GSBC 2022Q3

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Great Southern Bancorp Incorporated Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please see our forward-looking statements disclosure in our third quarter 2022 earnings release for more information. President and CEO, Joe Turner; and Chief Financial Officer, Rex Copeland, are on the call with me today. I'll now turn the call over to Ms. Kelly Polonus. Ma'am, please begin.

Thank you, Howard. Good afternoon and welcome. The purpose of this call is to discuss the company's results for the quarter ending September 30, 2022. Before we begin, I need to remind you that during this call, we may make statements about future events and financial performance. Please do not place undue reliance on any forward-looking statements.

Thank you, Kelly. Good afternoon, everyone. We appreciate you joining us today for our third quarter earnings call. Our third quarter earnings showed continued strength, building on our momentum from the second quarter. We are focused on positioning our company effectively amidst the changing interest rate environment. As always, we aim to foster long-lasting relationships with our customers and make decisions that benefit all our stakeholders in the long run. I am proud of our dedicated team who works hard every day to achieve this goal. I will provide some brief comments about our performance before handing the call over to Rex Copeland for more detailed financial results. Then we will open the floor for questions. In the third quarter of 2022, we reported earnings of $18.1 million or $1.46 per diluted share, compared to $20.4 million or $1.49 per diluted share in the same period of 2021, reflecting a decrease of $2.3 million year-over-year. However, the factors contributing to this result varied significantly between the two quarters. In the third quarter of 2022, we generated $8 million more in net interest income than the same quarter last year, even after accounting for $1.6 million in PPP fee accretion in the 2021 quarter. The primary factor influencing the difference between the two quarters was the change in provision expense, which amounted to $3.3 million this year, contrasted with a negative provision of $2.4 million in the previous year—resulting in a swing of $5.7 million. Noninterest income decreased by about $1.8 million this quarter, primarily due to lower gains on loan sales. Our operating expenses increased by $3.4 million compared to the third quarter last year, with about $1.1 million of that increase relating to professional fees associated with our conversion efforts discussed in previous quarters, as well as nearly $400,000 in professional fees linked to a swap agreement we entered into this quarter. Salaries and employee benefits rose by approximately $1.1 million in Q3 2022 compared to Q3 2021, with roughly $300,000 of that related to our newly opened loan production offices. The remaining increase is primarily due to additional staffing and higher compensation levels reflective of the current employment market. Looking at our reported pretax, pre-provision earnings, we realized $26.1 million in Q3 2022, compared to $23.4 million in Q3 2021, an increase of $2.7 million, despite a 9% lower share count—13.6 million diluted shares in 2021 versus 12.4 million this year. Our earnings ratios are robust, showing a 13% return on equity and a 1.30% return on assets. Our margin now stands at 3.96%, up from 3.36% in the same quarter last year and 3.78% in the second quarter of 2022. The Federal Reserve has indicated potential further rate increases, possibly around 75 basis points soon, followed by another 50 basis points later on. During a rate increase cycle, we typically expect to see benefits from continued rate hikes, although we believe a significant portion of the margin benefits has already been realized. Regarding loans, our production and market activity remain strong, with net loans having grown approximately $490 million since the start of the year. Our pipeline has also expanded by over $400 million this year, indicating a robust loan origination environment. However, we foresee a slowdown in loan activity due to rising interest rates and cap rates. We are well-positioned with $1.4 billion, or really $2 billion, in unfunded commitments, including $1.4 billion in construction commitments expected to be funded over the next 15 months. Our asset quality metrics remain historically strong, with nonperforming assets at $3.4 million at the quarter's end, down $2.6 million from year-end and representing just 0.06% of total assets—very low figures. Our levels of past due accounts, charge-offs, and similar metrics are also at minimal levels. Capital-wise, we started the year in a strong position and continue to maintain a healthy capital base. Our tangible common equity to tangible asset ratio stands at 8.8%, slightly down from year-end but still very solid. In the third quarter, we declared a common dividend of $0.40 per share, totaling $1.16 in dividends for the first nine months of the year. We have bought back approximately 1 million shares at an average price of $59.28, and as of September 30, 2022, we have 222,000 shares remaining in our stock repurchase program. That concludes my prepared remarks.

Thank you, Joe. Joe has covered some points already, but I’ll provide additional details. I’ll begin with net interest income and margin. As Joe mentioned, our net interest income this quarter rose by approximately $8 million, reaching $52.9 million compared to $44.9 million in the same quarter last year. In the second quarter of 2022, it was $48.8 million. Additionally, we had $1.6 million in accretion of deferred fees for PPP loans included in last year's third quarter figures. Our net interest margin was 3.96% for the third quarter, an increase from 3.36% in the same quarter last year. This notable rise is mainly due to higher interest rates compared to last year, along with growth in our loan portfolio and investment securities. The average yield on loans increased by about 44 basis points from the previous year, while our cost of deposits rose by 23 basis points over the same period. We have utilized some excess liquidity for loans and investments. As Joe mentioned earlier, we remain generally optimistic in a rising interest rate environment and will continue to monitor our position. We are actively working to mitigate risks associated with potential future rate declines. Over the past nine months, our asset mix has shifted, as well as our liability mix. We had a greater number of non-time accounts at the end of 2021, and we've observed some shifts in that mix throughout 2022, with excess funds flowing out as anticipated. Several customers have drawn down on accounts they had funded previously, leading to a decrease in our transaction accounts by about $212 million since December 31. Meanwhile, retail time accounts or CDs have risen by about $105 million, and we added broker deposits, which increased by approximately $290 million throughout the year. We occasionally use home loan bank advances and employ various funding sources to manage our balance sheet effectively. Regarding noninterest income, it decreased by about $1.8 million to $8 million compared to last year's third quarter. As Joe noted, fixed-rate loan originations that we typically sell in the secondary market are significantly lower this year, which has reduced profit from those sales. Instead, we’ve been making some hybrid ARM loans that we keep on our balance sheet, leading to an uptick in our one-to-four family portfolio. I’ll discuss noninterest expense briefly. This quarter, our noninterest expense increased by approximately $3.5 million compared to the same quarter last year, reaching $34.8 million. As previously mentioned, this increase is due to merit raises for existing employees and the costs associated with hiring and replacing staff. We also had professional fees related to system conversions, and we incurred some upfront fees on swaps in the third quarter. Additionally, other operating expenses rose by about $570,000 from the last year, largely due to deposit account fraud losses, increased business development efforts, and one-time charitable contributions. The efficiency ratio for this third quarter was 57.09%, compared to 57.27% in the same quarter last year. This slight decrease was mainly due to increased income, primarily net interest income, though partially offset by higher noninterest expenses. Joe has already addressed the provision for credit losses. We experienced net charge-offs of $297,000 in the three months ended September 30, primarily related to overdrafts, along with a few small commercial charge-offs. In closing, our effective tax rate for this quarter was 20.5%, down from 20.9% a year ago. We continue to leverage tax-exempt securities, loans, and low-income housing tax credits to lower our tax liability. We anticipate our effective tax rate in the coming periods to be within the range of 20.5% to 21.5%. That concludes my remarks.

Our first question comes from the line of Andrew Liesch from Piper Sandler Company. Mr. Liesch, your line is open.

Thank you. Good afternoon, everyone.

Hi, Andrew.

Question on the margin here, just kind of diving into some of the deposit beta question here that maybe there's a little bit more expansion ahead. But at what point do you think or how many more Fed increases or what do we need to do you think that will finally see maybe some stabilization in the margin with some catch-up on the funding side.

I'll start addressing that. I believe we'll see some benefits on the loan side. It will depend on how we fund our existing balance sheet and any growth while considering the ongoing shift towards time deposits. If we continue to see a shift away from non-time deposits, funding growth may involve more time deposit-type products instead of non-time ones. Some of these can be structured as floating rate, resembling Fed funds-type floating rates, while others might require us to pay a premium initially. I expect we will see some benefits, but it's important to note that the initial rate hikes were minimal and did not significantly impact our cost of funds. The first 75 basis points barely moved our rates, and it was only after the second 75 basis points that we began to adjust our rates, benefiting from the first 150 basis points or so without much cost.

Yeah.

Then add to that, just marginally, it just gives probably a higher beta as you move forward.

I think there is probably substantially more competition for deposits now than we probably anticipated that there would be a year ago. I think we all thought a year ago the industry was pretty awash with liquidity and there wouldn't be much competition, but I think there is, you see a lot of high CD rate offers around. So, depositors are hungry for higher rates for obvious reasons.

There is likely a significant amount of liquidity available among the largest banks, but community banks may not have as much.

Not so much.

Right, right. All right. That's really helpful color. Thanks so much for that. And then just on the provision that you guys recorded in the quarter. I guess, how should we look at that balancing loan growth or any change in the CECL model or your own conservatism? I'm assuming, just curious like what are some of the puts and takes that went into that $3.3 million or so?

I’ll start, and then Rex can correct me if needed. The way the CECL model works, from our perspective, starts with an arithmetic calculation based on historical charge-off levels to determine what our lifetime losses should be on our loan portfolio. For us, and likely many in the banking industry, that number is decreasing because we continue to see effectively zero charge-offs quarter after quarter, which is positive but drives that number down. Additionally, we observe the Fed's indications, and Moody's, along with others, suggest we might be heading toward a recession. Therefore, as you notice increases in our reserve levels, it's more about preparing for a potential economic downturn rather than reflecting any issues with our portfolio. We've experienced consistent low or no loan charge-offs, with about $300,000 this quarter, most related to deposits and checking accounts. Our loan portfolio remains strong, and we are simply trying our best to estimate potential losses if the economy shifts downward.

Got it.

And there is part of it too, it's the growth. We've got growth on the balance sheet of the funded portion. But we also have growth in the unfunded portion or happened so far this year. And so, that liability has increased fairly substantially as well. So to the extent that either the on-balance sheet or off-balance sheet loans commitments continue to grow. I mean, I think we're going to have to continue to fund our reserves for that growth.

Right.

It's a combination of both. If you see us grow, those line items will likely need to account for that.

We are currently in a situation where we are not originating many new deals, but loans are transitioning from unfunded to funded. This won't lead to a significant increase in provision expense because the allowance for unfunded commitments is likely to decrease. As a result, you will see a credit in that area and a debit in your provision for, or allowance for, funding. That situation could also occur.

Right, that's helpful information. I appreciate it. That addresses the questions. Thank you all.

Right. Thank you.

Thank you, Andrew.

Thank you. Our next question or comment comes from the line of Damon DelMonte from KBW standby. Mr. DelMonte. Your line is open.

Hey, good afternoon, guys. Hope everybody is doing well today.

Thank you, Andrew.

I have a question about the deposit growth this quarter. I understand you don't provide a detailed composition on a period basis, but could you share the approximate breakdown for the end-of-period figures? You mentioned an increase in CDs and brokered CDs, so I'm curious about how much of the growth was attributed to that.

Yeah, I mean, I can give you that, like, in the September balance information and we'll have and obviously in our 10-Q filing. But I can't break that out a little bit. So the total of interest-bearing and noninterest-bearing checking is about $3.4 million or $1 billion, excuse me. The total, kind of what we call retail CDs is about $1 billion. And the brokered total combination of various things that fall under the brokered umbrella is about $360 million.

Okay, that's helpful. Thanks. Regarding the expense outlook, I know you mentioned it last quarter and again this quarter about the professional fees, which will be around for a while. As we look at the base for the next three or four quarters, do you think it will trend a bit higher than the $34.5 million range when excluding the swap fees?

Well, I mean that $1.1 or $2 million of the systems, that's going to be in there until the third quarter next year. So, that's going to stay.

Right. Yeah.

We noted that compared to Q2, our occupancy expenses in Q3 increased by around $300,000, with more than half of that—about 60%—due to increased utility costs. This figure may fluctuate. When looking at compensation expenses from Q3 to Q2, excluding the special bonus paid in Q2, there was an increase of approximately $0.5 million in the third quarter. We also recognize the FAS 91 concept allows us to defer origination compensation related to loan origination, and this deferral was about $300,000 higher in Q2 compared to Q3, contributing to part of the $500,000 rise in compensation. Additionally, the opening of the Charlotte LPO contributed roughly $50,000. We experienced a $600,000 rise in other expenses, which included a one-time $150,000 donation and increased levels of fraud losses that we have been experiencing consistently. It’s unclear if these losses stem from economic hardships. On the compensation side, the employment market remains strong, and with inflation at 7% to 8%, we expect some growth in compensation costs. If we exclude certain nonrecurring items, the compensation line is likely closer to $33 million rather than the $34.6 million reported, with occupancy costs and other expenses experiencing variability from quarter to quarter.

Damon, as we look ahead to the first quarter of next year, most of our salaried employees will receive their annual adjustments in January. Therefore, we can expect some level of increase to occur.

Got it. That's helpful, thank you. Regarding loan growth, it seems you have fairly strong pipelines with several closed but unfunded commitments, which should provide a solid source for growth. However, it also appears that you may be cautious about the possibility of experiencing a more significant recession later in 2023. Considering all of this, do you still believe it’s feasible to achieve mid-single-digit growth in the upcoming quarters, or do you expect it to slow down more quickly?

Yeah, I mean, we don't really give guidance as to what our loan growth is going to be, but, I mean, as I look out, Damon, I do think originations of new loans, particularly on the commercial side, will slow down and I think that's a result of a tougher economy and we deal with really good customers. And I think they see the same thing. That $1.4 billion of construction commitments, that we'll fund over the next 15 months or so. A $100 million a month, a bit of it still has to do with or have to do with lower levels of payoffs. And I think that's an environment that's going to stick around for a while. With the longer-term interest rates being up, we were really getting paid off either from our customer putting a longer-term firm mortgage on the project or selling the project. And that's still going to happen. But it may not happen as frequently or as quickly as it did before. So those things could come together and result in loan growth for us.

Got it. Okay, that's very helpful. That's all that I had. Thank you.

Okay. Thanks, Damon.

Thank you. Our next question or comment comes from the line of John Rodis from Janney. Mr. Rodis. Your line is open.

Hey, good afternoon, everybody.

Hi, John.

Hi, John.

I guess, Joe, maybe just a question for you on the back-to-lending. Are there any areas or markets that you're maybe starting to get more cautious on sort of pull back, so to say?

As far as loan type or geographically?

I guess, both.

No, I don't think geographically we're necessarily pulling back anymore from any market than we are from the others. I mean, I think we're equally conservative across our footprint. As far as loan types, I think office continues to be something that you would be worried about, possibly industrial warehouse, that sort of thing. You are starting to see reports that there may be some overbuilding in those areas. So those would be maybe two product types we might be a little more conservative in. But geographically, I think we're equally open or maybe better said, equally conservative in all our markets.

Okay. Makes sense. And then just one other question on the buyback. You leave a little bit over 200,000 shares. Would you expect to complete that or it sounds like maybe you're getting a little bit more cautious on capital, just given the current environment too.

I think we will eventually complete the buyback. However, I expect our repurchase activity to slow down compared to what you've seen so far. We have repurchased about 1 million shares in the first nine months, but I don't foresee maintaining that pace. We may occasionally buy back shares in the market, but the volume will likely decrease.

Okay. Makes sense. Thanks, guys. Have a good day.

Thanks.

Thanks, John.

Thank you. I'm showing no additional questions in the queue at this time. I'd like to turn the conference back over to Mr. Turner for any closing remarks.

No closing remarks. We appreciate everybody joining us today and we'll look forward to talking to you in January. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.