Earnings Call Transcript - BFST Q1 2024

Operator, Operator

Thank you for standing by. My name is Mandeep, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Business First Bancshares Q1 2024 Earnings Call. Please note the instructions regarding the call.

Matthew Sealy, SVP, Director of Corporate Strategy and FP&A

Thank you. Good afternoon, and thank you all for joining. Earlier today, we issued our first quarter 2024 earnings press release, a copy of which is available on our website, along with a slide presentation that we will reference during today's call. Please refer to Slide 3 of our presentation, which includes the safe harbor statements regarding forward-looking statements and the use of non-GAAP financial measures. I am joined this afternoon by Business First Bancshares' President and CEO, Jude Melville; Chief Financial Officer, Greg Robertson; Chief Banking Officer, Philip Jordan; and Chief Administrative Officer, Jerry Vascocu. After the presentation, we'll be happy to address any questions you may have.

Jude Melville, CEO

Great. Thanks, Matt, and thanks, everyone, for making us a priority this afternoon. We know that you have a lot on your plate. We appreciate your interest. We have a lot to discuss today, and I want to leave time for questions, so I'll jump right in. To begin, we were disappointed by the headline profitability for the quarter. The first quarter of the year tends to be our softest but it was a little softer than normal this year because of greater-than-anticipated margin pressure and some expense timing. Core ROAA is 0.77%, core ROAE is 8.9% and core EPS is $0.50. Greg will provide more detailed specifics. But big picture, I would say there wasn't one single quarter-moving event that occurred. It is more an accumulation of small impacts. We've been fortunate that many quarters, a number of small things have added up to outperformance. Sometimes the opposite occurs, and that was the case here. We've already taken a number of steps to remedy these relatively small issues and anticipate a relative flattening of both margin and expenses over the remainder of the year, leading to improved profitability which remains a priority. Margin movement in particular was positive in March, which leads us to believe some of the adjustments are working. Again, I'll ask Greg to get into further detail in a bit. But first, I will take a moment to survey a few of the things that I consider most important about the quarter, not all of which will be reflected in the short-term results. First, a significant part of the margin miss was due to outside success in raising liquidity. As you know, we've been working, in particular, over the past 7 or 8 quarters to transition from a company whose priority was loan growth to one that is more balanced and robust in its production expectations. We grew loans by approximately 8% annualized to a healthy rate of growth, and that growth was led by C&I relationships and growth in relationships in Texas. By comparison, we grew deposits by an annualized rate of 24%, a positive sign that the work we've undertaken to shift our focus is undoubtedly taking hold. While we grew M&A accounts significantly, we also stemmed the tide for the first time in 7 quarters of outflow of noninterest-bearing accounts, remaining essentially flat and experiencing an uptick in the last half of the quarter. Funded accounts show compositions of the deposit base, and we're pleased with the improvement in the mix of funding sources. In present circumstances, if we're going to miss, my preference is to miss by gathering too much liquidity rather than too little, particularly given some of the opportunities we have on the horizon to continue putting those funds to work. And the fact that these deposits are relational. We conducted successful funding campaigns over the quarter, but the upside surprise was primarily the result of increases within existing accounts as we continue to grow with our clients. Second, another of our priorities in coming years and quarters is to increase noninterest income. This quarter, we were able to consummate the acquisition of Waterstone, a loan service provider of SBA products. This partnership gives us more internal capability for generation of SBA opportunities. We're already beginning to see an uptick in the pipeline for SBA eligible credits. Waterstone also serves other banks, and we look forward to incorporating their work into our nascent corresponding banking function, along with investment portfolio management, loan participation and deposit collections and an internal swap desk. We shifted some management positions around to ensure we give the opportunity for proper attention and look forward to seeing this portion of our revenue stream grow over the coming quarters. The acquisition had an unprojected impact this quarter on tangible capital and earnings, and we're excited about that investment. Finally, we're pleased to announce the acquisition of Oakwood Bank in Dallas, Texas. This is an in-market transaction of approximately $830 million in assets with a similar culture and client focus. We believe the partnership to be a very logical next step in the continued development of our now meaningful presence in the North Texas market, bringing our total credit exposure in Texas to 44% of our loan book and 31% of our deposit base. More important than the immediate impact, we believe it positions us well for accelerated future growth in one of America's strongest markets, both through physical presence and through the addition of substantial talent bolstering our commercial banking leadership in the market. This acquisition fits squarely with the longer-term plans we've discussed with you on previous calls: efficiency through scale, risk mitigation through diversity of the portfolio, and increased profitability through accretive growth. I'm honored that the Oakwood team would agree to partner with us and would note the terms of the deal leave our teams and our shareholders in linked arm alignment as we work together to continue the development of our potential-filled franchise. It was a meaningful and positive quarter for B1 Bank, and I thank our team for all the effort that went into it. With that, I'll turn it over to Greg for further details for our Q&A period.

Gregory Robertson, CFO

Thank you, Jude, and good afternoon, everyone. I'll spend just a few minutes reviewing our Q1 highlights, including some of the balance sheet and income statement trends. And we'll also discuss our updated thoughts on the current outlook. On Slide 17 of our investor presentation, the first quarter GAAP net income and EPS available to common shareholders was $12.2 million and $0.48 a share, which included $715,000 of pretax acquisition-related expenses and $50,000 of pretax gain on a former bank's premises and equipment. Excluding these non-core items, non-GAAP core net income and EPS available to common shareholders was $12.8 million and $0.50 per share. As Jude mentioned, these results were softer than anticipated due to continued margin pressures and an elevated noninterest expense. I'll start on the margin as there are several items to unpack here. Our reported core net interest margin of 3.27% was down 11 basis points from the linked quarter, primarily due to three factors: strong deposit production within our money market deposit product which weighed on the margin from both a volume and a rate perspective. As we have mentioned in the past, we have been working to establish the balance sheet in a more rate-neutral position by attracting a high volume from non-maturity deposit accounts. Our goal has been to work the loan-to-deposit ratio closer to the low to mid-90% range, but admittedly we do not anticipate getting there as quickly as we did. The combination of higher volume and the current market rate environment weighed on the net interest margin. First quarter total core loan yields continued to increase on a linked quarter basis. Results were driven by Q1 new and renewed loan yields of 8.50%, which fell short of our expectations at about 8.65%. We also benefited from a large municipality credit during the quarter which came with a tax component and low-cost deposits. The headline rate was about 7% on the relationship, which we were comfortable with given the deposit side of the relationship, and that did pressure overall Q1 loan yields. I'd like to point out some trends throughout the first quarter on the margin that should be helpful in understanding where we've been and where we think we're going. Our core net interest margin was down in the first two months of the quarter by 14 basis points. Then in March, we actually picked up 3 basis points to end the quarter down 11. This was partially due to the fact that the overall total new deposit costs have been declining each month since December, which appears to have had more of an impact in the latter part of the first quarter. We also benefited late in the quarter from an inflow of noninterest-bearing deposit relationships, the quarterly impact of which was more muted during the quarter. Dovetailing off this last point, I think it's important that early in the first quarter, we experienced impactful outflows in noninterest-bearing funding. Starting off behind the curve was a challenge from a margin perspective. That said, we certainly are encouraged to see some solid traction in lower-cost and noninterest-bearing account wins during the first part of the second quarter. We are pleased with the early Q2 relationship-gathering efforts that continue on the funding side, and we continue to see upside to the overall funding base and composition in the near term. The intermediate long term, we aim to operate around a 3.00% to 3.50% core net interest margin, which we view as realistic and sustainable in a higher-for-longer rate environment. Moving to the income statement. Noninterest expense was elevated during the first quarter due to the Waterstone acquisition, which contributed to about $500,000 in additional expense. Additionally, we had $1 million of incremental bonus-related items during the quarter, which was more related to the ending point of the fourth quarter being down and the first quarter being up to more normalized levels. We also had some IT-related expenses in the quarter that we have been mentioning on calls that we have agreed to certain IT enhancements, and we brought those online sooner than anticipated. We view the core noninterest expense figure of $41.8 million as a relatively good run rate going forward, and we expect a modest increase from 2% to 3% each quarter for the remainder of the year. First quarter GAAP noninterest income was about $9.4 million, with core noninterest income of $9.3 million, which excludes a small gain on former bank premises and a loss on the sale of the security. While this is a fairly clean run rate going forward, there were several areas that came in lower than we expected and therefore, we anticipate Q2 revenue from our fee income business segments to contribute in a more meaningful way going forward. Now if I could direct you to Slide 19 of our investor presentation, past due loans did increase during the first quarter, primarily due to one credit. That credit was about a $10 million exposure that we've since resolved. So we expect those past due loans to normalize to about $10 million at quarter-end with the removal of that credit. Nonperforming loans did pick up slightly, and they were really attributable to two loans that we had. Both of those relationships were reviewed, and we don't see any loss given default exposure in those relationships. The overall credit book remains very stable with no systemic movements aside from those two outlier credit instances. Moving on to the balance sheet. Total loans held for investment increased to $96.1 million or 7.7% annualized during the quarter. Loan growth was largely attributable to the net growth in the C&I portfolio of $68 million and in the residential real estate portfolio of $34.6 million, somewhat offset by a $7.8 million reduction in C&D portfolio. We are proud of our team's continued focus on production through key commercial relationship wins. The DFW region accounted for 44% of the net loan growth for the quarter, while our Southwest Louisiana region produced about 29% of that growth, and the capital region produced 14% of the loan growth in Q1. Texas-based loans, as Jude mentioned earlier, represent approximately 37% of our balance sheet today of the overall portfolio. Deposit production exceeded our expectations during the first quarter, with total deposits increasing $324 million from the prior quarter, representing almost 25% annualized loan growth or deposit growth. Noninterest-bearing deposits remained relatively stable, both in terms of balances and as a percentage of total deposits. We're pleased with the composition of our noninterest-bearing deposits and we have held it to 23.2%, which compares to the prior quarter of 24.8%. While still early in the second quarter, we're encouraged by the level of core low-cost deposit gathering we've experienced in the first month of the quarter. Overall, we remain highly encouraged and optimistic about the prospects ahead. And that concludes my prepared remarks. I'll hand it back over to Jude to wrap up.

Jude Melville, CEO

Good. Well, thanks, Greg. I think with that, we'll just jump to Q&A. We have a lot of movement in the quarter and, of course, we just announced the acquisition. And I don't know if people maybe haven't had time yet to digest it, but I'm looking forward to answering any questions on that front as well.

Matt Olney, Analyst

Starting on the margin. It sounds like the margin this quarter was pretty volatile. Greg, I think you mentioned that in the first two months, it was down and then it stabilized in March. Can you provide what that March margin was? And do you think that's a good starting point for the second quarter? Any other considerations we should have more near term on the margin?

Gregory Robertson, CFO

Yes. I think let me go into a little detail about how we kind of arrive there. And then I'll follow up with the answer to your question, ultimately. What we experienced, I noted this a little bit in the comments; we experienced the outflow of noninterest-bearing in the beginning of the quarter of about $50 million. And that's what impacted the averages for the quarter for the margin. During the remainder of the quarter, we were very successful in gathering noninterest-bearing to almost bring that $50 million back to zero. Showing the noninterest-bearing piece of that being flat was a really big deal and a win for us. And Jude had mentioned those types of accounts we're gathering are relationship accounts. So to get that money market that we were offering with a certain rate, you have to have an operational noninterest-bearing account that went with it. So I think that's important. The second thing from a deposit standpoint, our average deposit rate for those money markets in December for the new dollars coming in the door were about 5.17%, and in March, they were 4.24%. So moving those rates down on the new dollars coming in the door, we had shown some signs of that as well as to continue to gather the noninterest-bearing, I think really, really weighed on what we feel like the margin was.

Matt Olney, Analyst

Okay. That's helpful, Greg. And then I guess along with that, you mentioned the liquidity build in the first quarter was more than you expected. Curious what the expectations are from here from the liquidity aspect, whether that's a loan-to-deposit ratio? Or how you think about that?

Gregory Robertson, CFO

Yes. I would expect our expectations are to continue with that high single-digit loan growth, 6% to 8%, and to be able to fund that through deposit growth. Now we don't expect to have 24% annualized deposit growth going forward. We do want to hold the loan-to-deposit ratio in that 93-ish range for the balance of the year.

Matt Olney, Analyst

Okay. Got it. That's helpful, Greg. And then I guess, switching over to expenses. I think the messaging was the core $41.8 million number in Q1 is a good kind of launching point. And I think you said sequentially from here, 2% to 3% increase each quarter. Did I capture that right? I think for the year, that gives me somewhere between 172 and 174, if I heard that correctly.

Gregory Robertson, CFO

That's about right. Yes. We think that you're right.

Matt Olney, Analyst

Okay. And then just lastly for me on the acquisition. Congratulations on the deal. I know you guys have been in Dallas for a number of years. Would just appreciate any kind of comparison as far as the customer base. How does the customer base in Dallas for Oakwood compare to Business First's customer base? Any kind of overlap at all? And just in general, any kind of comparisons?

Gregory Robertson, CFO

Yes. I think one of the attractions of the deal was the similarity of the following efforts of the client makeup. We do have a handful of shared clients already. But for the most part, they're not their clients, but they are shared client types. A lot of the production staff for Oakwood came from regional or larger banks, and they tend to do deals similar in style and form to us. I think we'll have the opportunity with the expanded balance sheet to help them do more of what they do. And I don't anticipate a lot of culture shock when it comes to the production side of the house. Excited about them fitting in there. They also with their production staff coming from larger banks, we look forward to benefiting from the leadership and depth that they can help us provide to our current bankers. So we're excited. I think it's a really good fit in terms of client base and in terms of bankers.

David Melville, CEO

Matt, circling back to your question on the expense base. I want to make sure I heard you right. What you were implying, I think I heard low 160, 162, 160. Or did you say 170?

Matt Olney, Analyst

I thought it was 172 to 174, I thought is what I heard.

David Melville, CEO

So Matt, we do think that from an integration standpoint, this is right down our alley, and there will be a lot of good cultural overlap. As you mentioned, we've been in the market for a while. We have about $1.8 billion to $1.9 billion in loans outstanding. And so we feel like we had a really good perspective through the due diligence process, and I'll let Greg talk a little bit about the diligence efforts and the all-encompassing nature of that process.

Gregory Robertson, CFO

Yes. Matt, we were able to, as our investor deck shows, have very deep penetration in reviewing their loan book. We came away feeling very comfortable about not only the quality of the portfolio but also the, as you mentioned, it feels a lot like Business First's early days where there's not a lot of clients but a really great quality of clients. So we came away feeling really good about not only the level of talent they have but also the quality of the portfolio and how it will map over to our bank, not only from a credit standpoint but also from the margin and all of those things that we get to do when we integrate.

David Melville, CEO

And I would say, in addition to our specific diligence, they just have a good track record of Roy Salley's career in particular, of being credit-focused and really in terms of prioritization, I think well aligned there.

Michael Rose, Analyst

Yes, maybe we could just start on the increase in past dues. If I look at Page 28 of the slides, it looks like it was in the all other category. So I just wanted to get some color on the increase there of the migration.

Gregory Robertson, CFO

All right. Thank you. Yes, Michael, you there?

Michael Rose, Analyst

Yes.

Gregory Robertson, CFO

Okay. Sorry. Yes, as I mentioned on the call, I think the main thing that made past dues go up is we had one commercial real estate loan that had some issues with some guarantors, and we've resolved that loan. So we feel really good about it. Other than that, past due seems to be very normalized. That would have been $10 million in past dues or just slightly less than that for the quarter.

Michael Rose, Analyst

Okay. Yes. Sorry if I missed that. And then maybe just on the deal, I was looking at Oakwood, and it looks like they were going to go through an MOE, I think, in '22, and it broke apart because of CRA issues. Can you just address that? And then maybe just holistically, what drove you to this bank out of all the other options in and around the state of Texas? I know you mentioned some of it had to do with looking like Business First in the earlier days, all the stuff you just mentioned in relation to Matt's question, but I would just like some color there.

David Melville, CEO

Sure. I think in terms of our ability of the partnership being an end-market transition that we felt like we could understand certainly was attractive. The size also is kind of the ideal size. It's meaningful but not a best kind of acquisition, which is in line with our last acquisition a couple of years ago in Houston. And then I would also say just we've known the management team for a number of years, and we still feel very comfortable that they had the right spirit in terms of the partnership. And if you look at the deal, the economics of the deal are very well aligned, and it's clearly a situation in which they chose to invest in us and believed in the opportunities of the partnership versus an upfront cash-out, which in terms of lining up reasons you do an acquisition, the intent and the value structure of the management and the Board is number one, that leads to the right culture, and we believe they have the right culture. So being an end-market deal that we felt was low in terms of integration risk, being the right size and having the right culture, we felt that all fit well both with our ability to conduct the transaction successfully and in terms of the federation of our strategic plan that we've outlined here on the call. We've had for a number of years ago to increase to 7.5-ish size, like that's a really good kind of sweet spot size-wise and this accomplishes that with the consummation of the transaction. We also have had a goal to approach 50% in terms of our credit risk being outside of Louisiana. And so this materially moves us in that direction. If you're going to be well, there's much to be desired across Texas, Dallas certainly is, I think many people would consider the strongest of the markets in Texas and one of the strongest in the country. So all else being equal, certainly, that was an attractive place for us to make the investment. And doing so with the right partnership structure also was a unique opportunity to make this kind of move in the environment in which we're operating in which stocks across the board are down. I won't address the rationale for the breakup of the potential MOE experience. Certainly, we weren't a part of that, but CRA is an issue that we wanted to be sure that we were comfortable with prior to taking regulatory approval. And so we've had the chance as part of our diligence process to identify and understand the investments that they've made over the past couple of years, and they've been significant, including opening a branch in Southern Dallas. We feel like they've been doing the right things, and we have a strong record as well as CRA success and commitment. So we feel comfortable that we're together, but they're independently on the right track from a CRA perspective, and together we feel like we will be a good candidate for approval to the regulatory process.

Michael Rose, Analyst

Okay. That's great color, Jude, I appreciate it. Maybe just last for me. It looks like the deal is going to close in the fourth quarter. Slide 16, I guess, implies some earnings accretion in 2024. So I assume that it would close sometime earlier in the quarter. Is that fair? And then just, I guess, separately, this is going to put you kind of closer to $8.5 billion. And just wanted to see where you were and what you need to do as you get prepared to cross $10 billion because this will definitely move you closer?

David Melville, CEO

Sure. Well, I think it puts us closer to $7.5 billion. But nonetheless, the point is the same, and we're certainly cognizant of the investments needed and the challenges that we'll need to prepare to take on as we approach $10 billion, whether you start from $7.5 billion or the $8.5 billion, this is something we're already working on. You've witnessed a number of hires that we have made over the past couple of years. So adding folks that have had experience going over that $10 billion mark is kind of step one. We believe the people and having that experience complement the organic work that we've done over our now 18-year history. We think is the first step and preparation for that. We have also started to invest significantly in ensuring that our IT infrastructure is adequate. As we mentioned during our last call, this year we aimed to invest in technology that we believe will enhance our preparedness. This includes improvements in production practices and optimizing data flow so that we are ready to address regulatory inquiries. So that was in the works already. This acquisition gives us some scale to help, frankly, to afford some of those investments that we're making. So we're trying to make those investments prior to getting to the $10 billion mark, so that we retain optionality when we do get there, and we'll be well prepared for it. So I think this actually helps us prepare, and we feel like we're doing the right things to be ready to hit that $10 billion mark without having to stand still for a while as we kind of catch up with ourselves. We're actively aware of that and actually actively investing to be prepared.

Michael Rose, Analyst

Just do you expect that to close the deal, I meant to say $7.5 billion. I'm sorry about that. I think it looks like the deal could close earlier in the fourth quarter, just given that you expect some EPS accretion in 2024. Is that fair?

David Melville, CEO

Yes. As you know, part of that is outside of our control, but this will be our sixth acquisition as a team. We feel confident in our understanding of the process and the logistics involved, and we hope to close early in the fourth quarter, close to the start of Q4.

Gregory Robertson, CFO

We believe so. In the investor deck, we outlined that we expect the cost savings to begin being integrated around the middle of 2025 after the conversion, adhering to that timeline. We are optimistic that it could happen sooner, but that's when we anticipate the income accretion to start.

David Melville, CEO

From a regulatory perspective, we feel like this is right down the middle of the fairway, and you identified the CRA being an issue that is one that occasionally trips up deals that are even right down the middle of fairway. But we feel like we have a good handle on that. And all the other elements of the deal are ones that would lead us to believe that our regulatory partners would feel comfort with the addition.

Feddie Strickland, Analyst

With this transaction, I think I see in the deck, it puts you at 44% pro forma taxes on loans. Do you think given the current trajectory, you could potentially exceed 50% of loans in Texas by mid- to late '25 just with this transaction and all the loan growth?

David Melville, CEO

Yes, I think that's a plausible outcome. This suggests we are about halfway towards our goal. Approximately half of our growth is originating from Texas markets. Therefore, our partnership with the bankers of Oakwood should enable us to increase that figure over time. I believe it is reasonable to expect that we will be close to, if not at, that target by the end of next year.

Feddie Strickland, Analyst

I noticed that Oakwood's portfolio has a stronger emphasis on commercial and industrial loans from the legacy Business First portfolio. I apologize if I missed this earlier, but was this decision made to achieve more diversification in credit or to strengthen your presence in Dallas?

David Melville, CEO

It was a mixture of things, but certainly the makeup of the portfolio and being an outsized and exposure to C&I was an attraction to us. If you think about growth in our loan book over the past couple of years, it's been kind of a return to a C&I focus. And we're proud of our team for decreasing our exposure relative to capital of C&D and CRE over the last two years pretty substantially.

Feddie Strickland, Analyst

Understood. One last modeling clarification question. I know there's been a couple of questions on the margin already here. But Greg, did I hear you correctly that it's a 3.27% core margin ex accretion today, but do you see that going up to 3.50% but it's not going to go to 3.50% next quarter, right? Or is that kind of a longer-term goal?

Gregory Robertson, CFO

Yes. That's a longer-term operational goal. Achieving that goal by the first to the middle part of next year seems quite reasonable.

David Melville, CEO

I think that one thing intriguing about the bank is that we have similar loan and deposit costs and yields. They're a little higher than us on the loan side but not order of magnitude higher. So we're very comfortable that they're getting paid for what they do. And then they have a little higher deposit cost. So we think we have the opportunity with our more expanded branch network to be able to continue to put to work this thesis of gathering funding in other markets and putting them to work in Dallas. This helps us achieve greater balance than we've ever seen, not only with loans but also with deposits, which now make up about 31% of our combined franchises on a pro forma basis, particularly in Texas. We believe the Louisiana franchise will positively contribute to our funding base, allowing us to align their deposit costs with ours, which presents an opportunity for increased margins through the acquisition and our internal efforts.

Operator, Operator

This concludes our Q&A session. I will now turn the conference back over to Jude Melville for closing remarks.

David Melville, CEO

Good. Well, I appreciate everybody spending time with us. It was a bit of a noisy quarter, and we believe that we're doing the right things from a managerial aspect to address that noise and feel as confident about our ability to produce returns over the year as we did this time last quarter, and we'll continue to work hard to make that happen. We'll just take a moment just to welcome the team and the board and the shareholders of the Oakwood Bank. They built a solid franchise and one that we're excited about partnering with and believe that together we can all achieve as much as we hope to achieve. We're excited about the cultural alignment that we found with this deal. So thank you to them, and we welcome them. And thank you to our team for all their results, but also for being the kind of bank that people want to partner with. I'm proud of it and look forward to taking some more steps forward this year. Thank you.

Operator, Operator

This concludes today's conference call. You may now disconnect.