Great Southern Bancorp, Inc. (NASDAQ:GSBC) Q3 2020 Earnings Conference Call October 22, 2020 3:00 PM ET

Company Participants

Kelly Polonus - Director, Communications & Marketing for Great Southern Bank
Joseph Turner - President and Chief Executive Officer
Rex Copeland - Senior Vice President and Chief Financial Officer

Conference Call Participants

Andrew Liesch - Piper Sandler
Michael Schiavone - KBW

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Great Southern Bancorp, Inc., Third Quarter 2020 Earnings Call. At this time all participant lines are in a listen-only mode. [Operator Instructions]

I would now like to hand the conference over to your host today, Kelly Polonus, Investor Relations. Please go ahead.

Kelly Polonus

Thank you, Sara. Good afternoon and welcome. I hope everyone is well. The purpose of this call is to discuss the company's results for the quarter ending September 30, 2020.

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. Please see the forward-looking statements disclosure in our third quarter 2020 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 Joe Turner.

Joseph Turner

Okay, thank you. Good afternoon. I also would like to thank everybody for joining us today. And I hope everyone on our call as well also. As we manage through the pandemic now in its seventh month, we remain focused on the well-being of our associates, customers and communities. I believe our associates are doing a tremendous job of serving our customers through this difficult time. As we said last quarter, we are actively working with any customers who may be experiencing financial hardship caused by this pandemic. While there is still a lot of uncertainty about the months ahead, we are ready to respond to the challenges produced by the health crisis and are in a position of strength to do so with our strong capital, earnings and liquidity.

I'll provide some brief remarks about the company's performance during the quarter. And then I'll turn the call over to Rex Copeland who will get into more detail on our financial results, then we'll open it up for questions. As expected in this operating climate, our earnings declined in the third quarter as compared to the year ago quarter. Still we achieve very good earnings of $0.96 per diluted common share in the third quarter. The primary driver of our earnings decline when comparing it to the year ago period were, number one, a higher loan loss provision, but 100% or almost 100% of that provision went to grow our allowance for loan losses. We had very low charge offs during the quarter.

We did have a lower net interest income than the year ago quarter, I think by about maybe $1.8 million or so, over half of that, though, is attributable to the result or the effects of the sub debt that we issued at the end of the second quarter. We had higher non-interest expense, which also affected us, which included $1.1 million related to special bonuses for our associates. As I mentioned earlier, our associates are doing a tremendous job for the company, we know that this is resulting in unprecedented hard times for our associates. Many of our associates have school aged children and they're dealing with virtual school. And some of our associates have spouses that have lost their jobs, which is very difficult. We can't solve all their problems, but we do want to show that we're in the boat with them and that's what the special bonus was for.

Our performance metrics for the third quarter were good. Our annualized return on common equity and I might add very high levels of common equity was 8.48%. Our annualized return on assets was 0.98%. Our annualized reported net interest margin was 336. And our efficiency ratio was 59.54. Our commercial lending production did decline in the third quarter as a result of activity in our markets being a little bit slowed. Retail mortgage lending production has been very strong, continues to be very strong, driven by low interest rates. We typically sell the majority of the fixed rate mortgages that we produce. Total gross loans which include unfunded loan amount increased 229.6 million since the end of 2019, but decreased about 11 million during the third quarter.

Outstanding net loan balances increased about $260 million from the end of the year and increased $14 million from the end of the second quarter. Our committed pipeline continues to be relatively steady and was about 1.2 billion at the end of September, a decrease of about 70 million since the end of last quarter. The unfunded portion of our commercial construction loans is about $715 million, a decline of 39 million from the end of June. I would remind you if you're interested in more information on our loan portfolio, we file a loan portfolio presentation each quarter and I think our third quarter presentation was filed yesterday. Asset quality is very, very strong. Through September 30, 2020, our non-performing assets are 5.5 million - as of September 30, 2020, our non-performing assets were $5.5 million.

Total net charge offs during the quarter were $63,000 as I said, almost exclusively on indirect automobile - on our indirect automobile portfolio. We actually had net recoveries, I think, in the commercial categories. One other thing I would mention is our internal loan classification watch list totals. At June 30, 2020, our loans classified as substandard were 9.3 million and loans classified as watch were $73.8 million. At September 30, 2020, our loans classified as substandard were 7.5 million and the watch category was down to 64.4 million. The decreases during the third quarter were due to two substandard loans that paid off and some payments received on watch category credit.

As I mentioned earlier, we fully understand that the difficulties we're in right now will likely persist and will result in difficult economic conditions as well. So we have been increasing our allowance for loan losses, we've increased by nearly $14 million since the end of 2019. As a reminder, our provision for loan losses is currently under the incurred loss methodology. Had we adopted CECL on January 1, we would have put $11 million to $14 million in our allowance at that time. And I think our current expectation would be that at the end of the year, we would put a similar amount into our allowance. And as a reminder, that won't flow through earnings that will be a cumulative effect of a change in accounting principle and will be a direct debit to our equity and a credit to the allowance.

Loan modifications, at the end of June, we had over a $1billion of loan modifications that's down to 395.5 million. At the end of September, 70% of those are paying interest only, so the modification was to remove the requirement to pay principal for some period of time up to maybe a year, but all different times, really three months, six months and then seven to 12 months. Our capital continued to be very strong as I mentioned. From the end of 2019, our total common stockholders' equity increased by about $22 million and our book value, tangible book value per share increased by $2.71. Our book value increased from $44.50 to $45, $45 at the end of the third quarter, it was $44.50 at the end of the second quarter. Our tangible common equity to tangible assets is very strong as well at 11.4%.

During the quarter, we did repurchase 206,400 shares of common stock at an average price of $37.39 per share. Additionally, we've paid a $0.34 per share dividend. In spite of the obvious economic challenges caused by COVID, we expect that we will continue to operate profitably, albeit not at 2019 levels, and we currently anticipate that our regular quarterly dividend can be maintained for the foreseeable future. Our Board of Directors has approved a new stock purchase program of up to 1 million shares and we may continue to repurchase common stock over the next several quarters if conditions warrant. The amount and timing of stock repurchases will be determined by the company in light of overall capital and earnings levels, credit quality metrics and the market for our stock.

And we'll always maintain open communications regarding our plans with our holding company and bank regulators. And prior to sort of re-commencing our stock repurchase program, we did have those conversations with our holding company regulators. Over the course of about two or three weeks, we're not required to seek the permission of the Federal Reserve in order to repurchase our stock, but we wanted them to know what we were doing. And at the end of those conversations, they said they had no objection to us repurchasing our stock in the manner that we were doing it.

So that concludes my prepared remarks. I'll turn the call over to our CFO, Rex Copeland at this time.

Rex Copeland

Thank you, Joe. I'm going to start today by speaking a little bit about net interest income and margin. Our net interest income for the third quarter of 2020 decreased about $1.7 million to 44.2 million. That compares to about 45.9 million for the third quarter of 2019. The net interest income was affected negatively by of course the Federal Reserve significant rate cuts that happened in March.

We also have some additional lower earning assets, SBA, paycheck protection program loans, some investment security purchases and also increased balances that we hold at the Federal Reserve and cash and cash equivalents and then also more recently in this quarter by the cost of the sub debt that we issued in mid to late June.

The core interest margin if you exclude the yield accretion from our acquired loan pools was 3.27% for the third quarter of this year. That compares to 3.75% for the third quarter in 2019 and is the same 3.27% as where we were in the second quarter of 2020. The decrease is a result of the same things I talked about previously.

The one thing that is a little different when you compare Q2 this year to Q3, we did have about - on an annualized basis, about eight basis points related to our cost of the sub debt that we issued in June. So if you look at that on the core comparison, we were at 327 in Q2, 327 in Q3, but we had eight basis points of headwind from the sub debt costs.

So we said on previous discussions and filings that the rank test would negatively affect our net interest income and margin in the near term, because we have a lot of loans that are indexed to LIBOR. But over the course of the next several months and a few quarters, a lot of our liabilities are time deposits, and some of our non-time deposits would re-price lower and that in fact is what we've been seeing in the last quarter or two.

If you look back and see where our cost of interest-bearing deposits was second quarter compared to third quarter, our third quarter number was 21 basis points below where we were in the second quarter and we were 62 basis points lower than we were in the fourth quarter of 2019. So our deposit costs continue to come down and we anticipate based on maturities that are coming up in the next couple of quarters that we will continue to be able - assuming right and stay where they are right now, we will continue to be able to reduce those deposit costs, maybe not quite as rapidly as we did in the last couple of quarters, but we still we should see some improvement there on the cost of funds side.

We are still having a little bit of impact, positive impact on our net interest margin and income related to the yield accretion on our FDIC acquired loans. That impact in the third quarter of this year was about nine basis points. We've got about $2.9 million remaining in the - on accreted portion that's going to come into income over the next several quarters, about 930,000 of that should come in to income in the fourth quarter this year.

Non-interest income for the quarter increased about 811,000 to 9.5 million when you compared it to the same quarter in 2019. A lot of that increase came in the form of gain on loans payables. Joe mentioned earlier we originated a lot of fixed rate single family loans. We typically sell those loans in the secondary market. And our gain on sale was about 1.9 million higher in Q3 this year compared to the same quarter a year ago, so quite a lot of originations there and income derived from that as we sold those loans.

Service charges, debit card fees, ATM fees, we continue to see a decrease there compared to the prior year, about $927,000 this quarter compared to the year ago quarter. We're seeing that kind of across a variety of things. Overdraft, insufficient funding fees or lower customers have opted to - they're not using those services as much as they were. So our utilization of that is down. A little bit of probably also in the second and third quarter this year, we were pretty proactive in waiving fees and things like that for customers as part of things were going on during the pandemic.

And I would say in the middle or late part of third quarter, we were probably not waiving as many fees and things like that now as we were earlier in the year. So I think toward the end of the third quarter that fee income sort of picked up a little bit from there. Also, we've seen a little bit less usage in income from our debit card and ATM fees. That may start to again expand too, but we kind of saw a little bit of a lull there in the middle of the year for that.

Other income decreased actually compared to the year ago quarter about $442,000. We had a larger amount of originations of interest rate swap deals with our loan customers in the year ago quarter compared to where we were this year. Those tend to be a little bit sporadic. We have them throughout the year, but not always at the same time at the same magnitude at each quarter.

Non-interest expense increased $3.3 million to 32 million this year - this quarter, compared to the same quarter in 2019. The largest portion of that was an increase in salary and employee benefits were up 2.9 billion compared to the prior year quarter. The largest part of that increase was, as Joe mentioned, the bonus that we elected to pay to our employees. That was about $1.1 million of the increase.

We also had probably compared to last year about 700,000 or so higher level of compensation, both salary and incentive and additional people in the mortgage area. So that income that I talked about a minute ago, we did have some offset to that in the form of compensation to the producers and the servicers in that area.

We've also had a few people out as part because they've had exposure to COVID or things like that. They're, they're quarantining at home, and we're continuing to pay people in regards to that. And so we have some costs associated with that, with people part time - people having to fill in, people that we normally wouldn't necessarily be paying, but we –they're off because of quarantine, we do continue to pay them.

So there's a couple of hundred thousand dollars or so probably in there. Maybe a little more that relates to that. So those are the main drivers. And then and then the rest of it, probably 3% to 4% of it is just from a year ago normal married increases and things of that nature.

Joseph Turner

And I think too Rex, we did have additional insurance costs because we no longer have the credit on our FDIC insurance.

Rex Copeland

Right, we had a full credit I think last year and then this year, we have had a partial credit and we had to start paying the full amount again this year. So that's why the insurance cost was higher. Occupancy expense was also higher than it was a year ago, about $530,000. Some of that was depreciation. We rolled out some new ATM, ITM units late in the - or in the fourth quarter last year. And we've got the depreciation on those and it's higher this year. Also just another repairs and maintenance things that occurred in the third quarter were $250,000 or so of it. So we just - those were the costs that that increased the occupancy line.

One last thing and non-interest expense, expense on other real estate owned and repossessions was lowered by about $400,000 compared to the prior year period. We just have - we've been - we're doing a good job, I think on working down that foreclosed assets that we have, the repossessed autos are much lower level than they would have been last couple of years. So we just got less cost associated with foreclosed real estate and with the repossession of autos and auto portfolio.

As mentioned before, our efficiency ratio for this quarter was 59.64%. That compared to 52.63% in the third quarter of last year. The higher efficiency ratio was mainly due to the higher level of non-interest expense that I mentioned and some of the reasons for that I just talked about. Also we had a small decrease in total revenue. Non-interest income was higher, but net interest income was a little bit lower.

So despite these increases in costs our non-interest expense to average assets remained at 2.34% for the quarter this year versus the quarter last year. Assets have continued to grow, as we talked about and the average assets for this three-month period were about $550 million higher or about 11% higher than they were in the third quarter of last year.

Just a couple of last things that I'll mention as we wrap up, income taxes, we had a little bit higher than normal effective tax rate in the third quarter 2020 and is a little bit higher year-to-date. We've got state taxes that we're paying in various states and some of those were a little bit higher this year compared to previous years and probably where we're going to be in future, the gain that we had when we terminated the interest rate swap earlier this year is flowing through in our state taxes and creating a little bit higher taxable income in certain states, some of which have higher tax rates than others. And so we're seeing a little bit higher effective rate there.

The Federal effective rates really pretty much the same. It's just really being driven by various state rates. So we expect we're going to continue looking at that, refining our estimates for that throughout the year. But I think our effective rate for this year may be a little bit higher, more like the nine-month effective tax rate. And then presumably they go back a little bit lower, more normal in 2021.

And then just one last thing, Joe mentioned already a little bit about CECL. Again, we anticipate based on what we know today that we will adopt CECL with our fourth quarter information. It'll be retroactive basically back to the beginning of the year and flow through our full year numbers. But we anticipate right now that that would be the case that the CECL adoption would occur as we finalize our fourth quarter financials.

And then like Joe said before we have previously discussed our CECL impacts in our previous filings. If you look at our June 10-Q, that's the most recent, I think information there. And we don't think there's anything different right now materially than what we've talked about before. So we'll provide additional color on that enduring the fourth quarter information.

That concludes the prepared remarks we have. This time we will entertain questions, and I'd like to ask our operator once again to remind the attendees how to queue in for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Andrew Liesh with Piper Sandler. Your line is now open.

Andrew Liesch

Hey, good afternoon, everyone. How are you?

Joseph Turner

Hi, Andrew.

Andrew Liesch

Hi. So just want to focus on expenses right now a little bit higher this quarter than I was forecasting. You guys had a pretty good run rate there below 30 million. It seems like maybe some of it was affected by the mortgage business this quarter. But is this like the new run rate we should be using or do you think it's probably still in that $30 million level?

Joseph Turner

Well, I mean, 1.1 million of it was this one - was this special bonus and so that - you need to back that out. The other cost, I mean, the other - there's some other COVID costs that relate to supplies and cleaning and equipment and that kind of stuff. And that's going to be with us for a while. [indiscernible] that probably 350,000 of our costs during the quarter were payments made to quarantine employees. Those costs will probably continue until we get out of the pandemic. I mean, I think the two things that that could adjust that seems to me is the 1.1 million will adjust as Rex said and then we did - our mortgage related compensation is up 800,000, I think from or 750,000, from where it was during the third quarter of 2019. So you back those two numbers or you normalize the mortgage and you back the 1.1 million off and yeah, you are at 30 million, but our mortgage volume continues to be strong. So you don't - it's hard to see that changing as long as our mortgage volume remains strong.

Andrew Liesch

Okay, thanks. That's helpful. And then around the margin, sounds like still some good opportunities on the funding side to improve some costs there. What are you seeing on yield pressures right now? And is the funding cost benefit - is that actually more than what you're seeing on the yield side right now?

Rex Copeland

Probably, I mean, I think the funding costs are coming down a little bit more. We have had a little bit of our loans repay, a lot of those are typically maybe at higher rates than the new loans that are coming on. So we have seen a little bit of decline in the yield on loans. I mean, if you look at our - in our press release, toward the end, I think on Page 19, you can see for the quarter, what our average yields and costs work. And then the first column there, we give you a yield and cost rates as of 9/30. So those are going to be the point in time numbers. And you can kind of see from there where the yields are on different asset classes. And then on the liability side, and you can see on deposits our 9/30 cost of deposits is 67 basis points. For the quarter it was 79 basis points.

So clearly, we anticipate we're going to see those costs come down a bit more, the other areas - probably not going to change much. I mean, the subordinated notes, those are fixed rate. And the sub debt is blooming, but it's tied to LIBOR and LIBOR hasn't been moving around too much. So the reduction on the funding side is going to come on the deposits. And then on the loan side, the only thing that you don't see in there that - the yield that we give you on the loans does exclude on the - at the point in time does exclude the yield accretion. So in the third quarter that was nine basis points of benefit, so you can kind of analyze that and say that well, maybe that yields a little bit higher than what we show here or will be, but it still is going to come down a little bit from where we were probably in the -

Joseph Turner

The nine basis points is in the three months ended September 30 number, but it's not in the point in time.

Rex Copeland

So we'll continue to see - I mean, we've been - probably have between 100 and 125 million of month - of TD, time deposits that are maturing and I think those probably have a weighted rate of somewhere around 140 or something like that. So we're replacing those at substantially lower rates than that. But it just - at 100 and 125 million a month, it takes a little time for it to work through, like we said, so we've got six months of that kind of stuff already through the pipeline, and we've got six to nine more months probably of time deposits that will roll off that will be able to re-price down.

Andrew Liesch

Okay. That's, that's very helpful commentary. I really appreciate it. I will step back. Thank you. But

Rex Copeland

Thank you.

Operator

[Operator Instructions] Thank you. Our next question comes from a line of Michael Schiavone with KBW. Your line is now open.

Michael Schiavone

Hi, good afternoon. How's everyone doing?

Joseph Turner

Good. Thank you.

Rex Copeland

Good. Thank you.

Michael Schiavone

Good. So fee income in particular mortgage sales were really strong in the quarter. Can you just share some color on the mortgage pipeline going forward as well as your outlook for fee income in general?

Rex Copeland

I mean, I think we're still originating quite a lot of mortgage loans and we've got quite a few commitments out there.

Joseph Turner

Do we have the mortgage pipeline in our pipeline numbers?

Rex Copeland

Trying to look back and see if we've got that commitment number in here. Yes. It's about - well, it's lower here. No, I'm sorry. It's a little bit lower than it was in the previous quarter end, but it's still like $94 million in commitments that are not closed. We've had a couple of quarter ends that were higher than that, but substantially higher than were year or two ago. And I don't - I mean, I haven't seen or heard anything that leads me to think that the fourth quarter is going to be much less than the third quarter. Yeah, I mean, we still - I think we're still doing very busy in the mortgage group. And I think they're still producing quite a bit in new loan commitments. So I don't know, I mean, we get to the very end of the year, around the holidays, maybe it'll slow down a little bit for that. So we may see a little bit slow down late in the quarter, but so far, the first part of the quarter, not really much change.

Michael Schiavone

All right, thank you, that helps. And then the release noted some initiatives the bank is making toward modernizing and consolidating branch and office space. When you review your overall footprint, you see further opportunity for like a larger scale rationalization of offices or branches?

Joseph Turner

I don't really think so. I mean, there may be - keep in mind, we've probably closed what 25% of our branches over the last four or five years.

Rex Copeland

35 branches.

Joseph Turner

Yeah, maybe more than that, maybe 30% or something, so yeah, there could be further consolidation. But it would be one or two banking centers here or there. I don't think there will be kind of large wholesale changes. Now, that's with customer behavior as it is in 2020, if that continues to change and people start accessing banks for - they do access, but in a number of different ways, but we found that for big transactions, borrowing money, opening deposit accounts, those sorts of things, they like to come in and do that in person. And so long is that the case, I don't know that there will be large scale rationalization.

Michael Schiavone

Okay, thank you. Last question, so capital is pretty healthy levels and you guys have actively been buying back shares and you refresh share repurchase program, but can you just talk about your capital allocation priorities in terms of M&A, buybacks, dividend, organic growth, et cetera?

Joseph Turner

Well, I mean, I think, we see the ability to continue to pay our dividend. Obviously, we're going to - to the extent we can grow, we want to grow. We think we can grow a lot and that would certainly not impact our ability to pay our dividend. The third priority among those would be buying our stock back and I end I think we would rather buy our stock back at 80% of book or 90% of book, certainly than buy somebody else's stock at some multiple above book. So that's kind of how we would prioritize.

Michael Schiavone

Great, thank you. Thanks for taking my question.

Rex Copeland

Thank you.

Operator

Thank you. We have no further questions in the queue at this time. I would now like to turn the call back to Mr. Joe Turner for closing remarks.

Joseph Turner

Well, we appreciate, as I said earlier, we appreciate everybody being on the call today. We'll look forward to talking to you after the end of the year and hopefully we will have a President and have a vaccine and hopefully things will be looking up. I certainly hope everybody has a wonderful and healthy holiday season. And we'll talk to you in about three months. Thank you.

Operator

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