GSBC 2023Q3

Hello and welcome to Great Southern Bancorp, Inc. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to Kelly Polonus. You may begin.

Thank you. Good afternoon, and thank you for joining us for our third quarter 2023 earnings call. The purpose of this call today is to discuss the company's results for the quarter ending September 30, 2023. 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 financial performance. 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 third quarter earnings release and other public filings. President and CEO, Joe Turner and Chief Financial Officer, Rex Copeland are on the call with me. I'll now turn the call over to Joe.

All right. Thanks, Kelly and good afternoon, everybody. We appreciate you joining us today for our third quarter earnings call. Our third quarter performance was solid, but down a bit as you saw, as we continue to navigate through a challenging operating environment. We earned $1.33 per diluted common share or $15.9 million compared to $1.46 per diluted common share or $18.1 million during Q3 of 2022. Earnings performance ratios were again solid with an annualized return on assets of 1.11% and an annualized return on equity of 11.47%. We mentioned on our last couple of calls some anticipated headwinds that we would face related to net interest margin. Net interest margin did decline to 3.43% for the third quarter compared to 3.96% for the same period in '22, and 3.56% for the second quarter of '23. The margin contraction primarily resulted from increasing interest rates on all deposit types during the third quarter and a full quarter's impact from net settlements related to two interest rate swaps. Like many banks in 2023, we have experienced much higher deposit costs compared to 2022 reflective of increasing market interest rates and significant competition for deposits. Deposit costs again moved higher in the third quarter of '23 but the pace of increases moderated compared to the second quarter. Rex will provide some color around our funding costs and deposit mix during his presentation. Also as you know, we had an ongoing significant professional fee expense item, totaling about $900,000 related to training and implementation costs of the upcoming core systems conversion. As far as liquidity and capital, our liquidity and capital positions continue to be strong. At the end of September '23 available secured funding lines through the Home Loan Bank and the Federal Reserve Bank and on-balance sheet liquidity were approximately $2.2 billion. As noted last quarter, our company's deposit base is diverse, and by customer type and geography and has a low level of uninsured deposits; approximately 16% of our total deposits are uninsured, excluding internal subsidiary account. Total stockholder's equity decreased by $1.4 million from the end of '22 and decreased more substantially by about $14.6 million from June of '23 as a result of increased unrealized AOCI losses due to market interest rate increases in the third quarter of '23. Importantly though, the retained earnings component of our stockholder's equity has increased $20.8 million during the nine months ended September 30, 2023. Our capital remains substantially above regulatory well-capitalized thresholds, and our tangible common equity ratio was 9.1% at September 30, '23. In the third quarter, the company declared a $0.40 per share common dividend; in addition, in our effort to enhance long-term stockholder value, the company continued to repurchase shares of common stock during the quarter. We bought back almost 107,000 shares at an average price of $50.52. The dividend and stock repurchases combined reduced stockholder's equity by about $10.1 million during the third quarter. At September 30, 2023, about 801,000 shares were available in our stock repurchase authorization. During the third quarter, new loan production and general activity were down compared to 2022 as expected. Total outstanding loan balances modestly grew by about $58 million since the end of 2022. Growth primarily came from the multi-family loan segment, much of this from projects completed and moved from the construction category to multifamily and commercial business loans, partially offset by a reduction in the commercial real estate category. At the end of September 2023, the pipeline of loan commitments and unfunded lines declined to about $1.4 billion, including $922 million in the unfunded portion of construction loans. For comparison, at the beginning of 2023, loan commitments and unfunded lines totaled about $2.1 billion, with $1.4 billion in unfunded construction lines. For more information about our loan portfolio, I'll remind you of our quarterly loan portfolio presentation that we have on file with the SEC and is available on our Investor Relation site under the Presentations link. Our quarterly loan presentation provides helpful information regarding our loan portfolio mix, by type and geography. Overall, our commercial portfolio is strong, diverse, and performing well. As expected, we are experiencing some payoff activity. Overall, credit quality metrics remained strong during the quarter; non-performing assets to total assets were 0.19% at September 30, 2023, decreasing by 1 basis point from June 30, 2023. Delinquencies in our loan portfolio continue to be at historically low levels, and more information about our non-performing and potential problem loans are included in our earnings release. That concludes my prepared remarks. At this time, I will turn it over to our CFO, Rex Copeland.

Thank you, Joe. I appreciate that. I'll start the discussion regarding net interest income and margin. Generally, like others, our comparisons for net interest income in the third and likely the fourth quarters of this year will show declines from the same periods in 2022. Market interest rates increased significantly in 2022, allowing us to raise rates on assets faster than liabilities, resulting in peak net interest income and net interest margin in the latter half of 2022, which extended slightly into the first quarter of 2023. Since then, though, some of our net interest income and margins have decreased as previously mentioned. For the third quarter of 2023, net interest income dropped by $6.2 million, about 11%, to $46.7 million, down from $52.9 million in the same quarter of 2022. This decline was mainly driven by rising interest rates on deposits in the third quarter of 2023 and the adverse effects of interest rate swaps that began settling in the second quarter of 2023, which did not impact the quarters in 2022. Specifically, those swaps had a negative effect of $2.7 million in the third quarter of 2023. Net interest income for the second quarter of 2023 stood at $48.1 million, showing a decrease of about $1.4 million between Q2 and Q3 this year. The new settling of interest rate swaps negatively impacted the third quarter by approximately $1 million more compared to the second quarter. Our net interest income was also hindered in the third quarter by strong competition for deposits in the industry and local markets. A significant number of time deposits maturing at relatively low rates in the second quarter of 2023 have now been renewed at higher rates, affecting all of Q3. We also faced higher-than-normal reductions in non-interest bearing deposits in the first quarter of 2023, which moderated in Q2 but increased slightly again in Q3. Customer balances in both checking account types have fluctuated this year. As market interest rates for some account types and time deposits have risen, some customers opted to move funds to higher-rate accounts. We anticipate more low-rate time deposits will mature in the fourth quarter of this year than in the third, but not as many as in the second quarter of 2023. The expected difference in rates on maturing time deposits for the fourth quarter compared to renewal rates isn’t as significant as it was in the second quarter, but there should still be some increase. We noted in our recent release that over the next 12 months, we expect time deposit maturities to amount to approximately $354 million within three months at an average rate of 3.16%, $352 million within three to six months at about 3.88%, and $350 million within six to twelve months at around 3.93%. Based on current replacement rates, we anticipate they will be replaced with rates of approximately 4.25% to 4.75%. In addition to higher funding costs on deposits, net interest income was further negatively affected by interest rate swaps as mentioned. If current market interest rates persist, these swaps will continue to adversely impact net interest income. For the fourth quarter of 2023, the negative influence from all interest rate swaps is anticipated to be about $3.7 million, while for the third quarter it totaled approximately $3.5 million. One of the swaps is set to terminate on March 1, 2024, and this specific swap negatively impacted net interest income by $2.8 million and net interest margin by 21 basis points in the third quarter of 2023. Moving forward, it is expected to have a negative impact of about $2.9 million in the fourth quarter of 2023 and $1.9 million in the first quarter of 2024, with no further impact afterward. As Joe mentioned earlier, net interest margin stood at 3.43% in the third quarter of 2023, down from 3.96% in the same period of 2022, reflecting a decrease of about 53 basis points, and down 13 basis points compared to 3.56% in the second quarter of 2023. When comparing yield rates between the third quarters of 2023 and 2022, the average loan yield increased by approximately 113 basis points, while the average rate on interest-bearing deposits rose by about 203 basis points. Regarding liquidity, our levels remain strong with readily available funding sources totaling about $2.2 billion as of the end of September 2023, which includes about $1.1 billion available at Home Loan Bank. We also have over $500 million in unpledged securities available for pledging if necessary. As of September 30, 2023, total deposits approached $4.9 billion, showing an increase of about $27 million over the three months ending that date. Total brokered deposits saw a minor decrease of less than $1 million during this period. Deposits generated through our banking centers and corporate services increased by $21 million, while those from internet channels fell by $5 million in the third quarter. Interest-bearing checking balances rose by $49 million, approximately 2.3%, while non-interest bearing checking balances dropped by $38 million, about 3.9%, during the same period. Regarding non-interest income for the quarter, we saw minimal variances, with a total decrease of about $132,000 compared to the third quarter of 2022. We experienced an overall increase in non-interest expenses of about $799,000, reaching $35.6 million. Notable variances include increased salaries and employee benefits by about $697,000 due to annual merit increases, particularly in lending operations. Additionally, deferred compensation costs related to originated loans dropped by $233,000 as loan origination volumes were lower this year than in 2022. We also saw an increase of about $531,000 in occupancy expenses compared to the previous year due to various computer license and support costs that are now being implemented. Other repairs and maintenance expenses added about $106,000 more than the previous year. Our total insurance expense increased by $498,000 year-over-year mainly due to announced increases in deposit insurance rates for the FDIC deposit insurance fund. We anticipate continued elevated expenses, around $180,000, in the fourth quarter, though we expect to normalize following that. Legal, audit, and professional fees decreased by $390,000 from the prior year, compared to a one-time fee expense from the previous year related to interest rate swaps. Additionally, there were about $150,000 in non-recurring type expenses during the third quarter related to various services that we do not incur every quarter. The efficiency ratio for the third quarter stood at 65.13%, compared to 57.09% in the same quarter of 2022 as expenses rose slightly while net interest income declined. During the third quarter of 2023, we did not record any provision expense on our loan portfolio, in contrast to $2 million recorded for the same period in 2022. For the three months ending September 30, 2023, we recorded a negative provision for losses on unfunded commitments of $1.2 million, compared to a provision expense of $1.3 million in the same period in 2022. Our total level of unfunded commitments has decreased, allowing us to relieve some reserves. Total net charge-offs were $99,000 for the three months ending September 30, 2023, compared to $297,000 in the same period a year earlier. At the end of the third quarter of 2023, the allowance for credit losses as a percentage of total loans stood at 1.40%. In terms of income taxes for the three months ending September 30, 2023 and 2022, the effective tax rate was 21.5% this year and 20.5% last year. These rates were near or below the federal statutory rate of 21% due to the use of investment tax credits and certain tax-exempt investments. We anticipate the effective tax rate will be between 20.5% to 22.0% in future periods, influenced by overall earnings levels and the utilization of tax credits and tax-exempt income, along with state tax expenses. These estimates may evolve over time and can affect the overall effective tax rate, as well as the various state taxing authority expenses. That concludes the prepared remarks for today, and we will now welcome questions from the attendees.

Thank you. Our first question comes from Andrew Liesch with Piper Sandler. Your line is open.

Good afternoon, everyone. I want to focus on the margin. It seems like there has been more CD repricing, and based on the statement in the release and what you shared today, 13 basis points might be a bit high for the fourth quarter. I'm curious about your outlook on the margin this quarter and whether it should stabilize thereafter. I know there's additional CD repricing coming, but with the Fed likely finished with rate increases, do you anticipate some stabilization in the margin as well?

I can give it a try and then Rex can add on. Andrew, it's a bit challenging to make a definitive statement because just when it seems things are about to stabilize, new deposit specials emerge. However, regarding our CD repricing, we're at a point where the CDs we're repricing are significantly below the market rate. The other CDs that we repriced, which are three to six months out and six to 12 months out, might be slightly below market but not by as large a margin, so they shouldn't have as much of an impact. We also anticipate that interest-bearing checking and non-time interest deposits will continue to reprice. We have fixed-rate assets that are also repricing, which should be beneficial. Nonetheless, it's difficult to pinpoint this exactly.

We have noticed that competition has calmed down for a bit, but some banks in various areas where we operate are offering rates above 5%. This mainly applies to certain products like CDs. This situation tends to fluctuate. In the upcoming fourth quarter, around $350 million worth of CDs will reprice, currently averaging about 3.16%. We expect to adjust those rates to the low 4% range. Additionally, other rates are in the high threes, approaching 4%. If conditions remain the same after the fourth quarter, the rate differences will likely be less than what we experienced, such as in the second quarter when we adjusted rates from the twos back into the 4% range.

I would say it feels better, Andrew, but it's just hard to pinpoint it exactly.

Got it. Well certainly that repricing gap is narrowing. You mentioned that the fixed rate assets that are repricing now, I guess. Do you have handy that percentage of or the dollar amount of fixed rate assets that have yet to benefit from the Fed's rate hikes since the beginning of last year?

We don't have that information, and I don't think Rex does either, Andrew, but we do have good disclosures in our K and also in our Qs regarding repricing, Rex?

The 10-K that we filed at the end of the year includes a maturity table for the first five years and beyond, along with a repricing table. We have fixed rate loans and variable-rate loans presented in two separate lines, which should give you a sense of the figures. While I don't have the exact number offhand, it's several hundred million dollars that likely hasn't repriced yet, particularly the mortgages.

That will reprice in the next year or so.

Well, they won't. That will happen next year. But…

Yeah.

I'm just thinking about some of our hybrid ARM product.

Yeah.

It's going to be fixed for a few years and then…

I would direct you to the 10-K table, Andrew, as it will provide you with valuable information.

Got it. Very helpful. I will do so. Thanks so much, and I will step back.

Thank you. Please standby for our next question. Our next question comes from the line of Damon DelMonte with KBW. Your line is open.

Hey. Good afternoon, guys. Hope you're both doing well today. Just wanted to kind of keep on the margin topic here. Could you give a little color as to like the rates at which these construction loans are funding that are in the pipeline right now? And then possibly like what new production is coming on?

I would say, generally, and this would be the rates that the loans are funding at, and the new production would probably be somewhat similar. I would say anywhere from 250 over SOFR to 300 would be kind of the rate.

At the end of September, in our press release, there are a couple of tables showing average balances and rates. The portfolio of construction loans had a rate of 7.89%.

Yeah.

Assuming that that sort of…

Yeah.

Indicative of what will become.

I would say new production is slightly higher than that, likely around 250 over SOFR or something similar. There may be some lower rate items included. Generally, I believe the overall rate could be a bit higher, but it’s likely to be in that range.

Got it. Okay. Thank you. And then how would you characterize the positioning of the balance sheet, should the Fed start to cut rates in the back half of 2024?

I think we're fairly well balanced. We tend to think of ourselves as asset sensitive. But we took that asset sensitivity off the table with those swaps that we began net settlements on in May. And so, I think we're reasonably neutral, would you say that, Rex?

It really depends on how steep the cuts are. If they are implemented gradually and in a balanced way, it should be manageable. However, if they happen quickly like they did in 2020, it could be problematic. With the potential for significant decreases, the economy could take a considerable hit.

Yeah. So the speed of rate cuts would be what would probably factor in a lot to that for us, but assuming that the Fed cuts in 25 or 50 increments and does it in a fairly, non-dramatic way that probably is not overly bad for us.

Got it, okay. And then with respect to your outlook for loan growth. How do you feel about non-construction related CRE? Are you originating loans that don't go through the construction process and kind of, I know, you gave some color on the construction pipeline and kind of where it is today versus like a year ago, I think it was. But how do we kind of think about overall loan growth and the drivers of that?

I mean, I think, loan growth will continue to be fairly modest, Damon, because, that I think that us taken a hard look at it, but I think it's also our customers taken a hard look at it. We had a meeting yesterday and one of our senior lenders thought that our customers to a large extent had their pencils down right now. I mean that they're struggling to make sense out of these rates and so they're just going to wait for a little while. So I think in light of that loan growth is going to be pretty tepid.

Got it. Okay. And then just lastly if I could squeeze one more in, I mean, you did buy back some shares this quarter and you've kind of been doing that consistently in previous quarters. Is it fair to kind of assume that given current pricing levels, you will continue to be opportunistic since you have some dry powder left on your current authorization?

I think so, yeah. I mean, I think we'll continue to be strategic about it, but yeah, I think we are, we continue to be interested in that.

Great. Okay. That's all that I had. Thank you very much.

Our next question comes from John Rodis with Janney. Your line is open.

Hey, guys. Good afternoon.

Hey, John.

Hope you all are doing well. Rex, I wanted to revisit your comments on the expenses, which were helpful. Regarding the system's conversion, is that still expected to happen in the middle of next year? Is the added expense of $900,000 to $1 million still projected to continue through roughly the second quarter of next year?

Yes. That should continue on.

Okay. In the press release, you mentioned some disagreements. Are there any financial damages that could be addressed, or am I misunderstanding that part?

Yeah, John. I mean we don't have a lot of color to provide beyond what was in the press release. We're just, as we said, we have some contract disputes and we're in the process of trying to work through those.

Okay. Rex, you mentioned some line items. If I heard you correctly, non-recurring expenses for the quarter were around $150,000. You also indicated that occupancy costs should remain elevated, while insurance costs may be slightly higher now but are expected to decrease in the fourth quarter. If we consider the third quarter expenses and adjust for that $150,000 to perhaps $200,000, is that how we should approach estimating expenses for the fourth quarter?

I believe the deposit insurance will remain high in the fourth quarter at around $180,000 and should decrease in the first quarter. The $150,000 in legal and professional fees was for some additional services, so that amount should decrease in the fourth quarter.

Okay. So, but other than that the other items are sort of as is and sort of a good run rate going forward, is that right?

Yeah. I don't think there's anything else that I noted in there that was sort of a one-off or unusual.

Okay. Just two more questions, just securities portfolio was down or maybe a little bit more than I would have expected. Should we expect some continued run-off going forward in the securities portfolio?

I think, I mean what was down in there probably, John, is just the unrealized loss being higher. I don't think, I mean we've got a little bit of cash flow coming off of it, but it's not big cash flow. So I would think that the securities portfolio is not going to change a lot in the next quarter or two.

Okay. But you are not putting new money to work in there either right now. Correct?

We have not so far much this year. No.

Okay. I have one last question for either Joe or Rex. Considering the net charge-off levels for your company and the industry over the past few years, they've remained under 10 basis points. Last year, yours was around 1 basis point, and the year before that, it was 0 basis points. You’ve even experienced net recoveries. My question is, given the current environment and what you're observing in your portfolio, do you anticipate that net charge-offs could exceed 20 or 30 basis points based on your current outlook?

We feel very positive about our credit portfolio, John. I'm not overly focused on what I see at the moment. After being in this business for a long time, I am a bit skeptical about believing we have resolved all issues and that there won't be any net charge-offs in the future. It is quite unusual in banking history to have net charge-offs this low. Currently, I don't see anything in our portfolio that suggests we will experience significant net charge-offs. However, looking at the historical context, I don't believe we have completely figured it out. That said, I do recognize that underwriting has improved significantly over my 30-year career, which is definitely a positive development.

So you're saying, a lot of people learn from '08, '09, I guess.

I think so, us included.

I hear you. No. I just wanted to throw that out there. I mean, that's a good shot. So I appreciate, guys. Take care. Thank you.

Okay. Thanks, John.

Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Joe Turner for closing remarks.

All right. Thanks everybody for joining us on our call, and we'll look forward to talking to you for our Q4 earnings release in January. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.