Great Southern Bancorp (NASDAQ:GSBC) Q2 2019 Earnings Call

0:00 Ladies and gentlemen, and welcome to the Great Southern Bancorp, Inc. Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require assistance during the program, please press star, then zero on your touchtone telephone. As a reminder, today's program may be recorded. And now I'd like to introduce your host for today's program, Kelly Polonos, Investor Relations. Please go ahead.

0:29 Good afternoon and welcome. This is Kelly Polonis, Investor Relations for Great Southern Bancorp, Inc. The purpose of this call is to discuss the company's results for the quarter ending June 30th, 2019. Before we begin, I need to remind you that during the course of this call, we could make forward-looking statements about future events and financial performance. You should not place undue reliance on any forward-looking statements which speak only as of the date they are made. These statements are subject to a number of factors that could cause actual results to differ materially from the results anticipated or projected. For a list of some of these factors, please see our disclosure in our second quarter 2019 earnings release. President and CEO Joe Turner and Chief Financial Officer Rex Copeland are here with me.

1:18 I'll now turn the call over to Joe Turner.

1:20 Okay. Thanks, Kelly. Good afternoon, everybody. And I also want to I also want to thank you for joining our second quarter earnings call. As is typical, I'll provide some preliminary remarks about the company's performance and then turn the call over to Rex Copeland, who will go into more detail about the income statement. We're excited about the way the quarter wound up. If you've had a chance to review the earnings release, you've seen that we did earn $1.28 per share and $18.4 million. We saw good loan growth during the quarter. We further improved on our operational efficiency.

2:05 We did experience a little bit of net interest margin during the quarter, which Rex will provide color around. Some operating metrics that I want to highlight, our return on common equity was 13.24. Our return on assets was 152. Our margin was 397. And our efficiency ratio was 54.5%. As for loans, we feel very positive about our loan portfolio. We've had good growth in 2019 so far. I think our loans are up, funded balances are up 124 million from the end of last year, up 62 million, I guess, in each quarter, I think. So, you know, nice loan growth so far. Our gross loan balances are up 42 million from the end of 2018.

2:58 Our committed pipeline continues to be at about the same levels, so we continue to have a strong pipeline. I will say just anecdotally, it seems like to me things on the loan side are starting to tighten maybe just a bit. As I said, our pipeline is still strong, but there seems to be maybe slightly less deal flow. then there was slightly fewer deals out there and so the competition is probably becoming even more significant. Asset quality continues to be strong. We're coming off historically low levels. We've told you before that asset quality can be kind of lumpy and we did add a $6.7 million relationship to our non-performings during the Second quarter, and in fact, that relationship has, you know, during the first week of July has transitioned into other real estate.

4:03 But, you know, this is a credit that we've had on our books since 07, and we've been, you know, watching it for some time. But even after adding this relationship to our nonperformings, our nonperforming assets, the total assets was still, you know, relatively low at 0.33%. Our capital position continues to be strong. Our total capital or total common stockholders' equity is $572 million, or 11.7% of total assets. Our book value increased from $38.36 to $40.30 from the end of last quarter.

4:48 The ratio of tangible common equity to tangible assets is very strong at 11.6%. We do want to point out that $32 million of our equity, it is GAAP equity, but it's derived from unrealized gains on our available for sale securities portfolio plus the mark-to-market gain on our cash flow hedge. So as you think about our capital, you may or may not want to net that part out. We were pleased during the second quarter to declare a regular quarterly dividend of 32 cents per share. That concludes my prepared remarks. I'll turn it over to Rex Copeland, and then we'll open it up for questions after Rex completes his presentation.

5:39 All right. Thank you, Joe. As Joe stated earlier, we did see a little bit of compression in our net interest margin. The margin was pre-'97 in the second quarter this year compared to 4.06% in the first quarter this year and 3.94% in the second quarter of 2018. So compared to the 2019 first quarter, the compression in our margin was really caused primarily by higher average rates on deposits, a little bit on borrowings, but mainly on deposits, and it's just slightly lower yields. on our loans due to LIBOR interest rates coming down just a bit in the second quarter.

6:24 The positive impact on our net interest margin from the additional yield accretion continued in the quarter. If you compare second quarter this year, second quarter last year, and then first quarter this year, the accretion added 12, 10, and 13 basis points each of those quarters respectively to our net interest margin. Our net interest income dollars were up though from the year ago quarter and the most recent quarter. Net interest income for the second quarter of 2019 increased $3.7 million compared to the second quarter last year to a total of $44.9 million. And then our net interest income was up about $300,000 from the first quarter of this year. So we continue to see growth in our assets, growth in our net interest income dollars but a slightly lower net interest margin as a percentage.

7:23 One thing to note, we did record loan interest income of $568,000 in the second quarter related to the interest rate swap transaction that we did late last year as part of our ongoing interest rate management strategy to kind of help us mitigate any issues with falling rates that we might have. So again, under the terms of the swap, we are paid a rate of about 3.02% fixed, and then we pay a floating rate on that, which is LIBOR. So the rate most recently when it re-stepped this past month was 2.4%. So we do have a margin there, or spread there, that we are receiving a benefit of. Like everybody else on the call, were very interested in what the Fed will do on July 31st with their interest rate decision.

8:17 We've indicated in past filings that we model various scenarios of rates up and down and then non-parallel and parallel shifts. We do believe that falling rates will be modestly negative for us. We do have about almost $1.6 billion of loans that are tied to primarily one month LIBOR, some three months, but they'll reprice based on LIBOR index within the next 90 days. We do have a fair amount of our portfolio is variable rate tied to LIBOR. We will do what we can to manage the funding cost side and work hard to be able to reduce some of our costs as if and when rates fall on the market and on the liability side of the balance sheet.

9:17 Non-interest income for the quarter decreased by $302,000 compared to the second quarter a year ago. Really, the reductions were primarily in service charge, ATM fees, some commissions, and then net gains on loan sales where we originated left fixed rate loans that we sell in the secondary market and more fixed to variable rate mortgages which we generally retain in our portfolio. We did offset some decreases there with an increase in income related to new debit card contracts which became effective at the beginning of 2019. So we did derive some additional income from that. Non-interest expenses, I think we're still tracking well.

10:04 on our expense containment and operational efficiency. As Joe mentioned, our efficiency ratio earlier was at 54.5%. Non-interest expenses were down about $1.5 million from the second quarter comparison of last year. A big driver of this was lower expenses related to other real estate owned and repossessions, and that was the majority of the decrease related to write-downs in the prior year period on some certain of our foreclosed assets. The decrease was offset a little bit by some increase as we had about $481,000 increase compared to a year ago quarter in salaries and benefits just related to additional staffing in various areas and the new loan production offices in Atlanta and Denver as well as other areas.

10:57 And then also other operating expenses increased about $192,000 the majority of that and we mentioned it in the earnings release related to a pledge commitment that we made in our Sioux City, Iowa market for $250,000 that will cover a 10-year period for the work that they're doing to expand and sort of remake a portion of their downtown area with an expo center and some other hotels and other businesses that are going into that area. Again, I mentioned our efficiency ratio was 54.5%. That compared very favorably to the second quarter last year, which the ratio was about 61.5%. So we continue to increase our revenues without a commensurate increase in our non-interest expenses.

11:51 Along those lines of efficiency, I'll talk about just briefly a couple of business initiatives, fairly small, but things that we did mention in our Earnings Release, we've got a couple of locations that we either have or will close. Our Fayetteville, Arkansas banking center has been consolidated into the Rogers, Arkansas office and we also recently announced plans to consolidate our Ames, Iowa banking center into our office in Ankeny, Iowa. That'll be late third quarter in September. I think that concludes all of our prepared remarks, so at this time we can open it up for questions. Certainly. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key.

12:44 Our first question comes from the line of Andrew Leach from Sandler O'Neill. Your question, please.

12:50 Everyone? Hi, Andrew. Hi, so I just wanted to focus on deposit costs here. It looked like they were up about maybe eight or nine basis points this quarter, I guess, or interest-bearing funding costs. And I know you added some of the internet CDs and CDARs in the first quarter, so maybe just the full quarter effect of that is pushing up the funding costs. But what can you guys do right now? Have you lowered your offered rates right now to kind of mitigate the effect of the drop in LIBOR?

13:21 We have on some things we've been working on some of that. We haven't lowered the majority of the rates probably. I'd say part of it is also negotiating on CDs. We're negotiating at lower levels than we were maybe two or three or four months ago. We're mindful of what competition is doing as well. Our home loan bank advanced rates are down a bit. They're sort of tracking more along with the change in LIBOR. Most of our borrowings from, well, pretty much all of our borrowings from the home loan bank are overnight type borrowings at this time. So we're trying to kind of manage through.

14:19 You know, this process right now, it seems like, I mean, if you think about it, really the rates started to transition, you know, maybe a month or two ago. I don't think all of it's necessarily all filtered through yet, but I'd say that we are seeing, as far as like on a month-to-month basis, I think overall the cost of deposits, the growth in that cost is slowing compared to the change that we saw in the fourth quarter and first quarter. and even part of the second quarter of this year.

14:52 Okay. And then can you just make a couple comments on the decline in deposits in the quarter? What drove that?

15:01 A little bit of it was seasonality, but, I mean, a lot of it is some retail CDs. You know, we continue to have a lot of competition in some of our markets with people running specials and things like that. and then some of it's just fluctuation in non-interest bearing deposits, non-time deposits. But I'd say retail CDs are coming down some and then some of our interest bearing and non-interest bearing non-time deposits have also been fluctuating in there.

15:38 Okay, that's helpful. And then you guys have done a good job in expense control over the last several years. If I just take the $28.5 million or so and back out the Oreo costs, maybe a little bit under $28 million, is that a good run rate to use, or could it be a little bit better than that, just with the branch consolidation?

16:01 You know, the branch consolidation is not going to make a huge difference. I mean, I can't tell you specifically on Ames, but I'm guessing... are non-interest expense names is probably in the $25,000 to $30,000 a month range. That's not going to make a huge difference. I think we're doing all the right things on expense control right now. I do think with our ORE balances going down, we should generally see the trend of ORE expense continue to decline.

16:39 Some of that relates also to auto and consumer loans, too.

16:44 Same thing there. I mean, I think the quality of our automobile portfolio, I mean, the total of our automobile portfolio is shrinking, obviously, and the quality of what remains is probably getting a little better. So over time, I think the trend in that line should be somewhat down. I don't think there's a whole lot more we can do to really reduce expenses. Our focus is going to be to grow the company where we can and sort of maintain expenses so that we'll gain better leverage.

17:22 Okay. Thank you. Those are all my questions. Thank you. Our next question comes from the line of Michael Pareto from KBW. Your question, please.

17:34 Hey, good afternoon, everybody.

17:36 Hi. Thanks for taking my questions. I wanted to maybe stick on the expense side of things for a second here and follow up to Angie's question. You know, we're seeing, you know, at least I'm seeing more and more of your peers kind of start to invest more heavily in technology and, you know, leadership as they plan for growth and whatnot. And obviously you guys have have done a nice job of keeping that expense growth fairly limited for almost three years now. And I'm just curious as you budget out into 2020 and think about that. I mean, is there a point where, you know, it doesn't make as much sense to have the limited expense growth where there's investments that really need to be taken into account to kind of continue to grow the bank? Or are we not quite there yet?

18:22 And is there still some things that you can do to kind of offset any investments you're making on a broader basis?

18:29 Well, I mean, yeah, I agree with the premise of your question, Mike, that, you know, not all expense is created equal and there's, you know, expense that you need to have in order to invest in your bank and, you know, good people, you know, that's one of those expenses and then you need to make sure you have attractive technological offerings, you know, the kind of technological offerings that, you know, are attractive to customers. And honestly, I think we do. We are, though, in the process of upgrading our online banking platform. And we have been improving our mobile platform, too.

19:16 And we're not just guessing. We've actually surveyed our customers and surveyed our customers against other financial institution customers and I think, you know, our customers seem to like our offerings, but we are going to be investing in improving those.

19:41 So as you guys think out, I mean, I mean, you basically had an expense run rate annually in the 112 plus million dollar range for almost three years now. I mean, you're on pace to the same this year. I mean, do you think next year that realistically given everything going on in the industry today that that number of trends may be a little higher or do you think there's still room to kind of offset what you're doing on the investment side with other, you know, corrections elsewhere within the company?

20:12 I mean, I would think, you know, significant, you know, to the extent we had significantly higher costs on, you know, our technological offerings We're not going to be able to offset those somewhere else in the company. I don't know, Mike, that that's going to dramatically increase our run rate. I do think it's probably reasonable to expect our non-interest expense to probably go up each and every year. because of technology and other reasons. Part of the reason we've been able to hold our non-interest expense level is I think generally that ORE line has trended downward and that's helped us to hold the overall level.

21:14 I think you look at other things. Our employee costs are up from where they were I think a year ago. I do think our expenses will probably trend up. I think if we were to try to hold them at $112 million kind of run rate because of what that means for your people, because of what that means for your investment technology, I think it would restrict our growth. Got it.

21:49 No, very helpful, Joe. Thank you for that call. And just secondly, I wanted to ask on the margin, you know, as I think about kind of where your core margin, excluding the purchase accounting, is trended, you know, if I go back to 15, you know, first few quarters of 15, I think you were in like the mid to low 370s range. You know, today you're in the 385 in the second quarter, low 390s in the first quarter. But, you know, I mean, the mix of the loan portfolio has changed a little bit. You have some higher yielding loans with the bigger construction mix. And then obviously you're doing some stuff on this on the hedging side. You know, as we think about where your NIM could trend as rates start to move the other way here after benefiting from them moving up the last year. But, you know, taking into account some of the things that you've done.

22:35 How are you thinking about the core NIM trend over the next few quarters, assuming the consensus economic outlook is reasonably accurate and we start to get at least one or two cuts in the Fed funds?

22:48 You want me to take that one? Yeah, go ahead. All right. So you're right, Mike. If you go back and look, I'm looking at our schedule of net interest margin on a core basis here. We were, you know, like you said, in the 370s. We trended down in 2016 and 17 into the 360s and 350s, you know, high 350s. We started back up again into 380s in 2018. It kind of peaked out, I think, here at 393 for a couple of quarters and dropped back just a little bit this time to around 385. And I think if you look at our earnings release, we have our average balance and rates and yields table in there. And and you can see for the quarter and year to date what our spreads have been and what our margins look like. At June 30, and again this is a point in time, our spread was 351. For the quarter, our average spread was 364.

23:49 It's a little bit lower, but the difference in there to get back to the margin and that 351 does not include accretion income. that's excluding whatever accretion income we would look for.

24:03 And the 364 does, right?

24:05 Right, the 364 does, that's right. So, you know, roughly 12 or so basis points in there for that.

24:11 So, in other words, I think what Rex is saying is that our spread during the quarter during the second quarter was roughly equal to our spread point in time when you normalize for And to get from a spread to a margin, I think what you'd have to do is take the extent to which your average interest earning assets exceed your average interest earning liabilities and multiply that by the rate on your average earning liabilities to get to where you might be. I think I agree with Rex. I mean, that's probably the, as you guys want to put together what our margin is, I think that's the best tool you have is to use the point in time rates that we've given you and just calculate what you think it's going to be during the third quarter. Now, I think what we've told you is that we do think that interest rate decreases are going to be modestly are all modestly hurtful to us.

25:31 I don't think anybody expects it to be dramatic, but it's probably certainly not helpful and probably could hurt us slightly.

25:48 We've already seen some of the pain on the asset side with LIBOR moving down, so like I said before, we've seen some of our you know, overall loan yield come down a little bit. But, you know, if the Fed cuts, LIBOR's probably going to go down some more and so we'll continue to see perhaps some lower, you know, lower yield on our portfolio overall by a few basis points depending on, you know, the magnitude of the cuts and kind of what they say as far as anticipated future cuts or not.

26:20 Got it. Helpful. And then just the last one, you know, the tax rate in the quarter looked a little lower. Was that a result of the one-time pledging expense or something of that nature? And we'll turn to, you know, kind of where it's been in the last few quarters going forward, or is there something else going on that we should be thinking about?

26:41 No, there wasn't really anything particular that was, you know, flowing through there this quarter. I'd say it was just kind of normal generally. It is impacted a little bit by tax-exempt interest income and tax credit activities that we have as far as being able to utilize the credits and writing off the investment and stuff in those. I think what we've said, the rate for the full year, if you look at the six-month rate, that's probably in the ballpark of what our rate's going to look like as we get through the next couple of quarters, I would think.

27:18 Got it. Great. Thank you, guys. I appreciate you taking all my questions. Okay, thanks, Mike. Thank you. Our next question comes from the line. John wrote us from Jenny Montgomery. Your question, please. Good afternoon, guys.

27:33 Hi, John. Hey, Joe. So I guess when you were talking about loan trends, you said you're starting to maybe see some early signs of slowing in demand. Is that across the franchise or is that in certain markets? Could you just maybe clarify that a little bit?

27:51 I would say that that's more maybe across the franchise you know it just seems like and it's pretty anecdotal I mean that I guess the hard facts are our pipeline which you know we publish that's part of the press release and it's it's you know it's still pretty strong you know and that's probably what would fuel the lion's share of our loan growth over the next six months anyway, but I just feel like there's maybe a little bit less deal flow and so the competition is a little bit higher for every deal. That's kind of my general feeling. Now, on the other side for Great Southern, we've got two loan production offices that are basically are just starting, and they're just starting at zero, and we've got experienced lenders there.

28:53 So if we're able and as we're able to grow those offices, that will certainly help us grow our loans. For instance, Chicago, which I would still say is in its infancy, I think it's a couple years old or something, and they're at $120 million in loans. So if if Atlanta and Denver were able to perform like that over the next couple of years, that's a quarter of a billion dollars of loan growth right there. Also, our consumer loans have been going down more or less $10 million a month and that's obviously going to slow down because that portfolio is decreasing and eventually that's going to stop altogether because those loans will have paid off.

29:44 So, you know, we've got some positive things too. I was just more wanting to make a general statement about, you know, just my perception. And, you know, it's probably, I mean, it's a perception that's been formed over the last, you know, 60, 90 days. So it could be, you know, a result of customers being on summer vacation or whatever. It might be a bit seasonal. But, you know, I do, I mean, if you were asking me right now, I feel like the market is starting to, just the new deal flow is just starting to flow slightly.

30:24 No, Joe, I mean, that's helpful. That's great. And then, Rex, maybe just a quick question for you on the securities portfolio. So you saw the securities portfolio go up a little bit. Just sort of the plans going forward. It's what, roughly 6% of assets today. And I guess, do you plan to grow it much further from here? And especially, I guess, if deposits trend down more or don't go much higher?

30:50 Yeah, I mean, we just kind of watched that and we've been trying to grow it a little bit just from the standpoint of the types of securities that we've been putting in there are sort of intermediate type you know, term, fixed rate, multi-family agency type securities is a lot of what we've put in there. Help us with our, you know, to try to mitigate down rate scenarios, etc., but also provide a decent yield. The yield was more decent several months ago than it is today. So, you know, we're going to try to bring in a little, you know, a few more securities if we can as the market presents decent timing to do that as far as rates go and yields on those securities.

31:40 So I think we'll continue to see some growth in there, but I don't think it's going to be anything dramatic. We've probably grown that portfolio pretty decently over the last year or so. I don't think the growth will be at the same pace in the next six months that it's been in the last 12 months or so.

32:01 and it probably stays below 10% of assets, I would assume.

32:04 I would be.

32:06 Okay. Okay. Thanks, guys. Thank you. Our next question comes from the line of Stan Westhoff from Walthausen & Company. Your question, please.

32:18 Good afternoon. Hey, I just wanted to follow up a little bit on the big non-performing loan and then, I guess, subsequent Oreo asset now, I guess. How marketable is this property that you just got deeded over to you? How long do you think you might take to get it off the balance sheet, I guess?

32:45 Well, I mean, it's obviously hard to say exactly. I mean, we do think there's activity. It's actually really four pieces of property in all. three are in the central Missouri area and the ones in Iowa. I think there's activity on each of them and activity or certainly indication at level that would satisfy our investment in the asset. I think we feel pretty good about where we are right now. But, you know, we're not going to feel really good until they're actually sold.

33:34 Yeah, I mean, just looking back over time, you guys have not been afraid to hold on to real estate for a time and you've actually made quite a few big strides here in the last couple years here and got it down to, I guess, what would be a normal level. I mean, at one point, your Oreos were actually higher than your non-performing loans. What exactly happened with this property owner? Did he just bought up the land, got it somewhat developed, and it didn't pan out the way he planned on it?

34:06 The relationship, as we pointed out in the earnings release, is maybe 12 years old. It was a development that didn't go well, and the person continued to try to market and sell the property. And in the interim, we've been insisting on semiannual principal reductions. And eventually, the customer just got to the point where they didn't want to make those reductions. And, you know, we just reached a resolution then.

34:46 All right. Let's go ahead. Take my question. Thank you. Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Joe Turner for any further remarks.

35:00 No, I don't have any further remarks. We appreciate everybody being here or being on the call and look forward to next quarter's earnings call. Thank you.

35:09 Thank you. Thank you. Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.