SB Financial Group Inc (SBFG) 2006 Q4 法說會逐字稿

Good afternoon and welcome, ladies and gentlemen, to the Rurban Financial Corporation fourth quarter 2006 earnings conference call and webcast. At this time I would like to inform you that this is a conference call being recorded and all participants are in a listen-only mode. We will open the conference up to the investor community for questions and answers after the presentation. I will now turn the conference over to Ms. Valda Colbart, Investor Relations Officer.

Good afternoon, everyone. I would like to remind you that this conference call is being broadcast over the Internet live and will also be archived and available at our website, www.RurbanFinancial.net until February 15, 2007. Joining me today are Ken Joyce, President and CEO, Duane Sim, CFO, Mark Klein, President and CEO of The State Bank and Trust Company. But before we get started I'd like to make our usual Safe Harbor statements and remind everyone that comments made during this conference call regarding Rurban's anticipated future performance are forward-looking and therefore involve risk and uncertainties that could cause the results or developments to differ significantly from those indicated in these statements. These risks and uncertainties include but are not limited to risks and uncertainties inherent in general and local banking, insurance and mortgage conditions, competitive factors specific to markets in which the company and its subsidiaries operate, future interest rate levels, legislative and regulatory decisions or capital market conditions, and other factors set forth in the company's filings with the Securities and Exchange Commission.

I will now turn the call over to Ken Joyce, President and CEO.

Thank you, Valda. Thank you for joining us this afternoon to discuss the fourth quarter 2006 and year-to-date financial results for Rurban Financial Corporation. Over the next 20 minutes or so, Duane Sim, Rurban's CFO, and I will discuss this eventful quarter and try to add some detail to the earnings release that went out last evening. I have also asked Mark Klein, State Bank President and CEO, to join us in this process and provide some commentary on the banking segments progress and plans. Overall we see this past quarter as a continuation of the progress we have made over the past several years, which has accelerated since 2006 with the beginning of several growth and profitability initiatives.

Our primary task for 2007 is to improve the profitability of our banking segment. We have struggled over the last three years with credit problems that originated prior to 2002 which have taken a tremendous toll on Rurban's resources, and thus diverting our attention from income generating activities. We're confident that these problems are now behind us and we are able to enter a new year focused on growth and profit improvement. Nonperforming loans are below our projected 1% of total assets and we have virtually no OREO on our books. The actual number of nonperforming assets to total assets is 70 basis points, approximately the same as the median of the publicly traded Ohio banks.

We reduced these nonperforming assets to $3.9 million as of year-end down from $8.9 million or 1.67% of assets at the end of 2005. We have not had a significant credit (indiscernible) our nonperforming that was originated since 2002. The high quality of our recent underwriting combined with reducing our problem assets is a clear indication of the success of our controls and our attention to quality underwriting standards. We've been working for the past 18 months to build an infrastructure that will accommodate the next phase of our recovery. We already accomplished several major initiatives, one is we diversified our geographic footprint to new growth markets. Number two is we brought in the right management team. Number three, we began the process of creating a sales culture. Number four, we began to grow. We have already increased our loan and deposit portfolios using some of these new strategies.

In June of 2005, we acquired two Lima branches and recruited an outstanding lending team led by David Anderson to develop that market and grow our presence. We projected that the acquisition would be profitable within one year. We met our expectations as to growth as our loans grew $20.7 million for 2006. The Lima branches turned profitable around midyear and are profitable on a year-to-date basis including a full allocation of indirect expenses. We remain excited about the opportunity for the Lima market and expect continuing growth and profitability.

We acquired The Exchange Bank in the Toledo Metropolitan market as of the year-end 2005 at an attractive deposit acquisition cost of about 8.15%. The Exchange Bank operates in both Wood and Lucas counties, which are showing both deposit and population growth. The banks had some asset quality problems but our experience indicates that those would be able to be fixed fairly quickly and we have done so. Nonperforming assets have gone from $1.5 million at the acquisition date, down to $268,000 at year-end 2006. This represents 31 basis points of nonperforming assets to total assets. This reduction was accomplished through a combination of loan workout activity and problem loan sales.

At the time of the acquisition, we targeted a net income run rate for the fourth quarter 2006 of approximately $30,000 per month on a fully allocated basis and we have not achieved that profit goal. The goal is not met even though we improved profitability of our portfolio quality. We exercised solid expense control. We had a 12.5% year-over-year loan growth which was he net of problem loan sales and the sale of the credit card portfolio. The overhead costs to operate this bank separately is simply too high to overcome in the short-term, therefore we had made a decision to merge Exchange Bank with State Bank and Trust, which we announced in December.

We have completed the regulatory applications to merge The Exchange Bank into The State Bank and Trust Company. Subject to the receipt of regulatory approval, we expect to complete that merger by the first quarter of 2007. These moves should result in The Exchange Bank acquisition meeting our target goal to be accretive to earnings shortly following the merger date. At the same time, we plan to merge the trust and investment company Reliance Financial Services into The State Bank and Trust Company. This merger is also subject to regulatory approval. We have filed the necessary applications and expect completion of the merger by the end of the first quarter. This merger will also add economies and will integrate sales efforts into the various markets more effectively under one single charter.

We took an after-tax charge in the fourth quarter of approximately $283,000 to reflect the identified costs of these mergers. We would expect some additional charges in the first quarter when we will be able to quantify additional merger expenses and fully identify the costs. We are targeting between $1 million and $1.5 million of annualized savings from these mergers. The CEO of the combined banking entity following these mergers will be the current State Bank and Trust CEO, Mark Klein. A major component of our strategy has been to get the right management team in place and Mark is part of that dynamic management team.

We introduced Mark Klein at a previous webcast and I have asked him to join us today to discuss his progress after one year and his upcoming initiatives for 2007 in the expanded footprint. Mark's primary job is to improve the profitability of the banking unit. At this time, I will turn the call over to Mark Klein.

Thank you, Ken and good afternoon. I am pleased with our progress and the results of 2006 and also encouraged with our prospects for continued improvement as we move into 2007. While we have made tremendous progress, we still have a long way to go. However the sales culture we introduced to the entire organization in 2006 was met with enthusiasm and has yielded some outstanding results which I will share with you today. I am convinced that this bankwide sales initiative led by our management team and reinforced with an incentive plan that rewards specific individual contributions will continue to provide the momentum that will enable us to deliver our goals for 2007.

Briefly, looking back on 2006, our success hinged on several key components. Total loans grew at $39.5 million or approximately 15%. Total commercial loans grew $37.4 million or approximately 23% over 2005. $23.5 million or 63% of the increase came in commercial real estate loans and approximately $13.9 million or 37% of the increase came in commercial, business and agricultural loans. Core deposits grew $29.6 million or 9.43%. Individual referrals to our business partners in 2006 total 431 with 134 closed referrals leading to $5.9 million in mortgage loans, $4.7 million in commercial and consumer loans, $1.2 million in savings and money market deposits, $3.8 million in certificates of deposits, and $10.2 million in trust assets.

Residential loan production for the entire Banking Group was $43 million or 95% increase over 2005 volume of $22 million. Commitment to maintain high level of asset quality with a more rigorous underwriting process for commercial loans and, as Ken mentioned, improvement in asset quality to peer level of less than 70 basis points for nonperforming assets.

We accomplished these goals by bringing more value to our clients than our competition in providing expertise as we discussed strategy, financial needs, and loan structuring with existing as well as prospective clients. In fact, a common thread to all our successes was our ability to be in the client's home and business, as evidenced with over 3900 business development calls by retail, real estate, and commercial lenders. This continued focus on assessing and providing solutions to 100% of our client's needs continues to drive our daily activities.

Quite simply, our plans for 2007 are to continue building on our successes we have identified in 2006 with continued emphasis on sales calls, quality loan underwriting, proactive identification of client needs, employee recognition, and clearly defined individual goals with financial incentives. At this time, I will turn the discussion back to Ken.

Thank you, Mark. Congratulations to you and your team on making the substantial contributions to our progress in 2006. A few words here about our loan workout Company, RFCBC. This company was created in 2003 and has handled a high of about $42 million of problem loans. It is now down to one relationship with a single loan on a payout schedule. We expect to see this workout Company go dark by the end of 2007. Our (technical difficulty) compared to 2005 we will continue to have legal expenses connected to our litigation and collection efforts on charged off loans for the next two quarters, at which we would expect the legal fees to decline substantially. We would also expect some recoveries in 2007 to help offset these continuing legal fees.

At this time I will turn the webcast over to Duane Sim, our Chief Financial Officer. Duane will give you the information behind the strategy and progress I have discussed. He will also give some additional clarity to the information presented in our recent press release.

Thank you, Ken. Good afternoon. Our fourth quarter and year-to-date results were a reflection of several initiatives to improve our core bank earnings going forward. Our overall core earnings are improving and this will be more apparent in 2007 as we merge our banking subsidiaries. As we mentioned in our press release, we are targeting approximately $1 million to $1.5 million and the annual pretax savings as we work through the merger of our Banking Group. I want to remind you that our year-end balance sheet for 2005 includes the assets and liabilities of Exchange Bank. However the 2005 Rurban income statements provided in our earnings release do not include Exchange Bank because it was acquired at the close of business on December 31, 2005.

I will also point out that RDSI's acquisition of DCM, the item processing company headquartered in East Lansing, Michigan, was completed in early September 2006 so its results are included in this quarter for the first time. Balance sheet growth slowed during the fourth quarter, restricted by restructuring that we completed in December of 2006 as we sold $17.5 million in securities and paid off $9 million in the higher costing FHOB advances. This restructuring should have a positive effect on our margin for 2007 and I'll discuss this in a minute.

We continue to be encouraged by the loan growth we see in our markets and we see additional opportunities to leverage our growth as we enter 2007. The prime driver of our loan growth is the commercial lending group. Commercial loans increased $38.2 million or 20% for 2006. Excluding mortgage loans sold, our residential loan portfolio grew $5.3 million or 6% and consumer lending grew $400,000 or 1%. Overall loan growth for 2006 totaled $43.1 million or 13%. Excluding the credit card sale and the workout of problem loans, total loans would have been well above -- total loan growth would have been well above 15% for the year.

On the deposit size, our non-interest-bearing deposits showed a decrease of approximately $5.5 million during 2006. This decrease is a result of customers migrating into higher yielding instruments. Increases in interest-bearing deposit accounts were $35 million or 11% in 2006. This growth was retail in nature as broker deposits were relatively stable throughout the year. Overall deposit growth was $30 million or 8% for 2006.

As Ken mentioned, we have been successful in reducing our nonperforming assets by $5 million during the past 12 months to $3.9 million or 70 basis points of assets. RFCBC at one point had three loan workout specialists and is now down to a part-time loan workout specialist. Legal expenses declined but continue to be relatively high throughout 2006 and we expect that to decrease substantially in 2007.

Let's transition to the income statement and I will focus on a few key year-to-date and quarterly results. We reported net income of $2.8 million or $0.55 per diluted share for the year, which represents a $2.1 million increase over the $673,000 reported in 2005. The fourth quarter results were $710,000 or $0.14 per diluted share, a $1.1 million increase over the loss of $344,000 reported in the fourth quarter of 2005. Primary reasons for this year-over-year improvement was the overall growth in The State Bank and Trust Company, namely earning asset growth, increases in non-interest income, improved expense control, and the continuing success of RDSI. Net interest income totaled $15 million on a year-to-date basis compared to $12.1 million last year.

Increases in earning asset levels throughout the banking footprint and the acquisition of The Exchange Bank were the priority drivers of this increase. These increases and earning asset levels were offset by the margin compression that was rampant in the first half of 2006 and continued to be a problem in the second half of 2006. Although the rate of change is clearly slowing, it appears to be stabilizing. This margin pressure is driven by the inverted yield curve and strong competitive pressures on the loan side. The restructuring of our balance sheet at year end will improve the margin by approximately 15 basis points assuming no other changes in rates.

We continue to position our balance sheet for growth as we leverage our ability to fund growth, loan growth, with a portion of our investment portfolio and focus on core retail deposits as we enter 2007. We anticipate approximately $10 million in callable securities yielding 4% to be used for loan fundings throughout 2007. Overall earning asset yields were 6.38% on a fuller tax equivalent basis for 2006 compared to 5.55% in 2005. The overall cost of funds increased to 3.62% from 2.76% in 2005. The net interest margin was 3.13% for 2006, compared to 3.14% in 2005.

Net interest income for the fourth quarter of 2006 increased $438,000 to $3.6 million compared to $3.1 million for the fourth quarter in 2005. Once again, the growth in earning assets and the acquisition of The Exchange Bank were the major contributors to this increase. Management recognizes that one of the contributors to our relatively weak margin is our high mix of investments to total earning assets and we will continue to focus on reducing the investment portfolio and increasing our loan portfolio throughout 2007.

The loan loss provision for 2006 year-to-date was $178,000 compared to $583,000. The 2006 provision declined compared to 2005 as our loan quality continues to improve. We are comfortable with our overall loan loss reserve at 1% of loans given the quality of our loan portfolio and the relative declining risk of that portfolio. The negative loan loss provision for the quarter is a reflection of selling the credit card portfolio during the quarter, a provision of $140,000 was essentially moved from the loan loss reserve to the liability reserve account. This was done because the credit card sale agreement has a put option on delinquent transferred accounts but we have elected to expense the reserve for this contingency to a separate liability account.

Net charge-offs for 2006 totaled $1.2 million compared to $1.7 million for 2005. Net loan charge-offs were 33 basis points on an annualized basis and reflect our improving abilities to reserve adequately for losses. The 2006 charge-offs were all fully reserved.

Total non-interest income year-to-date improved nicely from last year, increasing by $5.4 million or 30%. Data servicing fees drove this increase, with an increase of $2.3 million or 18% above the previous years' results. Another important component was the gain on sale from the mortgage lending operation. We originated and sold $40 million to mortgage loans, twice the amount compared to 2005 levels. The increase in non-interest income was also aided by non-recurring fees associated with the gain on sale of credit card loans, recovery on WorldCom bonds, and income associated with a recovery of impaired loans. Offsetting these onetime gains were losses on securities totaling $495,000 due to the balance sheet restructuring.

Excluding the previously mentioned non-recurring large items, total non-interest income increased $3.9 million or 21%. Total non-interest income increased $3.1 million or 69% for the fourth quarter 2006 compared the fourth quarter of 2005. Once again the data processing fees and the previously mentioned non-reoccurring fees associated with the gain on the sale of the credit card loans, recovery of WorldCom bonds, and income associated with recovery of impaired loans were primarily the reason for this increase. Excluding the onetime fees, non-interest income increased $1.7 million or 38% for the fourth quarter compared to the year ago quarter.

Total non-interest expense increased to $34.9 million year-to-date, compared to $29.1 million for the same period in 2005, reflecting a $5.8 million increase. These increases were the result of $4.9 million in operating expenses for Exchange Bank, $1.25 million in expenses associated with DCM, $215,000 in prepayment penalties on FHLB advances, and $283,000 of merger-related expenses. Excluding these items, non-interest expense actually decreased $783,000 between 2005 and 2006 results.

Professional fees year-over-year declined $334,000 as litigation expense dropped on problem loans throughout 2006 compared to 2005. The remainder of the decrease is due to improved expense controls. The current quarter operating expenses totaled $10.4 million compared to $7.6 million for the fourth quarter of 2005. The quarterly increase was once again driven by expenses at Exchange Bank and DCM, as well as the FHLB penalties and merger-related expenses which were recorded in the fourth quarter of 2006. As I mentioned earlier, we are targeting $1 million to $1.5 million in efficiencies and most will come from the operating expense cuts which we expect to complete by the end of the first quarter.

As I mentioned throughout my presentation, each company had a number of onetime adjustments during the quarter. These onetime adjustments increased income for the quarter by approximately $100,000 to $150,000. Excluding all adjustments, the core earnings for the fourth quarter would have been approximately $550,000 to $600,000. At this time I will turn the discussion back to Ken and he will update you on the progress of our fee income business segments.

Okay, thank you. I appreciate it, Duane. I think that we had a little cutout before so in other words, we may have missed a little section where it talks about the loan workout company, RFCBC. This company was created in 2003 and has handled a high of about $42 million of problem loans and it is now down to one relationship with a single loan on a payout schedule and we expect to see this workout company go dark by the end of 2007. Our professional fees, which are largely related to attorney fees connected to problem loans, are down by $334,000 compared to 2005. We expect to continue to have legal fees connected to our litigation collection effort charged-off loans for the next two quarters and then we expect those legal fees to decline substantially. We would also expect some recoveries in 2007 to help offset these continuing legal fees, although we cannot define those at this time.

As I discussed earlier, subject to regulatory approval we will begin merging our trust and investment company, Reliance Financial Services into State Bank and Trust. We expect that merger to be completed by the end of the first quarter of 2007 as well. Reliance did well in 2006, turning in a profit of $715,000 which included a onetime item that Duane mentioned of $105,000 after taxes. Profits is expected to be down slightly for Reliance for 2007 as it invests in the new banking footprint. The payback on the trust investment business can take two years to recoup investment staff and new markets.

RESI, our data processing and item processing company, continues to make excellent progress. It made $2.1 million on revenue of about $16.6 million. The DCM acquisition completed in September of 2006 has proven to be a real success since it is already exceeding our profitability goals. It has been immediately accretive to earnings and we have been able to continue to add new clients. The 50th bank was added in the fourth quarter, resulting in the combination of DCM and RDSI, servicing more than 100 banks throughout the Midwest as well as our recent entry to Florida.

We see 2007 as a continuation of the growth story for RDSI. At this time I will turn the webcast over to Valda to see if we have any questions from our investment community.

Thank you, Ken. It is now time for the question-and-answer session.

(OPERATOR INSTRUCTIONS)

While we are waiting to see if we have any questions, we would like to remind everyone that we would be happy to e-mail you directly regarding Rurban Financial corporate events.

George Geissbuhler, Sweeney Cartwright & Co.

I just had one question really. You are saying you have one loan left in the workout company.

That is correct.

I'm curious how big that one is.

About net of about $600,000 in total.

And you think that will be done in the next three or four months?

No, it is going to have a period of workout time connected to it, but we do not see a loss connected to it because it is well collateralized at this point and even if things should turn south on that entire relationship, we should be okay with it. So we do not see any risk in that remaining portfolio in that company at this point at all.

Tremendous.

Yes, it has been a long road and as we sit here I have to (indiscernible) work on the banking side and get it profitable and we think we've got the right people here in place with Mark; and we made some changes here in this last quarter to make it head that way.

Real good progress and keep up the good work. That's all I had.

(OPERATOR INSTRUCTIONS) Ross Habermann, the Habermann Fund.

I just had a couple of quick questions. What is your expectations? Do you see a significant falloff in '07 with what you call professional fees? I am not sure if that part includes the workout and so forth from the $870,000 expense you had in '06.

Do we expect to see a substantial falloff? Was that your question?

Yes.

Yes, we saw improvement of that in 2006 and I think we're still going to see some in the first and second quarter of next year. We are still in litigation on a couple of issues. My only uncertainty is that we're going to get recoveries that are potentially going to offset that. I do not know that at this point, but following that once we get resolution of that, that is kind of the last as I see it of the legacy issues that are active at this point.

You talked -- I think you said that in pro forma you are at $500,000 to $600,000 without all the onetime items for the quarter. Any large expenditures, expenses expected for the upcoming year? And is sort of this a base to grow from to hit our -- what was it -- I think you threw out a couple of months ago you were shooting for a 1% return on assets I think in some interview you had. I wonder if we're going to see anything like that over the next year or two. Or is that wishful thinking?

We do not think it is wishful thinking and we see a target of a run rate of probably 80 to 90 basis points by the time we get to -- at least by the fourth quarter and we're trying to stay conservative with that number, Ross. We have got a pretty good run rate going right now. We think the restructuring that we've done on the investment portfolio is going to add to that. The loan growth that we saw this year we think we can do that again next year. The question certainly part of the question becomes margin and what happens to that margin compression in the course of next year. It looks to us like our margin compression is stabilizing at this point, so that loan growth will be a lift to earnings. And as we mentioned, we have identified at least $1 million to $1.5 million of expenses that we're going to work out of the income statement here in the first quarter.

Do you think you can generate those savings within the first quarter or will they gradually come in over the year you might think?

Good question. That is kind of a run rate that would be an annualized expense saving number that I am discussing in terms of the $1 million, $1.5 million.

Just one final question. How are you positioned on, in terms of interest rate exposure and if we continue to get this and flat, inverted yield curve through summer into the fall, is that 80 to 90 basis points goal a realistic expectation based on a continued flat yield curve?

We would -- in terms of how we're looking at next year, we would expect to see probably a couple of increases in prime rate. Those are our expectations. The market may have changed a bit here as you look at it over the last few months. It may be flat. If it is flat, it is going to affect as somewhat. We're going to have to find another way to do that if it continues flat. But flat continuation of the present shape of the curve is not going to hurt us much. If it continues to invert, that is another story. We and every other banking organization I think would be impaired if it continues to invert. If it stays about where it is at, we're going to be in reasonably good shape. If it improves and we see some prime rate increases, that would be very encouraging for us.

Thank you.

We seem to have no further questions at this time. I will turn the conference back to Mr. Ken Joyce.

Okay, thank you very much and thank you, Valda, for hosting this. That seems to be the end of the questions, so we will end Rurban's fourth quarter 2006 webcast call. Thank you for joining us today.

That does conclude today's conference. Thank you for your participation. You may now disconnect.