Sarah Mekus; Executive Assistant and Corporate Secretary; SB Financial Group, Inc.
Mark Klein; Chairman, President, & CEO; SB Financial Group, Inc.
Tony Cosentino; EVP and CFO; SB Financial Group, Inc.
Steve Walz; EVP and Chief Lending Officer; SB Financial Group, Inc.
Brian Martin; Analyst; Janney Montgomery Scott LLC
Good morning, and welcome to the SB Financial third quarter 2023 conference call and webcast. I would like to inform you that this conference call is being recorded. (Operator Instructions) I will now turn the conference over to Sarah Mekus with SB Financial. Please go ahead, Sarah.
Thank you, and good morning, everyone. I'd 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 ir.yourstatebank.com.
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 materials as well as our SEC filings. These materials are available on our website, and we encourage participants to refer to them for a complete discussion of risk factors and forward-looking statements. These statements speak only as of the due -- as of the date made. And SB Financial undertakes no obligation to update them.
I'll now turn the call over to Mr. Klein.
Thank you, Sarah, and good morning, everyone. Welcome to our third quarter conference call and webcast. Highlights for the quarter include net income of $2.7 million down from both the linked and prior quarters as funding costs and lower mortgage volume have impacted profitability.
Pretax pre-provision return on average assets of 96 basis points, with return on tangible common equity of 10.8%. Total interest income of $14.8 million was up $3 million or 25.8% from the prior year and up $390,000 or 10.8% annualized from the linked quarter. Loan balances were higher from the linked quarter by just $4.2 million. But it's now risen nearly $64 million or 7% over the prior year quarter.
Our expansion markets in Fort Wayne and Columbus were the catalyst growing 29% and 15% respectively. Deposits were higher by $14.1 million or 5.2% annualized compared to the linked quarter and remained steady to the prior quarter, albeit with higher funding costs that rose from 46 basis points to 176 basis points.
Loan to deposit ratio of 91.1%; our second consecutive quarter above 91% at higher by nearly 6 basis points from the prior year. Operational liquidity of nearly $500 million, that is 35% of total assets and sufficient to meet all of our growth needs and noticeably, we have not needed at any time to access the Federal Reserve term funding program.
Expenses were slightly higher than the run rate this quarter that Tony will touch on shortly, as we had some nonrecurring items that impacted results. Mortgage origination volume all lower than the linked and prior-year quarter did show a very high and a more traditional level of sold volume at 88%. Capital levels remained strong with tier 1 leverage of 11% compared with tier 1 of 13.6% and total capital or total risk-based capital of 14.8%. Customer deposits for the company that are below the FDIC insured threshold were nearly 84% of total deposits. And when we exclude any collateralized deposits, that level increased to 89%.
And finally, asset quality metrics remained strong with delinquency levels at 33 basis points and year to date net charge-offs of only 1 basis point. We continue to concentrate on our five key initiatives. That's revenue diversity, it's all about net interest income, and fee-based revenue; more scale in our current households; more scope; and operational excellence; and asset quality.
First, revenue diversity. The mortgage business line has been under significant pressure this year from not only higher rates, but also the lack of inventory in most of our markets. This quarter was reflective of not only the new lower level of activity, but also the ongoing sites or pipeline. The expectation is that the $15 million to $20 million per month level of volume will continue for the majority of the next six months.
We have, as previously indicated, been actively moving away from residential portfolio growth by changes to pricing with an emphasis on shorter duration products. It was encouraging that we sold 88% of our production in the quarter and the yields on those sales were in line with what we achieved in the last four quarters. Despite the headwinds that all banks have encountered this year, including us, quarterly noninterest income has remained fairly stable.
Our $4.2 million this quarter was up slightly to the prior quarter -- prior year, but down slightly from the linked quarter. We have settled into a 30% level of fee income to total revenue, which while down from our very high historical levels of high 30s to low 40s, would still place us well into the top quartile of our peer group.
As we look at our year to date results, the negative impact from the mortgage business line with $1.2 million of servicing right impairment and an additional $900,000 due to lower gain on sale has clearly overshadowed a this year in our other fee based business lines. As such, we remain committed to our title insurance business. And despite the obvious headwinds from the residential sector, we are pleased with the product, with the progress we have made this year in making the Peak Title, the number one choice for our clients and our markets.
For the current year, our State Bank commercial team has delivered over $145,000 of revenue or 11% of Peak's total revenue for the year, which is over double the commercial revenue from the prior year. This commercial contribution is nearly as high as our internal residential level of contribution for the year. We continue to emphasize the quality and capacity of our peak business line to all of our clients. As I indicated in our second quarter webcast, our goal continued to be to generate 50% of Peak's revenue, all else remaining constant.
This quarter, State Bank delivered 34% of Peak's revenue and now claims 30% of their revenue year to date. We spent the majority of the quarter integrating our new wealth management leader, mitigating the loss of a prior wealth adviser, remaining connected with our current wealth management client, and developing new contacts as well.
However, revenue growth has been challenged by the downward pressure in the equity markets and our need to identify for wealth advisors. Regardless of this, business line continues to deliver a stable $3.7 million to $4 million in annual revenue and continues to provide us a competitive advantage over our community bank peers. It remains a great complement to our private banking and commercial customer bases and helps ensure that we are providing our clients a comprehensive solution to all their financial needs.
Secondly, more scale. Loan growth from our linked quarter rose slightly, as I previously stated. Consecutive year or quarter-over-quarter growth gaining back several quarters has been a noticeable achievement in our overall balance sheet growth. We understand that growth will become more difficult as we look out to a potentially further slowing in the economy.
Based with that scenario, our response will be to work twice as hard to deliver the same or better results. By doubling our calling efforts to our clients as well as our prospects that are tied to our competitors, a number of home has stepped away from lending. We expect that when the economy does turn, we'll be in better positioned to achieve pre-pandemic levels of loan group.
Growing deposits from the linked quarter was a key achievement as we have worked extremely hard this past year to maintain our deposit levels on par with the prior year. We have given our bankers, the flexibility to elevate every deposit conversation with clients to ensure we are keeping and growing those valued relationships.
Obviously, maintaining that deposit level has come as a reduction of our net interest margin with our year-to-date deposit cost of funds of 101 basis points from the prior year. Keeping in that rise less than the increase in our earning asset yields that have risen to 119 basis points does feel like an accomplishment in this rather challenging environment.
Third, more scope. We closed just under $1 million in SBA loans this quarter. And thus far for 2023, we have originated $7.4 million. That production, which we anticipate will approximate $10 million for this year is certainly less than our capacity and well below the goals we have set for this very profitable sector. With the increases in prime lending rate, we intend to adjust our traditional pricing model to drive portfolio balances and revenue higher.
Fortunately, we are often able to attract the entire deposit relationship with each new SBA credit. Also, when coupled with our strong credit culture and the added safety net of the government guaranteed, asset quality elevates, and revenue stabilizes. We expect to expand our fourth quarter success and provide emphasis to a stronger 2024 in the SBA arena.
As we have discussed in prior quarters, our investment in technology to help us better identify and target clients for business expansion continues. We are in the midst of our salesforce integration project. And we are confident that both our corporate sales champion and consultative sales approach with each client will bring us closer to a bigger bank process, but with a community bank feel. As a result, we have accelerated sales trainings for each of our staff members with a focus to retain 100% of our current clients and delivered a strong community bank brand for all prospects alike.
Operational excellence, our fourth key thing. Operating expenses were up just slightly in the linked quarter as we had some check fraud and other portfolio non-reoccurring items. However, a large portion of our expense base is variable and tied to the number of units produced in our SBA and mortgage business lines. As those volumes have declined, the associated compensation levels have also declined. We've also taken steps to reduce the fixed costs of both of these areas by reducing support staff and shifting responsibilities to departments with excess capacity.
In fact, from the prior year, total FTE is down  or 6%, reflecting those impacts. Beginning in the fourth quarter, we will identify initiatives to further improve our efficiency ratio. That said, we expect that our fourth quarter expense level will reflect a more efficient run rate near the $10 million per quarter range.
And finally, to deliver more value to our commercial client base, we recently launched a comprehensive calling strategy across our entire footprint to deliver and potential implement positive paid risk mitigation software to protect our 1,700 client accounts from fraud as well as constrain our operational risks.
And finally, asset quality. Charge-offs were again low this quarter, just $5,000 and for the year we've had just $88,000, which equates to just one basis point of total loans. In fact, we have to go back 13 quarters to identify a period with net charge-offs exceeding just $65,000.
In addition, our reserve coverage of nonperforming loans at 474% gives us great comfort moving forward that our asset quality is strong, stable, and prepared to confront any additional weaknesses in the economy. For all the underwriting and dynamic loan administration are clearly the common threads here, we have a slight uptick in delinquencies from the linked quarter, which were all in the under 60-day category.
The clients involved in increase our now current. And we would expect that when we report our 2023-year delinquency, they'll be back in the mid-20 basis point range. We also do not anticipate having any material level of delinquencies in the near term in the portfolio outside of identified nonperforming credits.
And Tony Cosentino, our CFO will give you a few more details on the quarter. Tony?
Thanks, Mark, and good morning, everyone. Again, for the quarter, we had GAAP net income of $2.7 million with EPS of $0.39 a share. It is notable that our pretax pre-provision earnings adjusted for the OMSR recapture for the nine month period are up $550,000 or nearly 6% from the prior year nine month period.
Highlights of the income statement this quarter, full margin income has declined for the quarter from both the linked and prior years, despite very strong growth in interest income in excess of 25% as a significant accumulation of funding costs impacted total margin. Margin ended the quarter down 7 basis points from June quarter and was down 37 from the prior year. However, we have seen some stabilization in our margin with declines in the past three quarters of 25, 20, and now 7 basis points.
We anticipate that the fourth quarter will likely be the low point in our margin with the expectation that in 2024, we will start to see some slow improvement. In addition to the shift in the mix of assets away from securities to loans, increases in asset pricing have driven earning asset yields higher in every quarter this year. And they are higher by 89 basis points when compared to the third quarter of 2022.
Loan yields have increased by the same levels as new volume and contractual repricing have stayed consistent to market movements in the rate curve. This quarter, our margin betas have followed the pattern of the last two quarters and that our funding betas are exceeding the repricing betas on our earning assets.
Specifically, the deposit and total cost of funding betas were 88 and 87, respectively. These are approximately 1.5 times higher than the loan and earning asset betas, which are 60 and 58. Since the Federal Reserve began the rate increasing cycle, the betas for both sides of the balance sheet are nearly neutral. For the earning asset beta at 31 and the cost of funds beta at 28.
Our level of fee income to average assets remained even to both the linked and prior year quarter at 1.2% and as Mark pointed out, has stabilized at the 30% level relative to total revenue. We track our coverage of non-interest expense to assets by noninterest income to assets every quarter. In a perfect world driving that coverage to zero is ideal, but we understand it's extremely difficult.
This quarter at negative 1.9 is part of an improving trend in this metric for this calendar year as we have adjusted operating expense to reflect lower levels of fee income, especially in the mortgage business line. Although this quarter did show some positive in residential mortgage, especially our level of sold loans and that our gain on sale percentage of 2.2% is in line with the linked and prior-year quarters. Our ability to hedge the pipeline, coupled with our historically high pull through rate mortgage clients, nearly 90% has allowed us to command very good loan sale yields despite the tough secondary market.
We do, however, expect the next six months in the mortgage business to be difficult with total origination levels of roughly $100 million. This would mark our lowest origination level in a number of years, but it's reflective of the near 8% rate mortgage market. As rates potentially stabilizes at 2024, our consistency in the market should allow us to quickly return to higher origination levels. Despite the slight uptick in total expense this quarter, our trend line to drive annual operating expense below the $41 million level remains on track. We have reduced operating costs on consultants that are adjusting operating hours in our retail locations, which will contribute to the expense reduction that Mark just mentioned.
Compensation and benefits as a percentage of total expense was 52.4% this quarter, down from 56.4% in the third quarter of 2022 with compensation per employee rising 2.9% annually, reflecting lower commission levels and our concerted efforts to manage employment costs effectively.
Now, let's returned to the balance sheet. The total size of our balance sheet experienced a slight decline from the linked quarter due to marginal loan growth with our levels of cash and securities declining. Securities as a percentage of total assets continued the reduction in the quarter as they are now just 16% of total assets. This compares to 17% and 18.7% for the linked and prior-year quarters. Regular amortization as small paydowns in the investment portfolio brought the balance down to nearer $200 million levels.
Encouragingly, this quarter, the deposit growth enabled us to pay down more high price repos and FHLB borrowings by over $26 million or 25% compared to the linked quarter. We did maintain a stable valuation of our mortgage servicing rights, which stood at 118 basis points. The servicing right balance increased to $13.9 million with the servicing portfolio now at $1.37 billion up just slightly to the prior year.
We continue to have very strong capital levels, as Mark has highlighted. Our common equity tier 1 ratio stands at 13.6%. And even with adjusting for AOCI, the level remains robust at 10%. Tangible book value per share is higher slightly compared to the prior year. And when we adjust for the AOCI impairment, our tangible book value per share would be [$18.92] per share, which is up 3.5% from year end 2022.
Our share buyback continued in the quarter, although volume was down compared to our historical buyback run rate per quarter. Specifically this quarter, we purchased 44,000 shares at an average price of [$14.02] for less than 85% of book and just slightly higher than our tangible book value. As we stated, our loan-loss allowance was stable in the quarter, reflective of both minimal provision and charge-offs.
Due to the small increase in loan balances, our reserve to loans remained flat to the linked quarter at a healthy 1.6%. Compared to the prior year, we've increased our reserve percentage by 11 basis points. Our criticized and classified loans were relatively stable compared to the linked quarter; now stand at $9.7 million, a decrease of $3.1 million or 24.2% from the prior year.
I'll now turn the call back over to Mark for closing comments.
Thank you, Tony. We continued our consistent pattern of raising our common dividend with our announcement this week of a $0.135 per share common shareholder dividend. And for the year, we've now deferred case dividends of $0.52 per share or nearly $3.6 million. Total dividend pay-off ratio for this year will be approximately 30% with a current dividend yield of around 4.2%.
And we continue to buyback our shares to return earning capital to our owners. Dealing with 11 rate hikes since early 2022, including  basis point hikes this year, has impacted our rate sensitive business lines of mortgage and SBA significantly. We have worked to adjust resources where appropriate, and we'll continue to do so moving into the fourth quarter.
Our budgeting process for 2024 is revealing in what markets and products we feel will have strength and how our operation will emerge with greater emphasis on margin expansion and stabilization, balance sheet growth, and mix change, and noninterest expense containment to preserve and grow EPS.
And I'll turn the call back over to Sarah Mekus for questions. Sarah?
Question and Answer Session
Thank you, Mark. We're now ready for our first question.
Brian Martin, Janney Montgomery.
Just thought maybe you could talk a little bit about the loan pipelines. These kind of how you're seeing those just given kind of the current market conditions? And then just how your markets are performing? So--
Hey. Good morning, Brian. It's Steve, we come to see 2023 is a bit of a year of acceptance for borrowers as they've gotten used to the new rate realities of some things. We thought we would see come to the floor earlier in this year have been delayed.
That said, we do have some optimism for the fourth quarter. Some of those projects come online anecdotally. We're hearing from lenders that we're getting more calls for folks. So pipeline seems to be accelerating again as close to -- adjust to the new reality on the rate side. But also seeing an economy that seems to be stabilizing and still showing some resilience has encouraged them to [perceive the projects that before they] had some trepidation model.
Okay. And as far as just kind of your outlook, whether it be fourth quarter or just kind of next several quarters, I mean, what type of growth rate appears a near term bogey as far as what you might be able to see?
Brian, we're going to end this year, probably 6%-ish type when we fully finish. I think as we looked at expectations, we're -- that's probably the low end of the range that we're looking at in 2024. A lot depends on really the commercial side because as you know, we've stepped back from the residential as much on portfolio.
SBA had seemed to show some strength a little bit here in the fourth quarter, and we've seen some more looks. So I'm hopeful that that number gets to call it a 7% to 8% range as we get out, which would be kind of a $70 million-ish type total number for the year. And we'll see a lot more as we finish Q4. I think as Steve said that's going to be pretty instructive in terms of what clients are looking.
Sure. Okay. No, I appreciate it. Thanks. And then how about just I think you touched a little bit on the mortgage production maybe being a little bit lower here over the next couple of quarters, just big picture? As we think about full year '24, can you give any thoughts or just how you're thinking about where that may shake out as far as what you're based on kind of extrapolating current trends, what you're seeing today?
(multiple speakers) both on -- both volume and your -- like you had the benefit this quarter showing you have more production. So just kind of what you're thinking on both fronts.
Right. I think Q4 is probably going to be a $50 million type range of origination. I think we're seeing a little bit -- or our pipeline seems to be in that $18 million to $20 million level. December looks to be dropping off a bit from that. So call that $50 million for Q4. I would think that's probably still going to be at a level as we look at Q1, based upon the forward rate curves and the things that we're looking at.
I do think our level of sales are going to be at a minimum of 85% to 90%. We are not seeing the level of portfolio either by the client or anywhere else. I mean, I think the clients that are doing mortgage and are interested are focused on fixed rate, Freddie Mac salable product. And we've had a certain -- certainly a back off in our PCG market, which have been incredibly successful for us in 2021 and into 2022. That certainly have seemed to come off the table quite a bit.
Yeah. Just follow up comment, Brian, we do clearly expect that volume to rise again, maybe in the latter part of 2024, that maybe we see some improvement in the rate environment and the rate curve. But we clearly have got some expenses in that back end of that process and positioned ourselves with same number of MLOs we've had from Columbus to Indianapolis to a lower Michigan to do that $500 million with no additional costs.
So we're prepared to move ahead when the market right size, so to speak. But it's going to be constraints with potential higher risk and lower inventory. But we're prepared and since they're variable rate on compensation, we're willing to kind of stand pat.
Got you. That's helpful. And how about just flipping over to the margin for a minute. I think, Tony, you said -- you kind of indicated that it might reach a bottom here in 4Q and maybe see some stabilization or improvement next year. I guess just the -- sounds like the funding cost pressures beginning to abate. Just kind of wondering how you're thinking about the benefits on the opposite side with asset repricing, maybe just how much in the way of loans reprice? And what trends you're seeing there to give you some stability and/or expansion next year?
Yes. I mean, we all talk about -- for all of us it's the million-dollar question. I mean, certainly the variability this year between how fast funding costs have risen relative to the asset side has slowed down. We were 2 times that. Early in the year, we're 1.5 times. We'll get closer to kind of a 1:1, in Q4 of deposit and funding costs rising relative to the earning asset side.
I'm hopeful that our discipline will allow the majority of the repricing that we have to flow through. I think it's going to be a big factor in terms of what calls all of those clients are getting as their loans are coming up to reprice and what that's going to do on a relative basis. But certainly if you look at the just the numbers of our portfolio and how it's repricing, it should maneuver its way to be at or slightly above what I anticipate funding costs to be as we move forward. So that's why I'm a bit hopeful for that to approve, call it into 2024.
Got you. And just the new production, what yields -- I guess you're kind of getting new production at? And just do you have any sense for I can follow-up just on what repricing occurs maybe over the next 12 months or if you have six months, what -- if you think about that loan book?
Brain, the margin we're seeing now is that [225 to 250] over the relevant index. And we're certainly looking to hold that as loans reprice. There are no banks have stepped back that we think a combined with our level of service, we should be able to retain those loans.
Got you. Okay. And then just the total repricing, how much repricing do you have here in the short term or in longer term?
We're probably going to have -- we're traditionally about 15% to 20% on an annualized basis of the entire portfolio. The majority of our portfolio reprices in that three-to-five-year rate curve duration. So every year we're probably in that 15% to 20% of total repricing. I think it will be a little bit better than that number percentage-wise in 2024. Just because the majority of the things we put on were relatively short term over the past three years. That's kind of where the client has been in anticipation of rates coming down.
Got you. Okay. And then last one for me. Just on credit, just -- sounds like things are still remaining very strong. I mean, anything that I guess you're seeing as you come through this quarter? It sounds like the trends in criticized and classified were pretty stable. So leading indicators [or at least other criticize] are continue remain strong. Just anything that you're more mindful of or you're seeing any stress in within -- in certain areas of the portfolio.
No, Brain, we've been very satisfied with the performance of our portfolio. We did a deep dive into our CRE portfolio, particularly the investment real estate things that were coming up for repricing. And we were very happy with what we saw as far as leases that were in place as well as the ability of those cash flows to withstand the pressure of interest rates. So we feel pretty good about where the portfolio is right now.
Okay. I think that's all my questions. So thank you for taking the question, guys, I appreciate it.
As there are no further questions, I would now like to turn the call back to Mr. Mark Klein.
Once again, thanks for joining us this morning. We certainly look forward to speaking with you in January to give you our fourth quarter and full 2023 year-end results. Goodbye.
The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.