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Edited Transcript of SBFG earnings conference call or presentation 24-Jul-19 3:00pm GMT

Q2 2019 SB Financial Group Inc Earnings Call

Defiance Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of SB Financial Group Inc earnings conference call or presentation Wednesday, July 24, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony V. Cosentino

SB Financial Group, Inc. - Executive VP & CFO

* Carol M. Robbins

The State Bank and Trust Company - Senior VP & Controller

* Jonathan R. Gathman

SB Financial Group, Inc. - Executive VP & Senior Lending Officer

* Mark A. Klein

SB Financial Group, Inc. - Chairman, President & CEO

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Conference Call Participants

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* Brian Joseph Martin

Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts

* Jason O'Donnell;Bluestone; CIO

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Presentation

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Operator [1]

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Good morning and welcome to the SB Financial Second Quarter 2019 Conference Call and Webcast. (Operator Instructions) I would like to inform you that this conference call is being recorded. (Operator Instructions)

I would now like to turn the conference over to Carol Robbins with SB Financial. Please go ahead, Carol.

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Carol M. Robbins, The State Bank and Trust Company - Senior VP & Controller [2]

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Thank you, Danielle. Good morning, everyone. I would like to remind you that this conference call is being broadcast live over the Internet and will be archived and available on our website at www.yoursbfinancial.com, under Investor Relations. Joining me today are Mark Klein, Chairman, President and CEO; Tony Cosentino, Chief Financial Officer; and Jon Gathman, Senior Lending Officer.

This call may contain forward-looking statements regarding SB Financial's performance, anticipated plans, operational results and objectives. Forward-looking statements are based on management's expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied on our call today.

We have identified a number of different factors within the forward-looking statements at the end of our earnings release, which you are encouraged to review. SB Financial undertakes no obligation to update any forward-looking statements except as required by law after the date of this call. In addition to the financial results presented in accordance with GAAP, this call will also contain certain non-GAAP financial measures.

I will now turn the call over to Mr. Klein.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [3]

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Thank you, Carol, and good morning, everyone. Welcome to our second quarter 2019 conference call and webcast. Our comments today, as with prior quarter, are supplemented by the earnings release we filed yesterday.

Highlights for this quarter, excluding the effects of the onetime temporary mortgage servicing rights impairment, include net income of $3.2 million, up $100,000 or 2.1% increase over the prior year quarter. After the effect of a onetime mortgage portfolio impairment of $699,000, net income was $2.6 million. For the full year, excluding the now $1.4 million OMSR impairment, the adjusted net income was $6 million, up 8% over the prior year.

Adjusted return on average assets, 109 basis points, down from the prior year of 135 basis points. Loan balances for the quarter grew $32 million or strong 16.4% annualized. Deposits for the quarter increased and grew to $11.7 million or 5.7% annualized. Mortgage origination volume improved this quarter to a robust $98 million and, over the last 12 months, now have a run rate of approximately $324 million. Asset quality metrics remain strong.

Our 5 key initiatives continue to drive our quest for high performance. They remain: revenue diversity and growth; more scale through organic balance sheet growth; more scope of services in each client household; operational excellence and intimacy with our client communications; and lastly, the foundation we feel of all strong-performing companies is the top-quartile asset quality.

First update on revenue diversity. This quarter mortgage origination and sales volume rebounded nicely with loan sale gains up 41% from the linked quarter. Total originations for the year of $100 million -- $150 million still trail our June 2018 year-to-date production by 10%, but we expect to draw nearly even with the prior year by the end of this third quarter.

Noninterest income to total revenue was 29.5% for the second quarter and 28% for the full year. The exclusion of the impairment would have increased the quarterly and year-to-date fee to revenue percentage to 33.2% and 32%, respectively. While our reported noninterest income of $3.7 million was down $500,000 or 12% from the prior year, the adjusted number of $4.4 million would be up $200,000 or 4% for the quarter.

We continue to actively pursue additional mortgage origination talent in each of our markets. We made progress this quarter with our mortgage loan production office in Indianapolis. We now have 3 originators hired with a few more to follow. And we look forward to competing in this dynamic market that's adjacent to our Ft. Wayne, Indiana market that we feel is much like our strong Columbus office here in Ohio.

This quarter saw the full realization of the revenue and income from our Title Agency acquisition that we completed in late March. We had total revenue for the quarter of $308,000 and net income of $56,000, which is well in line with our projections. We have begun to introduce this new business line to our lenders outside of the agency's primary market of Columbus. With the recent addition of an outside sales professional, we expect to continue to expand this revenue source and the customer service throughout our footprint in the coming quarters.

Our SBA production for the quarter came in at $4 million with loan sales of just $800,000 as our volume included several large construction draw loans that will be sold later this year. As a result, our loan sale gains were $124,000, which is up slightly from the prior year. With a flattening of the yield curve and the relaxation of competitors' credit standards, the SBA market has become a bit more challenged as a number of our competitors have begun to channel SBA-type credits into more traditional commercial loans. Our BDOs and business bankers have increased their targeting calling efforts. And we expect a better second half of 2019 in this critical business line for us.

Our residential portfolio now stands at approximately $14.5 million with a nicely weighted yield of 7.6%, which is a residual of the approximately $60 million we've done in this business line the last several years. Wealth Management assets under our care of $479 million represented an increase over the linked quarter of $17 million or 3.7% and up from the prior year by $71.8 million or 17.6%. This 18% increase in wealth assets under our care has resulted in a 10.3% increase in quarterly revenue compared to the prior year.

Our second initiative, more scale. Loan growth for the second quarter tripled to $32 million from the growth level achieved in the first quarter of 2019 of just $11 million. This growth increased our loan interest income to $10.3 million for the quarter, which is up $800,000 or 8% and up $1.3 million or 13.9% from the prior year same quarter. Total assets now stand at $1.03 billion and reflect year-over-year growth of $84 million or 8.9%. From year-end 2018, our loan growth of $42.6 million was very diverse in both product segment and geography. We have had growth in all of our product segments excluding consumer, which is generally flat for the year. All but 3 of our 10 regions have grown their loan balances in 2019, with each of the 3 nongrowth regions contracting under $1 million each.

Deposit growth continued to be positive for the quarter and year-to-date. This quarter, we grew deposits to $839 million, up $11.7 million or 1.4% and up $36.8 million or 4.6% from December 31 year-end. We continue to pursue strategies to expand our deposit gathering with our existing clients and prospects via technology, more calling efforts and expanded product offerings such as what we announced a quarter ago of courier service that we introduced. We currently have 2 courier clients, 1 new, 1 existing client and 2 more prospects in current markets.

Third is our strategy to develop deeper relationships. Our company passed a key milestone in the quarter. We're now servicing more than 30,000 households for the first time in our history. We have added more than 1,000 new households since the prior year same quarter. Products and services to all of our households also continue to expand as we now exceed 89,000 products and services, which is up over 4,500 or 4.2% from the prior year.

The second quarter continued our commitment to identify needs for each of our clients and refer those needs to our business line partners. Following up on $11 million we referred in the first quarter of 2019, we uncovered an additional $18 million in opportunities in the second quarter of this year.

Operational excellence remains the fourth theme. Later in the quarter, our mortgage origination volume turned more towards the refinance market. While our total volume for this quarter had only 7% of our own refinance activity, our current pipeline, which exceeds $50 million, is running closer to the 30% refinance rate. We expect in the second half of the year we'll exceed the $150 million volume we were able to originate in the first 6 months of this year. There continues to be opportunities to expand our presence through more origination, more originator for potentially even an acquisition focused on the mortgage business line.

Expense levels were up $500,000 from both the prior year and linked quarters due to the impact of the Title Agency, merit increases and higher commission levels due to mortgage volume. Noninterest expense to average assets is down to 3.6% from the second quarter of 2018 or 3.7%. Our net interest expense to average assets improved to a negative 2.1% compared to the linked quarter of negative 2.3%.

And finally, our fifth key initiative of asset quality. Nonperforming assets as we disclosed, 0.43%, in line with prior quarters. Total past due loans did spike a bit this past quarter, now stand at 0.68% due to a couple -- timing issues of a couple of credits that went past due. We would expect those to normalize in the third quarter.

Net charge-offs for the quarter, just $15,000. Our reserve to nonperforming remains in the top quartile of our peer group at 212%. Our asset quality and our risk-managed approach to credit analysis as well as our dynamic loan review process remain a strength to our company.

Now I'd like to turn it over to Tony Cosentino, who will certainly give us some more insight and details on our performance. Tony?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [4]

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Thanks, Mark. Good morning, everyone. Just reminding that for the quarter, we had net income of $2.6 million or $0.33 per diluted EPS. As been -- has been noted by Mark, our earnings were impacted by a $690,000 temporary impairment on our mortgage servicing rights. And absent that impairment, net income would be $3.2 million, up $100,000 or 1.6% increase. And for the year, adjusting for the large $1.4 million impairment, net income of $6 million is up $500,000 or 8% compared to the prior year 6 months.

Adjusted diluted earnings per share is roughly flat to the prior year at $0.75 due to the full year impact in 2019 of the capital raise we completed late in the first quarter of 2018.

Total operating revenue for the quarter was down 1.2% from the prior year but up 4.3% when you adjust for the impairment. Loan growth, as Mark indicated, up $32 million from March and up $61 million from the prior year or 8.1%. Loan sales delivered gains of $1.9 million from mortgage, small business and ag in the quarter. Mortgage volume of $98 million, lower by 10% from the second quarter of 2018. However, we were up from the linked quarter by $47 million in originations. Lastly, we continued to hold our nonperforming assets steady with the NPA ratio at quarter end of 43 basis points.

As we break down our second quarter income statement starting with the margin, net interest income was up from the prior year by 4.8% and up 5.9% to the linked quarter. Average loan yield for the quarter of 5.1% increased by 13 basis points from the prior year, and overall earning asset yield was up 12 basis points from the prior year to 4.88%. Obviously, our balance sheet impact of growth and the rate increases have, in fact, affected interest income over the past year.

On the funding side, we continue to experience an increase in the cost of our interest-bearing liabilities like all community banks, although it has slowed this quarter. The rate on interest-bearing liabilities came in at 1.28%, which is -- which was up 48 basis points from the prior year but up just 8 basis points from the linked quarter. Net interest margin at 3.88% was up 7 basis points from the linked quarter.

For the full year, our margin was 3.84%, down 5 basis points from the first 6 months of 2018. Total interest expense costs have risen significantly from the prior year due to higher deposit costs, loan growth funding needs, reduced fees from mortgage loan origination and obviously the increased competitive nature we've experienced in deposit rates.

Total noninterest income of $3.7 million was down from the prior year by 13%, reflecting the temporary impairment. Adjusting for that impairment would increase noninterest income to $4.4 million, up 4.4% from the prior year. As Mark indicated, we had a strong contribution from our newly acquired Title Agency with total revenue for the quarter of $300,000 and was reflective of our efforts to integrate the business line into the rest of our company. Given the pipeline for our mortgage and commercial business lines, we expect an expanded contribution from the Title Agency in Q3. In addition, this quarter we sold a few bonds due to the reduction in rates and realized a small gain of $200,000.

Mortgage originations for the quarter of $98.4 million were down from the prior year by $11.1 million or 10.1%. Over the last 12 months, we've originated $324 million in mortgage volume. And we expect to eclipse the $300 million mark in originations in 2019 for the fifth consecutive year.

Total mortgage sales were $71 million for the quarter, which was down from the prior year as well. And as the bulk of our volume accrued late in the quarter, our sold percentage of originated volume was just 72% compared to 85% from the linked quarter. We expect that third quarter sold percentage to trend closer to the mid-80s.

Total gains on sale came in at $1.7 million, which was 2.4% of our sold volume. The servicing portfolio, now at $1.11 billion, provided revenue for the quarter of $691,000 and is on pace to deliver $2.8 million in total revenue for the year. The servicing portfolio has increased by $82 million or 8% from the prior year.

Given the impairment, the market value of our mortgage servicing rights declined again this quarter. Our calculated fair value of 98 basis points was down 8 and 23 basis points from the linked and the prior year quarters, respectively, and did result in a $690,000 impairment. At June 30, 2019, our mortgage servicing rights were $10.3 million, which was down $400,000 or 3.5% from the second quarter of 2018.

The total temporary impairment remaining on our books now is $1.6 million. With the stabilization of rates potentially in the second half, we do have the potential to recapture a portion of this impairment prior to year-end 2019.

Total operating expenses for the quarter were $9.1 million, up $500,000 or 6% from both the linked and prior year quarters. The quarter included the full impact from the Title Agency of roughly $250,000 and the commission on $47 million in higher mortgage volume of approximately $350,000.

Total headcount adjusted for the Title Agency was up slightly from the prior year as we continue to add staffing in risk management and operations. We expect to remain stable on staffing for the remainder of 2019 and anticipate expense growth and/or reduction will be coordinated with the level of mortgage and SBA volume.

As we turn to the balance sheet, loan outstanding at June 30 stood at $814.5 million, which was 79.2% of the total assets of the company. We had loan growth of $61 million and asset growth of $84 million from the prior year. And we were up $32 million and $8 million, respectively, from the linked quarter. At $32 million, the loan growth from the linked quarter would be a 16% annualized growth rate. And as Mark indicated, compared to the prior year, our loan book grew in all but one segment led by commercial at $28.7 million followed by residential real estate at $18.9 million.

On the deposit side, we're up from the prior year by $86.5 million, which is an 11.5% growth rate and up from the linked quarter by $11.7 million. We continue to utilize our balance sheet very efficiently as our loan-to-deposit ratio improved from the linked quarter to 97%. Our deposit cost of funds have continued to increase as competitive pressures and funding needs have squeezed the margin. We do expect this to level off somewhat in the second half of this year, absent rate declines from the Fed.

Looking at our capital position, we finished the quarter at $133.9 million, which was up $8.8 million or 7% from the prior year. We completed a small share buyback in the first quarter of 2019. And we have just announced a larger buyback of 400,000 shares, which we expect to complete by the end of this year.

Regarding asset quality, total nonperforming assets now stand at $4.5 million or 43 basis points. The total level of nonperforming assets is up $200,000 from the linked quarter, including a nonperforming asset total of $800,000 and accruing restructured credits, which elevate our nonperforming level by 8 basis points. Absent these restructured credits, total nonperforming asset ratio would be just 35 basis points for the company.

Provision expense for the quarter, $200,000, was down slightly from the prior year but up from the linked quarter. We did have small loan losses in the quarter of $15,000 or just 1 basis point. Our absolute level of loan loss allowance of $8.3 million is down from the prior year. Due to loan growth, the allowance to total loans percentage has declined from 1.13% in the prior year to 1.02% currently. This allowance level still places us above the median of our peer group, and our coverage ratio of nonperforming is in the top quartile. We now have NPL coverage with our allowance of 212% at quarter end.

I'll now turn the call back over to Mark.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [5]

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Thank you, Tony. We certainly accomplished a number of initiatives this quarter with the integration of our Title Agency. We discussed the announcement of the expanded share buyback and a return to more normalized, stronger production pipelines in commercial and the mortgage business line. With potential added certainty in the rate curve, we certainly expect our results to continue to improve throughout the second half of 2019.

In addition, this quarter, our company was recognized once again by the American Banker Magazine for the fifth consecutive year as one of the top 200 publicly traded banks based on our 3-year average return on equity. It certainly is gratifying to see our hard work being recognized amongst our peers.

I'll now turn the call back over to Carol Robbins for questions. Carol?

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Carol M. Robbins, The State Bank and Trust Company - Senior VP & Controller [6]

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Thank you, Mark. Danielle, we're now ready for any question.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Brian Martin of Janney Montgomery.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [2]

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Just a few things on the core. Just kind of -- the loan growth was obviously strong this quarter. Things picked up. But just -- and you talked a little bit about, I couldn't catch it quick enough, the geography, where that was at. But just kind of looking forward, how does the pipeline look and -- geographically? Are there markets that are stronger than others today? Or just can you give a little frame kind of how things are looking in the back half of the year?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [3]

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Sure, Brian. I'll have Jon kind of play on that. He's deep in the weeds there. Volume generally has been good all over in our newer markets. But Jon, maybe you can help me out with where the growth has come from?

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Jonathan R. Gathman, SB Financial Group, Inc. - Executive VP & Senior Lending Officer [4]

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Absolutely. We've had an interesting cross section of growth, as Mark said, in our newer markets, particularly Toledo and Columbus, then very strong. Our old footprint here in Defiance had a nice beginning to the year. And I think looking forward, we see something very similar in terms of growth that's -- it's pretty geographically diverse. We have a number of loans we expect to close in Lima, some of which already closed at our construction draws. Lima has done a nice job, Findlay. So it's geographically widespread, and we expect a very solid second half of the year.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [5]

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Okay. So similar to what -- I guess this pace is -- the current quarter's pace is probably not sustainable but -- for the back half of the year but still a strong, upper single-digit type of growth rate?

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Jonathan R. Gathman, SB Financial Group, Inc. - Executive VP & Senior Lending Officer [6]

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Yes. I think that's our target. It's somewhere in that 8% to 10% range.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [7]

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And Brian, from my perspective -- Brian, this is Mark. We've typically been right around that median level, median to maybe the third quartile, which we're really happy at that level. We're not looking to be in the top quartile on the growth phase. We don't want to get out of our skis. We're pretty diligent in who we loan our money to. And a little conservancy in that arena we think will be rewarded.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [8]

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Yes. Okay. All right. And maybe just going to the fee income. Just maybe if you can touch a little bit on maybe, Mark, just on mortgage and just kind of your outlook for the year. I think Tony said it was maybe somewhere -- you're targeting over $300 million in kind of originations. Just kind of how that's tracking and kind of what you see is the -- based on your comments about refinance volume picking up here in the second half.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [9]

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Yes. I'll make a few comments, and Tony can certainly chime in. But certainly yes, we've had a few higher rate mortgages in our sold portfolio, which was certainly recognized by the impairment. And so we've begun to make sure that we don't lose a lot of those clients to some other competitors. So we're not only refinancing those 4.5s to 4.875s ourselves at a much lower rate and putting in the back of the portfolio. We still find ourselves now because of the [3 7 5] or so on a 30-year finding robust mortgage volume in all of our markets particularly Columbus.

So we were built for that $350 million to $400 million. Our expectation is up in the high 300s for this year. And we think we're going to get that given the strength of the pipeline that we currently have, which has grown nicely this last quarter and -- but looking for great things in the second half of the year. But we booked some mortgages on our own books, which will be those private client, more [3 1, 5 1, 7 1] kind of loans. But generally, the mortgage volume has been robust, and we expect it to continue in the last half.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [10]

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Okay. And then the folks you talked about adding in Indianapolis, were they contributing this quarter? Or is that part of the explanation for kind of getting to that $350 million or upper -- mid-$350 million type of level on originations for this year?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [11]

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Well, clearly, we've said a number of quarters, Brian, that the variable is not -- the number that we're looking for, the variable is the number of producers. And those numbers come and go. We'll have someone in Northeastern Indiana retire, and then will add somebody in Indianapolis. But currently, we were looking for the $35 million mark or so out of Indianapolis. We've had a little slow start. We've employed a number of different channels to find those individuals. We now have 3 as we've said. And we're looking for one more in the third quarter and another one in the fourth quarter.

And quite honestly, we've always contended that Indianapolis has much promise as Columbus, Ohio has with their $200 million to $250 million that they do. So we look for them to contribute to the second half year. Tony, I don't know if you have any perspective on that. But if we got $15 million, $20 million out of Indianapolis in 2019, I think we would be pleased, but it would miss our mark by 30% to 40%.

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [12]

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Yes. I would say from our initial expectations, Mark, we're probably on 50% to 60% of that in 2019 from Indianapolis. But I think we had a bit of a slow start. But Columbus maybe hasn't outpaced what we thought going into this year. So I think that will make up for that level.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [13]

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Okay. And maybe just, Tony, just on the kind of -- you talked about I think in your prepared remarks, about the sale percentage volume being -- picking up next quarter. Just how about the gain on sale margin? How do you see that playing out? A bit of a drop this quarter from 1Q to 2Q, but any thoughts on that?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [14]

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Yes. I think early in the quarter, we were trying to help a little bit with volume. We ran a couple of specials and tried to look at some things in some of our markets to increase volume a little bit. I think we worked our way through that as the second half of the quarter came together. So I anticipate that in Q3 our sale percentage will be in line with what we had in 2018, and the percentage of originated volume will certainly increase as we get a better start on the late volume we did in Q2.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [15]

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All right. That's helpful. How about just a couple of things here -- one more thing on the fee income side. The SBA business, you talked about it being -- maybe Mark talked about it being a bit more competitive with people doing it more on the traditional loan side. But how are things tracking? I guess how do you guys see things unfolding in the second half in that business given kind of the efforts you're taking to improve momentum there and then -- but also with the challenges of the competitive market?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [16]

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I'll make a couple of comments, and Jon can certainly clean this up. But from where I sit, Brian, this remains a critical business line for us. We've done $60 million we never would have had, had we not had the business line. This is a portfolio of 7.6 percentage nice. We made great gains on the business line and that we're committed to the business line. But clearly, and I know Jon will clean this up, we face a lot of -- a lot more competition in that arena, what we felt was a perfect SBA, because of leverage or liquidity or capital or some of those key attributes of a normal commercial loan. We're finding some competitors are doing -- as you might expect at this 120-month bull market, they're doing 100% financing in some arenas and kind of rendering that business line crippled, if you will, a little bit. But we're still finding some good prospects, I believe. Jon, would you agree?

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Jonathan R. Gathman, SB Financial Group, Inc. - Executive VP & Senior Lending Officer [17]

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We are. We're obviously disappointed in the second quarter, but we had a very good first quarter. And we're anticipating return at those levels. I think the other thing I'd add to what Mark said. Rates are projected to come down here through the second half of the year, that will certainly also help that SBA business line both in terms of -- while those competitive forces won't change, certainly the lower rates will help. And then also yields should improve likewise.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [18]

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So Brian, last comment. Maybe several of those loans that we booked that we've enjoyed the benefit of increasing our balances might have gone through SBA maybe several quarters ago because now we're having to take a bit of interest rate duration risk to put them on our books where before we might have been able to push those into the SBA arena. So it's just changing our mix a little bit, but that requires a bit more work and a little better execution.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [19]

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Yes. Okay. Perfect. That's helpful. And just last couple, just on the margin. I think you guys talked about the funding cost easing a bit here this linked quarter. How are you thinking about the margin today with -- I mean obviously you have the pickup in mortgage in the second half, which helps the margin. But just as far as the rate environment, if we get a couple of cuts, particularly one in July here, late July, and then maybe one later in the year, how does that impact the margin or just kind of your outlook from here?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [20]

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Yes. Brian, this is Tony. I'd say our general movement would be some shrinkage in margin if we get the rate cuts. Not demonstrably in 2019, but we're fairly asset sensitive. And we're probably a 2:1 ratio of up versus down on the rate move, how that would help us. So I think we've modeled in kind of a July and late of the year rate move. But in general with mortgage volume increasing, we would expect margin to stay roughly in the same range it was here in Q2 absent anything else that's unseen at this time.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [21]

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And Brian, just one comment to tag on to Tony's comment is that we know that, that is going to be met with reductions. When rates went up, we followed some of those rates up to remain competitive and share liquidity. When rates decline, I think we're going to manage early. We have to take a hard look at what we've done and make sure that we preserve the margin on the way down here.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [22]

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Yes, because the percentage of loans that are variable rate versus the percentage of deposits that are indexed, I mean can you give I guess an update there? I guess what percentage of the loans and deposits move with rates or I guess...

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [23]

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Well, I would think -- as I said, Brian, we generally look at on the loan side about 2x what is on the deposit side in terms of rate moves relative to prime. And that's kind of an average we use based upon our portfolio. So we think a 25 basis point cut will probably cut $400,000 in interest income on an annualized basis, nothing else being impacted. And we probably could recapture half of that on the deposit side given variable rate product.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [24]

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Okay. And the variable rate product just meaning you're able to I guess actively manage the deposits a little bit lower?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [25]

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Exactly. Money market and interest-bearing DDA being the primary avenue that we could impact in the short term.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [26]

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See, this obviously, Tony, will take a bit to correct itself. But clearly, money market and some of those discretionary items, we will have to be fairly aggressive on if we see some declines here.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [27]

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Okay. So kind of a flattish margin from the 3.88% level in the back half of the year, maybe a little bit lower than the 3.88% in the fourth quarter depending on mortgage volume. Is that the same kind of how you're thinking about it?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [28]

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That's exactly what we're forecasting as we sit here today.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [29]

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Okay. And if you get an additional cut or 2 in 2020, Tony, just kind of a crystal ball, kind of framing how things would look in 2020, what's your big-picture outlook on where the margin trends beyond '19?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [30]

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Well, I think as a general rule, our margin with further rate cuts is going to trend downward, and it's just a matter of how much. We've been able for the most part to outgrow the margin squeeze via -- on balance sheet loan growth and our level of mortgage production, which we still are very committed to on both of those avenues. So while on paper it would trend down, I think we can outgrow the squeeze in margin in 2020 as we sit here today.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [31]

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Okay. All right. That's helpful. And how about -- just going to your comment on the buyback, I think the buyback was I guess expanded here. Just kind of your -- how many shares are remaining on this? Or I guess have you been active thus far in the quarter? And I guess it sounds like you'll get it all completed by year-end?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [32]

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Yes. The -- we announced the buyback right at the beginning of the quarter of 400,000 shares. We've done roughly 20% of that, I would say, through the first 20 days or so of the quarter. And I would anticipate we'll be able to get that done by 12/31/19 based upon what I see out there in the market.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [33]

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Okay. Perfect. And that recapture of the MSR, I guess what's kind of the barometer to look at as far as when you may recapture that or how to recapture some of that?

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Anthony V. Cosentino, SB Financial Group, Inc. - Executive VP & CFO [34]

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Yes. It really is kind of contingent on 2 things, obviously overall market rates and once they kind of stabilize and what our remaining portfolio is likely to refinance. And again, there are some obvious candidates that we'll refinance given how the rates have moved. But that will come to a point where the economics just don't work, and that will be time and stabilization of rates. And as prepayment speeds slow down, they were extremely fast in Q1 and Q2 relative to anything we've ever seen on our portfolio. So that's why we anticipate them stabilizing in the second half. And if rates stay where they are, then I think we can expect to recapture some of that, not necessarily all but some.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [35]

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Okay. All right. And you talked, Tony, maybe about the staffing just kind of not much change in the second half of the year. So the expense level that you see in the second quarter here is kind of pretty I guess comparable to what you think in the third quarter and then maybe -- in the third and fourth quarter. If volume picks up or volume is -- on the mortgage side is kind of the driver, maybe expenses are up a touch in the third quarter and down in the fourth quarter. Is that kind of how you're -- what you're alluding to there?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [36]

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A couple of comments, Brian. We've continued to make bets in adjacent markets, and we've continued that trend on into Indianapolis. And so as I told our Board this year, we're going to balance a little bit of pessimism with optimism and maybe be a little critical on the expense side. And so we're looking hard at the expenses, and we try to make sure that we keep some positive margins there with the growth. But a lot of our expenses have come in the operations and the compliance and CRE arena and all the compliance arenas that we have to get better at and get right.

So it hasn't been because we expanded in the new markets per se. It's more of the backroom kind of thing to make sure we remain compliant, and that is mandated. It's something that -- do we seek ways to do that? No, but we know we have to be seamless and robust all the way from when we hired our Chief Technology Innovation Officer and adopted the total restructuring of the backroom.

So that has been generally a key source of our increased expense, and we're cognizant of that. And we know we have to improve on and grow the balance sheet to improve that efficiency ratio from something in the low 70s to the strategic number for us which most likely will be in that middle to low 60s. That's the goal, but it hasn't been delivered yet.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [37]

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Okay. And with the expenses at least in the -- in absolute terms, it sounds like there is less expense growth you expect in the second half of the year, I mean at least relative to what we said in the second quarter. I mean I guess we shouldn't -- given your staffing is not ramping up.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [38]

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Well, I think that's our -- I think the first statement clearly, our ebbs and tides come with mortgage volume. Clearly, when that -- and of course, in one hand, we love it. In the other hand, we don't. But it is a good variable base pay kind of business line. So when it ramps up, we love the gains we get out of that, assuming there's no timing differences. And clearly this quarter, we seem to have run into some timing differences not only on the production side but also the sales side.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [39]

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Okay. That's fine. And then just from an M&A perspective, I know you announced the buyback. But just -- I know you've talked in the past about just kind of looking at opportunities out there. Just any change on what you're seeing in the marketplace as far as opportunities? And I guess I mean kind of notable changes from the last quarter or 2 on opportunities and how you're thinking about that.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [40]

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Well, there clearly are opportunities out there. We continue to push those along a bit. I can honestly say we've taken a bit more of an aggressive stance, if you would, because we realized that banks are sold, not bought. But we think it's also our obligation to our stockholders to make sure that we're seizing opportunistic kind of acquisitions of small institutions that feel that maybe it's not going to get any better than it currently is, and we're finding some traction there. And some of those decisions are upon us and imminent. And we're excited about some of those that may be forthcoming. And we continue to reach out to several others. But again, if they truly are sold, not bought, they have to believe that there's greater opportunity with a $1 billion bank like ours that has certainly upside potential trading at 105% of tangible book kind of thing. But that would lead us to more cash deal than it would maybe stock because of currency strength at this juncture.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [41]

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Okay. And you mentioned in -- I don't know if it was you or Tony, Mark, in your prepared remarks on even outside of bank M&A, maybe a mortgage type of place. I guess are you seeing opportunities there? Normally, it's been hiring people and kind of building out like you do in Indy. But are there other opportunities on the mortgage side that are appearing, given the rate environment or...

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [42]

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Yes. There's -- there are niches out there. And again, it's all about management succession. It's all about monetizing what maybe someone has built. Clearly, there are opportunities to augment current business lines for us such as SBA as the commercial as maybe some other more defined business lines in the mortgage segment can certainly augment our production. So we've got some conversations going there, and those could be very good for us.

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [43]

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Okay. So both pipeline -- both the mortgage and the bank are at least -- maybe seem to have picked up a little bit from where they have been in recent quarters?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [44]

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Yes. Currently, we're -- we think we're in some of the right markets. We've got Indianapolis now up and going. Rates are great. We have a defined portfolio, if you will, of mortgages to call because the individuals that do our servicing right analysis would conclude that we're going to lose some of that portfolio. So we have a clear strategy to reach our brand to that percentage of the portfolio that most likely are candidates to refinance. And if they're going to refinance, why not put them back in our portfolio and book the gains again and book the servicing rights?

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Brian Joseph Martin, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [45]

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Yes. Okay. I mean that's all I had, guys. Maybe one number from Jon. The lease portfolio, what is the lease portfolio growth this quarter, Jon? I guess was that a -- I guess how is the growth trending year-to-date in that book?

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Jonathan R. Gathman, SB Financial Group, Inc. - Executive VP & Senior Lending Officer [46]

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I don't have that number right in front of me, but I think somewhere right around $2 million year-to-date.

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Operator [47]

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(Operator Instructions) The next question comes from Jason O'Donnell from Bluestone.

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Jason O'Donnell;Bluestone; CIO, [48]

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I just had a quick question on -- just going back to the whole bank M&A discussion. With regard to just your pricing discipline on bank deals if you were to do one, what line won't you cross in terms of tangible book value or earn-back just given the currency challenges? Would you guys be willing to go over, say, 4.5 years on an earn-back going forward?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [49]

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We have been very disciplined, Jason, in our approach. We like our $75 million organic growth that we pay for every year. So as opposed to paying $10 million, $15 million premium, we've been very disciplined. We like the 3 number. Good things come in 3s, maybe a 3, 3.5 if it's strategic. But again, given our currency or lack of currency value thereof, we've been very diligent in who we've talked with and what we've talked about and how we've presented that. And we've not veered from that.

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Jason O'Donnell;Bluestone; CIO, [50]

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So 4.5-year-plus deal, it sounds like what you're saying will be fairly unlikely?

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [51]

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That will be unlikely, yes, again given our current success rate and where we're currently growing and how we're doing that in each of our different markets. So we like the organic growth approach, one client at a time. But if someone can see the value in joining up with a $1 billion bank with -- covering 14 counties, then there may be certainly some good news to come.

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Operator [52]

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This concludes our question-and-answer session. I would like to turn the conference back over to Mark Klein for closing remarks.

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Mark A. Klein, SB Financial Group, Inc. - Chairman, President & CEO [53]

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Once again, thanks, everyone, for joining us this morning. We certainly look forward to delivering our third quarter results to you in October. Have a great week.

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Operator [54]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.