SB Financial Group, Inc. — FY 2018 Form 10-K
Business and reporting period. Ohio-based financial holding company operating State Bank and providing commercial and retail banking, mortgage banking, wealth management and related services, primarily in Ohio, Indiana and Michigan. This annual report covers the year ended December 31, 2018; it also reports unaudited fourth-quarter results. Unless otherwise stated, amounts below are in U.S. dollars.
Financial performance and position
- Revenue and earnings: Operating revenue was $49.9 million, up 9.4% from 2017. Net income rose 5.2% to $11.6 million; income available to common shareholders was $10.7 million. Diluted EPS declined 13.1% to $1.51, reflecting the 2018 share issuance and higher weighted-average shares.
- Interest income and margin: Net interest income increased 17.2% to $33.3 million. Fully tax-equivalent net interest margin increased 17 basis points to 3.95%. Interest expense rose 51.7% to $6.2 million as deposit and borrowing costs increased.
- Fees and expenses: Noninterest income decreased 3.4% to $16.6 million, including $6.9 million of mortgage loan and servicing-right sale gains. Noninterest expense increased 10.4% to $34.8 million, led by salaries and benefits, up 10.6% to $20.6 million.
- Fourth quarter: Q4 net income was $3.0 million and diluted EPS was $0.37, versus $4.0 million and $0.64 in Q4 2017. Q4 2017 included a $1.7 million one-time tax benefit from the Tax Cuts and Jobs Act (TCJA).
- Balance sheet and growth: Year-end assets were $986.8 million, up 12.6%; loans held for investment were $771.9 million, up 10.8%; and deposits were $802.6 million, up 10.0%. Total equity was $130.4 million, or 13.2% of assets, compared with $94.0 million, or 10.7%, in 2017.
- Capital and dividends: A February 2018 common-share offering generated $27.9 million net proceeds and issued 1,666,666 shares. State Bank was well capitalized; its reported Tier 1 leverage ratio was 11.23%, Tier 1 risk-based ratio 12.57%, and total risk-based capital ratio 13.50%. Common dividends declared were $0.32 per share for 2018, versus $0.28 in 2017. Regulatory and subsidiary earnings constraints may limit future dividends.
- Credit quality: Nonperforming assets were $4.0 million, or 0.40% of assets, versus $3.9 million, or 0.44%, in 2017. Net charge-offs rose to $0.36 million from $0.20 million; the allowance for loan losses was $8.2 million, equal to 1.06% of loans and 213% of nonperforming loans. Management also identified approximately $7.3 million of substandard loans with potential repayment concerns.
- Cash flow and liquidity: Operating cash flow was $13.9 million; investing activities used $87.6 million, primarily reflecting loan growth and securities purchases; financing activities provided $95.5 million. Cash and equivalents ended at $48.4 million. Reported liquid assets were $143.8 million, with approximately $98.9 million of additional FHLB borrowing capacity, $41.0 million of available federal funds lines and $42.3 million of unpledged securities.
- Debt and funding: At year-end, FHLB advances were $16.0 million, repurchase agreements $15.2 million and trust preferred securities $10.3 million. Deposits included $241.5 million of time deposits, of which $144.8 million mature in 2019.
Changes, outlook and notable items
- Loan growth was led by residential real estate loans, up 24.0%, and commercial business and agricultural loans, up 16.7%. Commercial real estate and construction loans were $340.8 million, approximately 44% of the held-for-investment portfolio, creating meaningful real-estate and geographic concentration.
- Residential mortgage production increased to $342.1 million from $315.8 million. The company sold $260.7 million of originated mortgages to the secondary market and serviced $1.085 billion of loans for others at year-end, up from $994.9 million.
- Net interest income and margin improved, but funding costs rose and noninterest expenses grew faster than revenue. The 2017 comparison also includes the TCJA’s $1.7 million one-time tax benefit; the company’s 2018 tax expense was $2.8 million.
- The company sold customer contracts and certain assets of RDSI’s remaining check and statement processing business effective January 1, 2018; RDSI was inactive with no material operations at year-end. The company reported no specific earnings or margin guidance. Management’s stated strategy is to grow profitability, market penetration, customer product use and operational performance while sustaining asset quality.
- On January 2, 2019, the company elected and received approval to become a financial holding company. Management said State Bank met applicable capital requirements, including the capital conservation buffer, and believed current liquidity was sufficient for anticipated needs.
- CECL was scheduled to take effect for the company after December 15, 2019. Management could not reasonably estimate the adoption impact but expected the new expected-loss approach could increase the allowance. Other material risks cited include interest-rate and deposit-cost pressure, local economic and collateral conditions, competition, regulation, cybersecurity and operational disruptions, and dependence on key personnel.
- Management reported no goodwill impairment in 2018. Ordinary-course legal matters were not expected to materially affect consolidated financial condition, results or cash flows. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether loan and deposit growth can continue to support net interest income as deposit pricing and overall funding costs rise.
- Whether credit performance remains stable, particularly in commercial real estate, residential mortgages and the identified substandard-loan pool; assess allowance adequacy and rising net charge-offs.
- The effect of the February 2018 share issuance and convertible preferred shares on diluted EPS and future dilution.
- Time-deposit maturity and renewal trends, liquidity availability, and the terms and maturity schedule of FHLB advances and trust preferred securities.
- Management’s CECL implementation assumptions and eventual effects on provisions, capital and reported earnings.
- Whether fee income can recover following the RDSI business sale and changes in mortgage gains, and whether expense growth moderates.
- Future dividend capacity, including regulatory restrictions and the subsidiary bank’s ability to upstream funds.