today's presentation may contain forward-looking information. Cautionary statements about this information as well as reconciliations of non-GAAP financial measures are included in today's earnings release material as well as our SEC filings and other investor materials. These materials are available on our website and we encourage participants to review -- refer to them for a complete discussion of risk factors and forward-looking statements. These statements speak only as of the date made and SB Financial undertakes no obligation to update them. I will now turn the call over to Mr. Klein.

Mark A. Klein

Thank you, Sarah, and good morning, everyone. Welcome to our conference call and webcast highlights for the quarter and recapping our recent earnings release, net income of $2.5 million, up $363,000 or nearly 13% for the prior year quarter, but would have been up just $296,000 or 14% when you exclude the effect of the OMSR recapture that Tony will speak up shortly.
Return on average assets, 0.73%, return on tangible common equity of 10.5%. Net interest income of $10.3 million was up $1.8 million or 22% from the prior quarter as loan growth better asset mix and increasing earning asset yields have offset the increase in deposit and other funding costs. Loan balances from the linked quarter rose $14 million, with loans raising now $126 million or 15% compared to the prior year quarter.
Deposits grew from the linked quarter by $24 million, but were down $28 million year-over-year. Expense is up slightly from the linked quarter, but down from the prior year. Mortgage origination volume is just $49 million. And asset quality metrics remaining strong with NPAs at just 35 basis points.
As with prior quarters, we discussed a number of times our path to deliver our 5 key strategic initiatives remain revenue diversity, the balance of net interest income with fee-based revenue, more scale with organic growth and potentially M&A, deeper relationships with each household, of course, operational excellence and asset quality.
For the quarter, our mortgage business line originated $49 million in volume, just slightly below the level from the linked quarter. While the level of sales in the quarter was below our expectations, the trend in the production arena is strongly moving towards our traditional model to primarily originate and sell loans into the secondary market.
We do expect sales to increase above the 60% level in the second quarter and to near our historical 80% level in the latter half of the year. Given the expectation of continued higher funding costs, limiting our level of residential portfolio of loan growth is the plan. Overall, noninterest income was $3.7 million level to the linked quarter, but down from the prior year quarter of $5.8 million or a reduction of 37%, primarily due to a significant decline in residential loan volume. The current quarter included a mortgage servicing recapture, as I mentioned, of $56,000 compared to a recapture of $890,000 in the first quarter of last year.
When we exclude the full impact of the mortgage business line from both years, our year-over-year decline would have been 16%. The title business is also off due to the decline in residential volume, as you would expect. However, we remain confident of our ability to drive revenue expansion in the coming quarters.
While we have made resource reductions to more closely line expense with expected revenue, we've also made for business to more consciously drive a greater share of State Bank's title insurance policy revenue to big title. Our Wealth Management division showed growth from the linked quarter as both revenue and assets under management increased.
We understand, as with before, the lumpy nature of this business line, with the value of the equity markets being one of the main drivers of our success. As such, we continue to identify a more holistic client experience and one that includes a complete banking relationship to complement our management of their 401(k)s and individual retirement assets.
Second key initiative, more scale, funding concerns and the need to grow and maintain client deposits remain center stage for a recent bank failure conversations highlighting the potential concerns of liquidity and meeting client needs. We worked very hard to grow deposits in the quarter. And in fact, we have now grown total deposits in each of the last 3 quarters.
This growth has come at a cost to our margin as total funding costs are up nearly 300% compared to the prior year on what was essentially a flat balance sheet. The market has been very competitive and the desire of our clients to accelerate returns on their cash. That's driven the marginal cost of funding up to that 4% to 4.5% level.
Loan growth in the quarter was again fairly strong as we were up $14 million from the linked quarter and up now nearly $126 million or nearly 15% from the prior year quarter. The bulk of that loan growth came from our residential loan business line as the salable Freddie Fannie product pricing due to the inversion of the yield curve remained elevated and certainly less desirable to our clients.
This pricing began to change later in the quarter making salable product to our clients, preferred. When we include the growth of our residential variable big products on our books, we have now growing our loan book each of the last 5 quarters. We were singularly focused in the quarter on reassuring our clients that we have a strong, well-capitalized bank with many avenues to meet all of their liquidity needs.
Uninsured deposits at our institution have averaged in the low to mid-teens and currently stands at 14%, which is at the low end of Midwest banks between $1 billion and $3 billion in size. Our average deposit size per account of $25,000 is at the median level of that peer group, and we are not reliant on any geographic region for the majority of our deposit funding.
In fact, our largest region comprises only 27% of the total deposit balance sheet. We have not had access either the Fed discount window or the bank term funding program to meet any of our liquidity needs. Third is our strategy to develop deeper relationships, more scope.
The PPP story has been completed, and we are focused on getting our teams back into the market and calling our clients' prospects that will undoubtedly need working capital to grow, albeit in a bit more challenging market. We closed over $7.3 million in SBA credits in the quarter, but due to timing, we were unable to get them sold and the gains realized in the quarter as we anticipated.
We expect meaningful fee income from sales in the second quarter with the pipeline of scheduled closings of nearly $6 million. We continue to expect 2023 to be one of our most meaningful years in SBA originations since we entered the business line in approximately 2016.
The corporate sales champion we hired late last year is being integrated into the fabric of our sales culture. The impetus here is to gain better utilization of our newer fintech platforms, including more and better data as we reported in prior quarters and to optimize the relevancy of each of our 7 business lines.
As a result, we expect to expand our household penetration and add additional products and services and are now over 36,000 households throughout the coming year. Operational excellence, our fourth key theme. The mortgage business line has been and continues to be a key entry point for us into the household throughout our entire footprint.
Over the last 10 years, we have originated now $3.9 billion in residential loan products. And the gain on sale during several of those very low rate years drove the increase in our tangible book value and certainly earnings per share. Clearly, the impact of the rapid rise in rates in 2022 and the lower available housing stock in a number of our markets has hurt our profitability.
This quarter's production was the lowest level that we've experienced in over 9 years. We believe that the market is showing some signs of life, and we are growing our pipeline almost exclusively in the salable purchase market. We continue our quest to rightsize the level of resources for the business line and a return to more traditional levels of annual volume and net mortgage banking revenue.
Operating expenses were down from the prior year quarter, but increased from the linked quarter. We acknowledge that our efficiency and expense to average assets ratio are too high given the potential headwinds on the prospects of incremental revenue growth. We have done a full review of our expense base and are confident that the coming quarters will show meaningful reductions from the baseline.
In fact, we recently developed a dynamic model that revealed cuts and expenses that for lack of revenue enhancements for 2023 and will deliver a more meaningful improvement in tangible book value improvement for our stockholders. As such, this initiative will provide us positive operating leverage anticipated for 2023.
Our client-driven contact center staff has continued to expand its reach and has allowed us to forgo adding open positions to our retail network. Particularly important as we have constrained hours of operations in some offices, reflecting the flight of the client to the digital platform.
Our contact center also allows us to do positive outreach and handle customer needs with a seamless, consistent message from a staff of 6 professionals. This focus along with the goals of our corporate sales champion will be a hard to expand single service households and expand our deposit footprint without an expensive client acquisition strategy.
Fifth and finally, asset quality. Charge-offs were slightly elevated in the quarter compared to the net recoveries we have experienced in the last 2 years. We have begun to see some weakness in our small credit card portfolio and the rise in interest rates has put strains on the household with the escalation of interest payments on our prime-based LOC portfolio.
A significant additional provision, we have set aside over the last several years that now includes the 2023 CECL adjustments of nearly additional $3 million puts us in a very strong position with allowance coverage of nonperforming loans that now stands at nearly 400%.
Delinquencies ended the quarter at $3.6 million or 37 basis points. But when we exclude the identified NPLs from the delinquency number, the percentage drops to just 3 basis points. We continue to have a robust internal review program that continually uncovers problem credits and what is expected to be a bit stiffer headwind with a potential recession on the horizon, but we are prepared.
At this time, I'd like to turn it over to Tony Cosentino for some additional details on the quarter. Tony?

Anthony V. Cosentino

Thanks, Mark, and good morning, everyone. Again, for the quarter, we had GAAP net income of $2.5 million with EPS of $0.35 per share. When we exclude the servicing recapture and the noncore expense items, core diluted EPS was $0.36, up 20% compared to the similar core earnings in the first quarter of '22.
Total operating revenue was down for both the linked quarter and the prior year quarter. However, when we exclude the servicing rights we capture from both years, operating revenue would be up 12.1%. Also, the continued lower level of mortgage gain on sale, which was down nearly $1.1 million had a significant impact on our ability to grow total operating revenue.
Margin revenue was up 22% from the prior year, and the efficiency of our balance sheet improved this quarter as our loan-to-deposit ratio rose to nearly 90% and total loans to assets rising to 73%. Now as we break down further the first quarter income statement, beginning with margins.
For the quarter, our net interest margin came in at 3.37%, which is up 69 basis points for the prior year. Due to the shift in our earning asset mix and a net deposit beta of earning assets versus funding. Compared to the linked quarter, the impact of much higher funding costs, as Mark discussed, could not be overcome by our loan growth and the improvement in earning asset yields.
Cash and securities as a percentage of total assets continued the reduction in the quarter as they are now just 19.5% of total assets. This compares to 20% and 30% for the linked and prior year quarter. Pre pandemic, we averaged just over 12% of assets in these lower yielding instruments. This shift in mix has benefited our interest income and is reflected in our earning asset yield improvement.
For the quarter, we had loan yield of 5.04%, up 21 basis points of linked quarter, and our overall earning asset yield improved 22 basis points from the linked quarter. So based on these 2 key measures were both 25 for the quarter, and interest income as a result of the improvement in these metrics was $13.8 million, up 7% for the linked quarter and 47% from the prior year quarter.
For the first time since the Fed began to raise interest rates, our funding base were higher than our earning asset and loan betas. For the quarter, our deposit beta was $48 million and our overall cost of funds beta was 55%, but with approximately 2x the earning asset loan betas referenced earlier.
We were able to raise deposits, primarily in the 1-year window, roughly 50 basis points below the marginal wholesale funding rate. Deposit costs, as you can expect, rose substantially in the quarter, up to 94 basis points from 53 in the linked quarter and up from 22 in the first quarter of 2022. Nonretail funds, which are approximately 17% of total assets provide a diverse mix of funding for our operations, predominantly using the [Seniors] and ICS product with some term and overnight FHLB borrowing, this pool of funds as a weighted average rate of 2.65%.
Fee income as a percentage of average assets was flat to the linked quarter at 1.1%, driven by lower mortgage gain on sale in the absence of any SBA loan sales. As Mark indicated, we expect a strong second quarter in SBA fees as we have several large credits that we are in the process of pricing in secondary market. Any kind of prior year comparison on fee income would not be meaningful given the large servicing rights we capture in the prior year and the strong mortgage activity we experienced in early 2022 and prior to interest rate increases that began in March of last year.
Mortgage gain on sale yield came in at the mid-2s for the quarter, which are not a harbinger of the future state as the volume of loan sales in the quarter was quite small. At these current levels of Freddie pricing, we would expect the prudent use of our hedge will allow us to realize yield levels between 2.25% and 2.5% moving forward.
At that level, our breakeven origination volume, assuming a 70% sale factor is roughly $350 million of annual originations. At this point, we are below that level when factoring in our current pipeline and the latest mortgage forecast. The upcoming quarter will be very important to us in settling the future direction as regards to the business line.
The market value of our mortgage servicing rights continue to move higher with the decline in refinance volume and ended the quarter with a calculated fair value of 126 basis points. This fair value was up 9 basis points for the linked quarter and up 21 basis points for the prior year. Our servicing rights balance remained level in the linked quarter of $13.5 million and remaining temporary impairment was down to just $121,000 with a recapture of $56,000 in the quarter.
It is likely we will capture the remaining impairment sometime this year. Our expenses in Q1 amounted to $10.8 million, which was expected to be higher than the linked quarter on a run rate basis. While we had some nonrecurring expenses of around $120,000, we anticipate that the expense review mentioned by Mark earlier, will result in lower annual expenses in 2023 compared to 2022.
Our focus on technology spend, which was a significant factor in closing the digital gap and advancing our company further along the technology path is largely compelled. Now as we turn to the balance sheet. Wholesale funding levels declined in the quarter by nearly 14% as we were able to not only fund higher loan growth but also reduced borrowings with our deposit gathering activity.
These deposits had come at the higher end of the scale, and we did see a larger-than-normal movement of deposit funding and term certificates in the quarter. Time deposits now comprise over 21% of our deposit book, up from approximately 13% in the prior year as clients sought to move liquid funds into predominantly the 1-year term window. Most of our new growth also came in at 1 year bucket.
One of our strategies was to price a bit aggressive at the margin, but that came with a stipulation that new funds from competitors were required. We were pleased with our results as total deposits at quarter end were up $23 million over 2022 year-end. Paydowns in the investment portfolio continue as scheduled with the portfolio on pace to decline by roughly $25 million this year through normal amortization.
Should rate decline accelerate cash flow from a predominantly mortgage-backed portfolio will provide the liquidity for our anticipated loan growth. The AOCI negative mark improved in the quarter as anticipated. Tangible common equity, including the AOC impairment, improved in the quarter to 7.29% with a tangible book value per share up to 13.93. Total equity net of AOCI of $149.4 million was up from the prior year, represented 11.1% of total assets. Regulatory capital continues to be strong with common equity Tier 1 and total risk-based capital estimated to be 13.5% and 14.8%, respectively, at the end of the quarter. We did buy back on or shares in the quarter at an average price of $14.54 and below our current adjusted TCE per share of 18.23.
As Mark mentioned, our loan reserve improved significantly in the quarter, ending at point 1.58% of total loans. During the quarter, we adopted CECL, which added $1.4 million to our reserve an additional $1.3 million to our unfunded commitment liability.
Even with the limited charge-offs in the quarter of just 3 basis points, we decided to add to our already peer-leading reserve with a net provision of $250,000. In addition, we had positive momentum in our classified loans as for the quarter, our criticized and classified loans now stand at just $9.4 million and are down 25% versus the linked quarter and 53% from the prior year quarter. I will now turn the call back over to Mark.

Mark A. Klein

Thank you, Tony. I want to conclude with acknowledging once again the dividend announcement we made in the earnings release last -- or this week, up $0.13 per share, a recent high at 36% of our earnings in the quarter. We expect to maintain our current common dividend methodology in 2023, even though it represents a greater percentage of our net income as liquidity asset quality and capital are all well positioned.
No doubt, a tough quarter for the overall industry with the economic and operational headwinds. Conversely, for SB Financial, given our high level of FDIC-insured deposits at over 86% of total deposits, low average balance per deposit account of just $25,000 and our diversified and market balance client base, we do remain confident that our overall direction will deliver meaningful returns for each of our stakeholders.
Now I'll turn it back over to Sarah Mekus for questions and comments and answers. Sarah?

Sarah S. Mekus

Thank you, Mark. We're now ready for our first question.

Question and Answer Session


(Operator Instructions).

Sarah S. Mekus

While waiting for any questions, I would like to remind you that today's call will be accessible on our website at


(Operator Instructions) Our first question comes from Nina Burns from Janney.

Nina Burns

This is Nina. I'm filling in for Brian Martin this morning. I know he made you guys aware that he had another call to join this morning. But we do want to know more about what your NIM outlook is and what your margin was for the month of March?

Anthony V. Cosentino

Yes, thanks. Yes, we did 3.37% fully taxable equivalent in March -- in the first quarter, excuse me, that March number was approximately [3.25%] as it obviously got lower as the quarter moved out. As we look going forward, April is probably going to be in that [3.20%] range and probably stay in that [3.20-ish] range in Q2. Obviously, loan growth, we feel good about our pipeline. And we feel like the latter half of the year, we're going to start to accelerate margin again.
We are hopeful that rate increases at the Fed have kind of stabilized, and we have a number of clients that will be coming off what we might call premium pricing in some of our transactional products in the latter half of the year, and we think we're going to be able to retain those clients at a slightly lower level than what we're paying them today. The bulk of our term certificates are probably going to be in the first quarter of 2024. But we do think deposit costs will move up in the second quarter, but then moderate to slowly move down in the latter half of the year and loan growth will provide some bonus in our margin going forward. So we do think slight move down in Q2 on margin and then from there acceleration higher.


If there are no further questions, I will now turn the call back to Mark Klein.

Mark A. Klein

Thank you. And once again, thank you all for joining us this morning. We look forward to speaking with you in July with our second quarter 2023 results. Have a good day. Goodbye.

Anthony V. Cosentino

Thank you.


The call has ended. You may now disconnect.