Community Bankers Trust Corporation (ESXB) CEO Rex Smith on Q2 2019 Results - Earnings Call Transcript
Community Bankers Trust Corporation (ESXB) Q2 2019 Results Earnings Conference Call July 26, 2019 10:00 AM ET
Company Participants
Rex Smith - President and Chief Executive Officer
Bruce Thomas - Executive Vice President, Chief Financial Officer
Conference Call Participants
Charlie Hough - Sandler O'Neill
Austin Nicholas - Stephens
Stuart Lotz - KBW
John Rodis - FIG Partners
Operator
Good day and welcome to the Community Bankers Trust Corporation second quarter 2019 earnings conference call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded.
I would now like to turn the conference over to Rex Smith, President and CEO. Please go ahead. I would now like to turn the conference over to Rex Smith, President and CEO.
Rex Smith
Good morning and thank you for your patience. Thanks for joining us today as we review the results of the second quarter and the first six months of 2019 for Community Bankers Trust Corporation, which is the holding company for Essex Bank.
Let me start with a reminder that during the course of our remarks today, we may make forward-looking statements within the meaning of applicable securities laws with respect to our operations, performance, future strategy and goals. I remind everyone that our actual results may differ materially from those included in the forward-looking statements due to a number of factors.
These factors and additional risks and uncertainties are included in our earnings release, our most recent Form 10-K and other reports that Community Bankers Trust Corporation files with or furnishes to the Securities and Exchange Commission. You can access all of these documents through our website at www.cbtrustcorp.com.
I will start today's call with a quick overview of the quarter and the first half of the year and then Bruce Thomas, our Chief Financial Officer, will cover details for selected financial highlights and I will conclude with our thoughts and strategies for the rest of the year.
I am pleased to report that the company posted a 10.5% increase in six months earnings year-over-year. Earnings for the first six months of 2019 were $7 million or $0.32 per share. This is an increase of $671,000 over the same period of 2018. This increase is also after provision expense of $125,000 for 2019, with no provision expense for the same period last year. The increase is attributable to numerous positive factors in the core operating metrics for the company.
Loan growth, excluding PCI loans, increased approximately $57 million or just under 6% year-over-year. For the first six months, loans increased $30.5 million or just over 6% annualized. Additionally, the yield on loans increased 26 basis points from the second quarter of 2018 despite both the competitive nature of our markets and a change in loan mix to more adjustable rate loans. This performance exceeds both their projected growth rate and loan yield expectations for the first half of 2019.
The bank also increased its growth rate in demand deposits for the first half of 2019. Non-interest-bearing deposits grew $28.4 million, or 18.7% year-over-year, compared to 9.7% growth year-over-year for the same period from June 2017 to June 2018. Non-interest-bearing deposits are almost 15% of total deposits, compared to 13.5% of total deposits this time last year.
I believe this shows that we can continue at double digit growth in these accounts, which will continually decrease our cost of funds moving forward. Unfortunately, our total deposit cost were up due to a significant amount of certificate of deposit maturities repricing when rates were comparatively high but our weighted average life on most of those CDs was six months. And so if rates continue to drop, we will be able to reprice a fair amount of them by year-end.
The tax-equivalent net interest margin was 3.69% for the second quarter, which was slightly lower than the 3.73% for the same period in 2018. Despite the higher funding costs, net interest income increased $1 million, or 4.4% for the six months period year-over-year. Non-interest income also continued to improve with a 43.1% increase on a linked quarter basis.
Much of the increase was due to gains on sale of securities but it was also a result of increases in service charged on deposit accounts, increases in mortgage loan income and increases in financial services fees. Non-interest expense was slightly up but that includes some one-time termination expenses associated with the closing of a non-performing branch and a pension expense from the retirement of a long-time senior officer.
I will now turn the call over to our Chief Financial Officer, Bruce Thomas, to discuss the details on the financial results of the quarter.
Bruce Thomas
Thank you Rex and thank you to all of you for taking time out to listen about our second quarter 2019 results and our thoughts about the future of the company. Net income of $3.5 million in the second quarter of 2019 equates to basic and fully diluted earnings per share of $0.16. The annualized return on assets was 1.01% and the annualized return on equity was 9.79%. For the six months ended June 30, 2019, net income of $7 million equates to basic earnings per share $0.32 and fully diluted earnings per share of $0.31.
The annualized return on assets was 1.01% and the annualized return on equity was 9.90%. The second quarter of 2019 was affected by one-time cost of $254,000. This cost decreased net income by $201,000 for the quarter which when annualized had a meaningful impact on ROA and ROE but will improve our run rate in future quarters. $210,000 of these costs were from the closing of the Fairfax office and $44,000 was a one-time pension expense was from a retirement of senior officer of the bank. Excluding these one-time charge, our ROA would have been 1.06% and ROE would have been 10.34% for the second quarter of 2019.
Next, we recorded a provision for loan losses of $125,000 in the second quarter of 2019. As a result of improving asset quality throughout 2018, there was no provision recorded during that year. Given that virtually all of our allowance is allocated to various portions of the loan portfolio, loan growth and even the slightest deterioration in credit will warrant additional provision in future quarters. Competition for funding was fierce among all banks for most of the second quarter.
The second quarter started with thoughts of higher rates and ended with a forward interest rate curve making a 100% estimate of lowered rate in July. Our cost of interest-bearing liabilities increased from 1.38% in the first quarter of 2019 to 1.45% in the second quarter of 2019. The second quarter versus second quarter year-over-year increase was from 1.08% to 1.45%. In spite of this, our margin has held up remarkably well.
The net interest margin was 3.69% in the second quarter of 2019 and 3.75% for the first six months of 2019. The six month 2019 margin is unchanged from that of the first six months of 2018. That is in spite of a decline in the net interest spread from 3.58% for the first six months of 2018 to 3.51% in the first six months of 2019. The reason that our margin has remained constant even with the lower interest spread is because of several factors.
First, the average balance of non-interest-bearing deposits grew $15.2 million year-over-year. Additionally, the average balance of shareholders equity increased $16.4 million. 2019 totals for shareholders equity include the payment of a dividend to common shareholders that did not happen in 2018. In total, the average balance of total assets grew by $59.8 million year-over-year. 63.8% of that growth was funded by non-interest-bearing sources.
This has enabled us to maintain our margin in spite of the higher increase in the cost of funds than in the yield on assets, which resulted in the decreased interest spread. The margin has held up over the course of the last year. The question is, how are they going to hold up now that it looks as if rates will be headed lower and we will continue to operate in a very flat yield curve?
Intensifying the situation is the effect from the yield curve having its lowest points at the three and five year spots, where many banks make their loan pricing decisions. Analyzing our loans at June 30, 2019, we find that 61.7% of our loan portfolio is adjustable rate. That is $625 million. Of that total, $494 million or 79.1% of those loans have an interest rate floor.
Drilling down further, we see that $269 million or 43% of the total adjustable-rate loan portfolio are 50 basis points or less from their floor. This will help yield on earning assets if, as predicted, rates goes appreciably lower. I am happy with some of the measures we undertook during the quarter that will give us flexibility and allow us to reprice our liabilities in a quick time frame. Of our maturing CDs, starting on July 1, 2019, $261.9 million or 40.6% of CDs are repricable by year-end 2019. Another $240.3 million or 37.1% are repricable between January and June of next year, bringing the total to $502.2 million or 77.7% of all CDs that will get repriced in the next year.
Additionally, we have taken further measures to stay nimble on the funding side of the ledger. During the second quarter of 2019, we replaced $10 million of brokered funding with $15 million of funding. Half of that funding was short term funding and will reprice and mature by year-end. The other $7.5 million we took on at longer-term while there was still speculation of higher rates.
However, we paid additional basis points that gave us a put option prior to year-end. Should rates go lower, as predicted, we have the ability to return the funding back to the depositor. The low level of Federal Home Loan Bank borrowings and broker deposits as well as our strong non-interest-bearing deposit growth will give us the flexibility to do so if it is official. Likewise, we have a $30 million notional swap that matures on November 7, 2019, at a fixed rate of 1.69%.
We have taken on a blended strategy at a forward start date, the same day the swap matures and that strategy will come on our books November 7, 2019 at a blended rate of 1.22%. This all shows that even though we are slightly asset sensitive, we work hard to protect our margin in the uncertain world of the direction of interest rates. Our interest rate risk modeling shows a preserve margin generated by our balance sheet in a multitude of interest rate scenarios.
With that, I will turn the call back over to Rex.
Rex Smith
Thank you Bruce. I am pleased with the consistent improvement in the majority of our core metrics, but I am also focused on some trends that we need to improve. I believe that our disciplined approach to growth and pricing and a strong commitment to lowering our funding costs, helps continue to grow our franchise value.
We have faced an unconventional interest rate environment, but we have managed to keep the growth rates we desire while keeping the balance sheet flexible for whatever may come ahead. We are focused on maintaining rate floors in our adjustable rate loans and therefore protection for the predicted rate environment. Still, we need to significantly change our funding mix and therefore our cost of funds, especially in a lower interest rate environment.
We continue to emphasize the importance of demand deposit growth and I believe the current growth rate shows that we have the ability to continue to attract those long term low-cost relationships. We also continue to focus on the most efficient and effective ways to gain profitable market share, which includes our customer service call center and our digital banking platform. We continue to gain momentum in our newer branch offices and as we have shown we will not hesitate to close those that cannot meet a desired rate of return.
I believe this quarter's earnings show that our future is very strong. We continue to gain positive market share in three of the best growth markets in the mid-Atlantic and we were able to post consistent earnings while including a provision and some other one-time non-interest expenses. I hope that you, our investors, are also pleased with our results and we are looking forward to the rest of 2019. I thank all of you who participated in the call today and for your ongoing support of the company.
With that, we would like to open the call for any questions.
Question-and-Answer Session
Operator
[Operator Instructions]. Our first question today will come from Casey Whitman of Sandler O'Neill. Please go ahead.
Charlie Hough
Good morning Rex. Good morning Bruce. This is Charlie Hough. I am on for Casey Whitman today.
Rex Smith
Okay. Hi Charles. Good morning.
Charlie Hough
How's it going? Good morning.
Rex Smith
Good.
Charlie Hough
So as you think about your loan growth this quarter, just curious timing wise, if most of the growth occurred towards the end of the quarter so we have yet to see the full benefit to interest income? Would you say that is a fair assessment?
Rex Smith
I think as I go back and look at for a call we are going to do with all our associates next week, we had a good January and then things got slow from February to like April, but towards the middle of May and through June, there was significant growth. And I think you will see that start to come forward in this coming quarter.
Charlie Hough
Okay. Great. Thank you. And then obviously you are at a faster pace of loan growth on an end of period basis this quarter. Did the level of paydowns in the CRE book come down? And then secondly, are you still thinking growth will come in around the 6%-ish range for the year?
Rex Smith
Yes. I think we are going to be at 6% and I was very encouraged because it's been, for the last two years, that first quarter of the year for us, has been either no growth or negative growth. And so we have gone through that first quarter with a decent amount of growth and then the second quarter last year was probably wrong about 3% annualized and so it's double and the pipeline looks really good. And we have got a lot of good projects out there. So I think I am very encouraged by it. And I think it is going to come in probably, we are going to hit that 6% mark.
Charlie Hough
Okay. Great. And then just lastly, I was wondering if you could provide an update on the M&A and capital strategy, maybe for the back half of the year?
Rex Smith
Yes. So we started the dividends and we continually look at that. Stock buyback is always, it's something that's out there that's being considered. That one is a little, it's one thing. We still carry that retained deficit. So that makes the stock buyback, timing wise, a little more difficult to try to achieve in a way we would like to achieve it until we get rid of that. But that comes off fourth quarter of this year. So we continue to look at that. And M&A, you know, as I tell people, the phone lines are wide open. We have had some discussions with some folks that we like talking with at the VBA from the side of our looking at an acquisition. But things are quiet right now. We spend a lot of time. We talk with all of our investment banking partners and we have got some good relationships with a lot of the folks out there. And they are saying, I don't know if it's summer, or where the markets have been, the rates, but it's a little quite right now. But we always keep the lines open.
Charlie Hough
All right. Understood. Thank you very much for taking my questions.
Rex Smith
Yes, sir.
Operator
[Operator Instructions]. Our next question will come from Austin Nicholas with Stephens. Please go ahead.
Austin Nicholas
Hi guys. Good morning.
Rex Smith
Hi Austin.
Bruce Thomas
Hi Austin.
Austin Nicholas
Hi. You know, I appreciate your comments and I apologize I jumped in a little bit late. But just on the margin, maybe just any commentary on your outlook for the back half of the year? And then maybe a little bit more specifically how we should be thinking about the impact just from a 25 basis point move in the earlier quarters and then how that impacts the margin as you look out more towards 1Q of next year?
Bruce Thomas
First of all, obviously the margin is presented on an annualized basis. So small things have a magnified impact that on just looking at one quarter and just a little commentary on our second quarter net interest margin. And I was scratching this out this morning anticipating questions. And we have a very few of these. We do have a fairly sizable, about $18 million, USDA and SBA loan portfolio, I mean not huge but it's been helpful.
We pretty much amortized the premium off that entire portfolio and it has really great deal and it is 100% government guaranteed. Almost all of that is the USDA loans. We have an SBA loan that paid off and it was a fairly new one, paid off in the second quarter and that had unamortized premium of $77,000 on it. And I backed that out or added it back and recalculated our yield and the yield on the loan portfolio would have been 5.04%, which was exactly what it was in the first quarter.
So we would have seen no deterioration in the yield on loans in the second quarter had that loan not paid off. So just a little sidebar there. And likewise on the securities side, there was some amortized premiums SBA loan pools that paid down a little quicker than normal, higher CPR and as a result just on that one month of June, we had estimated $45,000 over the normal run rate for amortization. Put that back and recalculate the securities yield and it would have been 3.31% versus 3.35% the prior quarter.
I would go through that exercise to state that I think even if rates get cut by 25 basis points on July 31, we still may see a couple of basis points increase in the cost of funds in the third quarter. But I fully anticipate that we are going to see a rebound in the yield on earning assets more resembling what we had in the first quarter as opposed to this quarter.
We just got kind of a double whammy on the asset side. And so I would anticipate that we may see a tick up of a couple of basis points on both the top and the bottom of the house. Therefore, I really don't look at much in the way of change in regard to our net interest margin for the third quarter.
Austin Nicholas
Understood. So kind of expecting it to be in that 3.69%, 3.70% range in the third quarter, if you exclude that kind of the [indiscernible]?
Bruce Thomas
And we have already gone with the rate cut process on the liability side. The answer is, it always depends. If others follow us, we are going to be able to get those liability prices down pretty quickly, those cost down. I don't know that we will get back to the first quarter range of 3.81%, but you know I would say in the 3.73% to 3.77% range would be a reasonable estimate for us next quarter.
Rex Smith
Another thing too, a couple of things we look at. One is, we are going to start a campaign for the next half of the year that's going to be really pushing for those demand deposit growth. And as part of that, we have talked about we are going to let some of these CDs run down a little bit and leverage the balance sheet a little more than we have done in the past. When I think between the additional leverage and the focus on, it's okay to let some of these rate sensitive one-horse folks who are just doing CDs go out and focus on the deposit side of the long-term low-cost relationships. We have shown we can do a pretty good job of that growth. So I think that's going to help us too.
Austin Nicholas
Makes sense. I appreciate all the details on the margin there and the deposit strategy. And maybe just on provisioning and asset quality, any thoughts around any areas that you are seeing any incremental built-in risk weightings? And then, any thoughts on CECL? I know most people don't have a disclosed kind of estimate but any thoughts on CECL and the day one reserve build?
Rex Smith
Well, CECL, for us in a 2023 event, more than likely. We are continuing though to move forward on it as if 1/1/202 was date implementation day. So as soon as we get something that it becomes disclosable, it will show up and we were still working to try to get that there.
And as far as credit quality goes, it I haven't seen any real deterioration in anything. As Bruce mentioned, sometimes one loan, if we have a $3 million loan that misses a payment and gets in the delinquency for the end of the quarter on a timing issue, it moves the needle a little bit, but there is nothing that we have seen in any particular loan class or any [indiscernible] category that gives us any real concern. It's credit quality remains good.
Bruce Thomas
And this will nein the 10-Q and I mentioned it in my comments. So I feel like I can expand on this. And this has been through the last several quarters. The unallocated portion of our allowance is pretty well gone. We calculated a number and that's pretty close to what our allowance is. So to the degree that we have loan growth or a negative migration in credit quality, even the slightest, it will precipitate a provision.
Austin Nicholas
Okay. Makes sense. That's helpful. And then maybe just bigger picture on capital and your thoughts around M&A. You obviously have continued to build capital and have a nice cushion there. But any thoughts on kind of changing the strategy in terms of the excess capital position?
Rex Smith
Well, as I said, I think once we get beyond, get through the accumulated deficit that's out there, the retained deficit, that opens the door for potentially looking at a stock buyback. The Board of Directors has discussed it a lot. There is some mixed opinions about that sitting on the board. But obviously, we want to make sure that we are utilizing capital the right way. And as I said on M&A, we continually, it's a small community in the mid-Atlantic of bankers. And we have good relationships. So we talk. And so phone lines are always open and conversations are always taking place. But as I said, it's a little bit slow right now.
Austin Nicholas
Got it. Great. Well, thanks for taking my questions, guys.
Rex Smith
Yes, sir.
Operator
Our next question comes from Stuart Lotz with KBW. Please go ahead.
Stuart Lotz
Hi guys. Good morning.
Rex Smith
Good morning.
Bruce Thomas
Good morning.
Stuart Lotz
I appreciate the color on a lot of the margin stuff as well as deposit breaking strategy. But I guess the bigger question, the bigger picture question for me, you are now at a 1% ROA. Many would argue that we have kind of reached a key profitability point for banks. What is your outlook for that and for, I guess, your other profitability ratios as we go into the back half this year? Is 1.10% your next target? Or are you just hoping to stay around 1%?
Rex Smith
No. We are not hoping to stay around 1%. And the campaign that I am talking about on the deposit side, if we do what we want to try to do and work on the expenses the way we are working on them, obviously we closed one branch in this quarter. We have a second branch slated to close a week from today. That's about it. But the combination of the two of them between branch expenses, operating expenses and salaries and benefits is a little over $0.5 million annualized. So that's going to help on that side.
And then for us, I would not put us in a category and we talked about that today, when you go to the UBPR and you put us and a bunch of national banks, the mid-Atlantic are is a little bit different. It's a little bit more vibrant. And for us, when you are sitting at 15% DDAs, there is another 10% to 15% of growth in that. And that growth alone moves the needle significantly on the ROA front. So one thing that I can assure you sure, I am sure some of my associates are listening now, we listed the broadcast. They are going hear four words from me over and over and over which are urgency, process, discipline and accountability.
And that is what we are working towards with this campaign on how we, the urgency of getting the types of deposits, the relationships we need, the urgency of getting the right pricing on the loan side and the types of loans that we stick to our process. We have the discipline to understand the process, stay with the process, work it through. And there is accountability. If you are not doing what we need you to do, you will be held accountable for it and those who do it right will be held in esteem.
And that is what we are and that urgency is the key to all of that. I think we have got a new sense of urgency and we have got the ability. It is not unreasonable for us to think that we can continue a pretty strong growth rate in that low cost deposit side. And that's what is fueling the machine is going to be what drives it for the next 18 months.
Stuart Lotz
Got that. So it sounds like next quarter, I guess this quarter the $8.7 million expense run rate, you have some coming out next quarter, call it $150,000 $200,000? That gets you to about $8.5 million run rate plus one-time expenses. Is that a good number to extrapolate here?
Rex Smith
I think so. My goal is to push it down a little bit more. But I think for your purposes of modeling, that's a good number to go with.
Stuart Lotz
Got it.
Rex Smith
I mean part of it, as we talked about it, what we have got internally for goals of return on assets or common equity is also part of that efficiency ratio, which is we are determined to get that down into the low-60s.
Stuart Lotz
And I guess back to Austin's question on provisioning. So I guess this quarter was your first time since 2017 where you actually looked to provision and with the unallocated balance or the unallocated reserve running out. And if growth picks up back up this year like you saw this quarter, what is a good, I guess, provision rate we could expect in the back half?
Rex Smith
Yes. Bruce and I just, you know, I think what we budgeted from here forward is about another $400,000.
Stuart Lotz
Okay. Got it. Thanks guys. Awesome. All right. Those were it for me guys. I appreciate your time this morning.
Rex Smith
Okay. Thanks Stuart.
Operator
[Operator Instructions]. Our next question comes from John Rodis with FIG Partners. Please go ahead.
John Rodis
Hi. Good morning guys.
Rex Smith
Hi John.
John Rodis
Hi. Rex, I just wanted to make sure I heard on the last question. So you said, operating expenses in the second half of the year, around $8.5 million per quarter. Is that right?
Rex Smith
Yes. I think that's a good number to look at. And as I said, there are certain things I am working on hoping maybe here or there, there is little bit of reduction. But I think that's a right number.
John Rodis
Okay. During the quarter, you guys saw a decent jump in service charges. Was there anything unusual in there? Or just sort of --?
Rex Smith
No. Just DDA growth. That's a good news. Again that DDA growth.
John Rodis
Okay. And then, either Bruce or Rex, I guess this was, if you look at, you talked about the margin, Bruce, but on an absolute basis, this is the first linked quarter where you actually saw a decline in net interest income dollars in quite a while. And I know you talked about the higher premium amortization. But as you look to the third and fourth quarter, if the premium amortization slows some, do you think you can grow net interest income dollars again?
Bruce Thomas
Yes. Because of the loan growth. And you know, there are two items that I mentioned there, ironically, were $125,000, pretty close to it, $123,000. And that gets you right back to the decline in the margin on a linked quarter basis net interest income. So yes, I think that loan growth will help us increase the net interest income.
John Rodis
Okay. Makes sense. And then Bruce, maybe just the tax rates sort of stayed around 18%, 18.5%. Is this still a good level?
Bruce Thomas
Yes. We do have a lower level of municipal securities. Part of for those securities gains were, there is such command in the marketplace for tax exempt municipal bonds in particular because the lower level of issuance and in particular the states that are impacted by the limit on the deductibility on their income tax return. So there is a high demand for that tax exempt income. And that's just made what I have my portfolio very attractive to people and to the extent that you can -- you can't always do it, but I watch this daily with the Bloomberg and the commentary coming across, if you can sell a bond at a gain, not decrease credit quality, not extend your duration and keep the same or get a higher yield, I mean that's a no-brainer. You would do it all day long. So to the degree that those opportunities present themselves, then I would be a seller of municipals and of course that would make that effective tax rate go up. But right now, I don't see a big need for us to do a lot of revamping the muni portfolio. So I would say that that run rate is pretty good.
John Rodis
Okay. Thanks guys.
Rex Smith
Thanks John.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Rex Smith for any closing remarks.
Rex Smith
I would just like to thank everybody for participating today and hope that we gave you good insights into where the company's headed. I will remind you, Bruce and I are available today and next week to answer any calls. If there are any follow-up questions, please feel free to give us a call and thank you again.
Operator
Thank you. The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.