Great Southern Bancorp (NASDAQ:GSBC) Q4 2018 Earnings Call

0:01 Good day, ladies and gentlemen, and welcome to the Grace Southern Bancorp, Inc. Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question-and-answer session, and our instructions will be given at that time. If during your conference days you require operator assistance, please press star then zero, and our operator will be happy to assist you. As a reminder, this conference call may be recorded for replay purposes. It is now my pleasure to hand the conference to Mr. Kelly Polonis, Investor Relations. Ma'am, you may begin.

0:30 Thank you, Brian. Good afternoon and welcome. This is Kelly Colonis, Investor Relations for Great Southern. The purpose of this call is to discuss the company's results for the quarter ending December 31st, 2018. Before we begin, I need to remind you that during the course of this call, we may make forward-looking statements about future events and future 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 the forward-looking statements disclosure in our fourth quarter 2018 earnings release. President and CEO Joe Turner and Chief Financial Officer Rex Copeland are here with me. I'll turn the call over to Joe Turner.

1:22 Thanks, Kelly. Good afternoon, everybody. and I also want to thank you for joining our earnings call this afternoon. As usual, I'll provide some preliminary remarks and then Rex will go into the release in a little more detail. Hopefully, you've had a chance to review the release. If you have, you've seen that we had a very solid quarter and year for that matter. During the fourth quarter, we earned $17.3 million or $1.21 per share. For the fourth quarter, our return on average common equity was 13.34%. Our annualized return on assets was 1.5%, and our margin was 4.07%. We did earn about almost $700,000 during the quarter from income on an interest rate swap that was entered into in October, net fees associated with one-time fees associated with entering into that swap.

2:23 That added about a penny and a half to our earnings. We continue to feel very positive about the loan portfolio, both in terms of production and in terms of quality. Our loans grew $46 million during the quarter, $263 million during the year. In spite of $42 million of paydowns in the acquired loan portfolio, and I think like $106 million of paydowns in the consumer portfolio as we continue to see that portfolio pay down. Really good healthy loan growth, great commercial loan origination volume, $1.35 billion of new originations across our footprint.

3:13 Atlanta and Denver offices were open during the quarter. and they're of course staffed by industry veterans and we're excited to see what they'll do in 2019. Our loan pipeline continues to be good, up about $140 million from the end of the year. Importantly, closed construction loans were up $204 million from the end of the year and up about $78 million from the end of the third quarter. and so forth. Asset quality continues to improve as well. Coming out very good numbers in the third quarter. Non-performers actually reduced by about $4 million to $11.8 million.

3:58 I think at this point we're something less than one quarter or 1% non-performer ratio to assets. We feel very good about where that is. – common stockholders' equity grew $60 million during the year. Of course, almost – not quite $10 million of that relates to mark-to-market gain on the swap that I mentioned earlier, but even without that, our common stockholders' equity grew $50 million. Our book value per share increased from 33.48 to 37.59.

4:44 Our ratio of tangible common equity to tangible assets is 11.2%. And we were calculating earlier today, even if you were to net the $9 million of mark-to-market gain-off and the approximate $10.5 million that we're going to pay for the special dividend that we announced earlier today, we'd still be 10.7% or 10.8% tangible common equity ratio. So a very strong capital position. We did repurchase 17,542 shares of stock during the quarter at an average price of $51.52. As I mentioned, we probably more importantly just announced our intent to pay a special dividend of $0.75 a share.

5:35 I think this underscores our commitment to return value to shareholders. That concludes my prepared remarks. I'll turn the call over to Rex Copeland at this time.

5:49 Thank you, Joe. I want to talk first a little bit about net interest margin. We mentioned some things earlier about this, but our core margin, which excludes the FDIC acquired loan portfolio accretion for the fourth quarter was 3.93%, which is 25 basis points higher than a year ago quarter and five basis points higher hired in the third quarter of 2018. Primary driver for the expansion versus the year-ago quarter is just some growth in the loan portfolio and also increasing interest rates. What kind of drove the expansion between the third quarter and the fourth quarter of 2018? A lot of it had to do with the interest income on the swap that was mentioned earlier.

6:41 So just a couple of things to clarify on the swap interest income. We will receive on this swap roughly 3.02% as a fixed rate that we will receive on it. It will pay one month LIBOR rate. So as of today, one month LIBOR is around 251. We are still in a position, and it resets every month, so we're still in the position where we would receive net payments. Now, if the one-month LIBOR rate moves higher, we'll receive less, or we could even end up having to pay net settlements on that. As Joe said, in the fourth quarter, we did record $673,000 of interest income related to the swap.

7:31 We've indicated kind of along those same lines, we've indicated in our past filings that rising interest rates may have a positive, you know, modest positive effect on our net interest income and margin, and that's been borne out so far as rates have moved higher, but as competition is significant for deposits, you know, we would anticipate that, you know, we may have a little bit of headwinds to margin improvement just because of higher funding costs from deposits and, of course, our borrowings outside of deposits that we utilize to fund our assets are really going to be kind of affected by changes in short-term LIBOR rates primarily.

8:17 Non-interest income for the quarter decreased by about $154,000 compared to the fourth quarter a year ago. We did have the largest decrease in that and the really most significant item was in gain on loan sales. Historically, we've sold fixed rate loans that we've originated, one to four family loans in the secondary market, both to gain on those at the time. Then more recently in 2018, we primarily have originated and more hybrid ARM type loans and so we've been holding those in our portfolio primarily and so we have not originated and sold as much of the longer term fixed rate loans in 2018.

9:03 Non-interest expense, our non-interest expenses were lower compared to the fourth quarter last year and a little bit higher compared to the third quarter of 2018. We continue to focus on efficiency and cost containment. Our core operating expenses, I think, are staying relatively stable, even as we've been able to grow our assets over the last year. The efficiency ratio in the fourth quarter was 55.6% and was 56.4% for the full year. We'll see some additional, you know, the full cost of the newest LPOs in Denver and Atlanta will start in the first quarter of 2019, but we expect that they'll begin covering those operating costs relatively soon.

9:50 Kind of going along with efficiency a bit, and this is not a large item, but we did mention that we are going to be consolidating an office in Arkansas, in Fayetteville, Arkansas, into our Rogers, Arkansas office. That'll be occurring here fairly soon. So we will have one office in Arkansas once that's completed, the one in Rogers. That was all the things that I had to cover. At this time, we'll entertain questions, and let me ask our operator once again to remind the attendees on how to queue in for questions. Thank you, sir. My pleasure. Ladies and gentlemen, at this time, if you'd like to ask a question over the phone, please press star and then 1 on your telephone keypad.

10:36 If your questions have been answered or you wish to move yourself from the queue, simply press the pound key. And our first question will come from the line of Andrew Leisich with Sandler O'Neill. Your line is now open.

10:46 Hey, guys. Good afternoon. Good afternoon, Andrew. Just some questions here on expenses. If I just maybe take out the charge or the fee for entering into the swap as well as OREO costs get right around $28 million. Now I'm guessing there's maybe a step up here in the first quarter for payroll taxes and bonus accruals. But beyond that, is $28 million a decent run rate for the expense base going forward?

11:19 I mean, probably reasonable in that. If you're going to exclude the ORE, I mean, that can be kind of choppy. So, you know, if you're going to exclude that from it, I mean, there will be some expenses there. We still do have some, and there are some expenses associated with it. So there would be some component of that,

11:39 you know. Yeah, we have, you know, Andrew, I mean, a number of our folks get read that have employment reviews annually, and so – raises probably kick in at that point. So there may be some increase there as well. We always try to highlight anything that we see as unusual or out of pattern, and we haven't. We didn't highlight anything really other than the swap fee. Okay.

12:18 And then just on the margin, the swap certainly was beneficial this quarter, but it seems like maybe the margin would have been fairly stable. Is that kind of your outlook going forward? I know you cautioned for rising deposit costs, but you're also doing a good job of getting stronger loan yields as well. So, I mean, if we kind of assume that, for now anyway, that the swap is accretive versus where we might have been previously forecasting, I'm sure the margin may be better now than what it was, say, four months ago.

12:53 Yeah, well, I mean, I would say this, Andrew. I mean, we didn't put the swap on to be, I mean, it's a benefit that it's initially accretive, but, you know, the purpose of the swap from our perspective is, you know, we told you we're slightly asset sensitive, which means that rates, if and when rates come down, would be hurt modestly. And so we put that swap on the books to benefit us when rates begin to fall. So, you know, that's number one. I mean, that, you know, that was not a, it was not really, we didn't put the swap on, a $400 million swap on the books to try to pick up $500,000 or $600,000 a quarter of additional interest income.

13:42 But, you know, as far as As far as margin goes, we haven't highlighted anything really different. The one thing I would say is that really most of the benefit from rising interest rates, because our loans are generally tied to LIBOR, most of the benefit happens prior to the Fed rate increase. – LIBOR is going to increase in anticipation of a rate increase. I would say most of the pain, the increase in deposit costs, happens subsequently.

14:26 I think you can kind of think of it like this. Probably like $1.4 billion or something like that of our loans are tied to one month LIBOR. So you can kind of see a large portion of our loan portfolio is going to be reflected by however one month LIBOR is moving around. Likewise with the swap, you can kind of figure out what our spread is going to be on that swap based on one month LIBOR. The part that's maybe not as clear is if we're generating some fixed rate loans that maybe they have a three to five year maturity or something like that. depends on what the fixed rate is, you know, that we're able to generate on that.

15:13 On the liability side, the borrowings and things that we have are going to be a lot tied primarily to one-month LIBOR rates, generally speaking. And, you know, deposits, like Joe said, we do have a bit of a lag on some of our deposits, especially CDs in particular, because maybe we have a CD that was originated, you know, a year ago. It's getting ready to come up for maturity. It's a one-year CD, and so A year ago, the rates were probably lower than what they are going to be today. There still may be yet some additional costs associated with deposits repricing up a little bit as they mature and replace.

15:55 I guess long-winded answer is saying we're not promising there couldn't be some contraction. There could possibly be some contraction, but we're trying to We're pulling every level we can, you know, negotiating for higher yields on loans, you know, trying to, you know, pay as low a rate as we can on deposits. We're doing everything we can.

16:20 Gotcha. Yeah, that's very helpful. Thank you so much. Thank you. And as a reminder, ladies and gentlemen, to ask a question for the star than one, Our next question will come from Michael Torito with KBW. Your line is now open.

16:37 Good afternoon. Hey, Mike.

16:42 I was, you know, I've been looking kind of at the loan growth production, you know, and it seems like the last couple years specifically the construction portfolio has seen fairly accelerated growth and, you know, I'm curious, I guess, you know, where I guess I have a handful of questions related to that. I guess one, you know, if you think about The percentage of the portfolio that's now in construction, which to me seems like if I'm looking at your filings from last quarter, it seems like it's north of 20%. How do you guys think about that number in terms of managing the concentration there? What do you think is a number where you – the range, I guess, where you feel comfortable bringing that construction exposure to as you continue to try and grow moving forward?

17:23 Mike, I'm looking at our portfolio report that we file every quarter, and we filed, I think, yesterday or today – and it's showing our construction land development at 17% of the portfolio. I think based on where we are, based on the way we underwrite those loans, the quality that we believe those loans are, we would believe we got quite a lot more runway there. We really like the the quality of the business. It's diversified geographically. It's diversified across property types. And we really think we have very high quality borrowers there. So, you know, I think we have a fair amount of runway there.

18:18 What's the difference between... I'm looking at the filing, though, and I see that if I sum up the four lines in the 10Q of the one to four family residential construction, the subdivision construction, land development, and Commercial Construction, it's like 1.4 billion, but that would seem to be a different number than the construction in the 8K that you guys filed last night. Do you know what the different segmenting is that makes up that difference?

18:49 That listing that you had may be, I have to look back and see, that may be gross. Does it include unfunded? It could be unfunded, perhaps.

18:58 Okay. That makes sense. And then I guess, can you remind us, I guess just a little bit, give us a little bit more rather about the construction portfolio just from a metric perspective like average credit size and what the typical yield is in that portfolio today?

19:19 I don't know that we've filed any of that. Mike, you know, I can tell you that we do that will typically do loans from $3 million to $15 million. Those are going to be variable rate loans. I would say at the very low end, $250 million over LIBOR. I'd say more typically $275 million, $300 million, $3.25 million over LIBOR. and I can't remember what else did you say besides pricing and... No, that... Well, you're asking about the yield.

20:04 Yeah.

20:05 Yeah. And then I guess my last question on the topic is just, you know, and the reason I'm asking really overall is I'm trying to get a better sense and obviously you guys did the special dividend which, you know, helps on the capital front and, you know, relative to peers, your capital levels still seem pretty healthy and I guess what I'm trying to understand is what's the right kind of number to be thinking about in terms of, you know, capital that would be deemed access. And, you know, I mean, as I try to think about, you know, the regulatory guidelines, I think it's, you know, with the risk weightings relative to the construction exposure, which I think is supposed to be less than 100%, I'm just trying to think about how you guys are thinking about that capital position and how much of it is, you know, we should really be considering as potentially dry powder for additional action, whether that be M&A, share purchases, organic growth, dividends, or capital that needs to be held as you guys continue to grow that construction portfolio.

21:02 Right, right. That's a good question. I mean, we're probably not going to get down to a number, but I would say this, Mike, you hit the nail on the head with our loan portfolio, heavy commercial real estate, construction, multifamily, you know, that's a portfolio that regulators do expect to see some, you know, higher level of capital. So given that, you are probably going to see a little higher capital levels out of grade seven than you might see, you know, other banks our size. But having said that, you know, we think based on our capital levels, where they are, you know, post payment of the special dividend, Based on what we believe are our operating prospects, based on what we believe about the quality of our loan portfolio, we still believe we have a very strong capital position and are going to continue to be in a position to grow the company organically, to consider acquisitions, to consider or buy additional shares. as we see shares priced at a level that we like and to consider more special dividends. So I guess what I'm saying is we don't believe we've fired our last bullet here. That's not the perception that we have.

22:35 Okay. That was very helpful, Joe. Thank you. And I guess just to wrap it up, just on that incremental capital deployment, I mean, it sounds like you guys are fairly agnostic. I mean, is it just really, you know, obviously see at the end of every – and the next year comes around, you'll see where capital levels are at. You know, during the course of the year, you'll use share of purchases modestly as the market permits and then kind of consider any dividends on top of your regular dividend at that point. Is that kind of a fair way to think about how you guys are approaching it or should we think about something else?

23:06 No, I think that's fair.

23:08 Okay. Great. Well, thank you guys for the call and for taking my questions. I appreciate it. Okay. Thank you, and I'm showing no further questions at this time. So now it is my pleasure to hand the conference back over to Mr. Joe Turner for any closing comments or remarks.

23:25 All right. Well, we appreciate everybody attending the conference today, and we'll look forward to talking with you in three months. Thank you. Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program, and we may all disconnect. Everybody have a wonderful day.

23:41 Thank you.