Bank7 Corp. Q2 FY2022 Earnings Call

Welcome to the Bank7 Corp. Second Quarter Earnings Call. Before we get started, I'd like to highlight the legal information and disclaimer on Page 19 of the investor presentation. For those who do not have access to the presentation, management is going to discuss certain topics that contain forward-looking information, which is based on management's beliefs as well as its assumptions made by information currently available to management. Although management believes that its expectations reflected in such forward-looking statements are reasonable, they can give no assurance that expectations will prove to be correct. They're subject to certain risks, uncertainties, and assumptions, including, among other things, the direct and indirect effect of economic conditions on interest rates, credit quality, loan demand, liquidity, and monetary and supervisory policies of banking regulators. Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may vary materially from those expected. Also, please note that this conference call contains references to non-GAAP financial measures. You can find reconciliations of these non-GAAP financial measures to GAAP financial measures in the 8-K that was filed this morning by the company. Representing the company on today's call, we have Tom Travis, President and CEO; J.T. Phillips, Chief Operating Officer; Jason Estes, Chief Credit Officer; and Kelly Harris, Chief Financial Officer. With that, I'll turn the call over to Tom Travis.

Thank you. Welcome to the call. We're delighted about our quarter. And as you can see in the materials, it was a record quarter, driven largely by strong loan growth. Of course, our recent acquisition helped a lot. I just want to make a couple of comments, and then we can get into questions and answers. One of the comments would be that sometimes, some of us in the world of business take for granted the strength and the depth of our teams. When you look at Bank7's results, specifically the loan growth and Jason and his team of commercial bankers, we can't take it for granted, and we need to give a big shout-out and thanks to them. When you look at the group of bankers we have, what's really comforting is about a half dozen or so have been together for 17 or 18 years, and there's probably another half dozen to maybe a little more that have been together for 10-plus years. There's a lot to be comforted by with that. We just don't have turnover; we have people that are dynamic and engaged. When you marry that with the skill set they have and the geographic territory in which we operate, it's just very comforting. Our earnings are truly core earnings, and the breadth and depth of the commercial banking group just continues to get stronger on a weekly basis. So, it's a real strength of our company. The second point I would make is that, since we've gone public, this was our first acquisition. Although we had prior experience in a lot of different areas and different sizes, it wasn't with Bank7. We're delighted at the integration and system conversion that we completed in early June. Darrell Mathews is our manager of operations and IT, and he had a large and broad team that came together to integrate the systems. As we sit here today, we're highly confident that we have achieved the objectives that we set out to achieve. At the same time, we've maintained our customer base from the acquisition. So, a lot to be thankful for, and really good core strengths of our company have come through; it's just really nice to see that. With that being said, we'll open it up for any questions that you might have.

The first question comes from Brady Gailey of KBW.

As I review the second quarter, I noticed that you allocated some cash to the bond portfolio. Do you still have excess liquidity available? Will you continue to invest funds in the bond portfolio, or is that mostly completed?

You're going to see the bond portfolio continually decline as we redeploy into loans.

Okay. And then the cost of funds really did move a ton. I think your total cost of deposits was up only 3 basis points to 27 basis points. Just remind us how you're thinking about your deposit beta going forward. I'm sure with what we're seeing in rates, the cost of deposits is going to go higher. How are you thinking about the pace of that?

Well, we're all having to be agile and nimble and dependent on the Fed and what they're doing, and of course, competition. The banking industry as a whole has not raised the liability costs rapidly, and we're no different. It has to do with our liquidity and our deposit profile. With that being said, I would expect you're going to see more substantial increases from us as well as for the entire industry in the back half of the year. I can't give you a deposit beta number, but I can tell you that for us, we've been very disciplined, and we're going to continue to be disciplined. We still have, what is it, 32% noninterest-bearing?

Yes.

So, I would say we'll probably have a larger increase in liability costs for the back half of the year than we did in the front half. Most of that is driven by the fact that the first Fed rate increase wasn't until, what, mid-March? It will be fully baked in here moving forward. We still expect our NIM to continue to head back towards a little more of our normal range, a lot of it has to do with reinvesting in the securities and the loans.

And just remind us what do you consider kind of a normal range for your net interest margin?

I think we included the average on that slide. It should be in the low 4% range. I usually mention this without including fee income. The low point was 3.91% in the first quarter, and it has risen back above 4%. As we continue to grow, we anticipate our net interest margin will decrease slightly, but we still expect to maintain it in the low 4% or high 3% range.

All right. And then lastly for me, it seems like other expenses ran a little heavy this quarter. They were almost $700,000. Was there anything onetime in nature in other expenses?

Brady, this is Kelly. Yes, there was related to the conversion of Cornerstone, approximately $250,000 that was onetime that I think we alluded to in Q1.

Okay. So you said it was $250,000 in the second quarter?

Correct.

Any other onetime benefits or burdens in the quarter?

I mean, look, the expenses in general you hear it all over the place, and you see it. There's definitely wage pressure and cost increases. We're going to be running higher expenses due to those factors. We still expect a slight increase in our efficiency ratios. I certainly don't want to give any guidance that we're going to go back to where we were, 35%?

Yes.

But it wouldn't surprise me if it was back into the 38% or 39%. I don't know if we can get to 37%. But it's difficult to do when you're down at those levels, but we do recognize the inflationary environment that we're in.

And our next question will come from Thomas Wendler of Stephens.

In the slides, you guys are mentioning going back to normal profitability levels. Just wondering if I could get a little clarity on that. Are you expecting the bank to drift up towards that 2017 to 2021 average return-on-average assets of 2.3%? Is that how I should be thinking about it?

Yes. I mean, I don't know that we're going to get back to that absolute number. However, if you were to simply cash in the bond portfolio, redeploy it into the loan portfolio and just look at that interest income lift without any change in the expense levels, you're going to be right back to those historical numbers. The question becomes what does the yield curve look like? What is the cost of funds look like? But there's no doubt in our mind that as we change the mix on the balance sheet, which is one of the benefits of the acquisition, we're going to get a lift.

All right. And then fees came in a little bit softer than we were expecting this quarter. Can you give me any color around that?

I would say the loan fees were in excess of our internal budget. We had a very strong quarter of new loan generation, and the fee component was very sound by our metrics. That's really all the color I can give you on that. We were very pleased with our fee income in Q2. About the...

And the next question will be from Nathan Race of Piper Sandler.

One of the highlights in the quarter was the deposit growth on a core basis. We haven't seen that from a lot of your peers thus far in the 2Q earnings season. So, would just be curious to get some of the drivers there. Is it just kind of winning more full relationships or new clients coming on board? Any color there?

I think it goes back to the opening comments regarding the banking team and the focus that we have in our company. We are just diligent in our pursuit of true relationships. We're aware of a couple of relationships in particular that had some asset sales and carried some really large balances, but I wouldn't attribute the success of the deposit growth strictly to that. I would say to you that it's that broad and deep commitment to every week when we meet and look at loans. We specifically focus on where the relationship is keeping their deposits. When we talk to a person, we give them a term sheet and talk about loan terms; we immediately tie the rate in the terms with the deposits, and we get commitments. The fact that our commercial bankers are so dialed in and doing it on a regular basis is really the strength. I'll just make a comment here. I was interviewing a person to maybe add an experienced person to our banking team in one of the markets as a lender. In the interview, they stated they're a long-time lender. We started talking about the deposits, and their response was, 'Well, I'm a lender. I'm not really focused on the deposits.' I tell you that because I think there's a need for keeping it top of mind awareness from your banking team, which is critical. It certainly is critical in our world.

Got it. That's helpful color. I appreciate that. And then just kind of turning to credit. It's nice to see nonperformers continue to trend in the right direction. I guess no charge-offs in the quarter. Assuming kind of low double-digit loan growth is still doable in this environment today, how are you guys kind of thinking about the need to provide for growth, assuming charge-offs remain fairly low going forward?

Yes. We'll see how the growth ends up in the second half of the year. I would say we were pleasantly surprised with the loan production in the teens. We're in the process of CECL adoption, so you're going to see lots of continued testing and modeling from us this quarter with full implementation coming soon. We're certainly paying attention to the provision and the performance metrics of the portfolio overall, but it just continues to be a really nice credit story.

Okay. Got it. And then just going back to kind of overall balance sheet dynamics, it sounds like you guys aren't expecting much in the way of deposit outflows. Deposit growth should largely keep pace with loan growth going forward. Does that imply a flat earning asset base from here as you guys just remix cash flows coming off the bond book in loan growth going forward?

Nate, this is Kelly. I think it would just be a direct result of the overall loan growth. So, if we can keep pace with the loan growth, that will be the main driver of the earning assets.

I would also add that it took Kelly the period between the Fed increase in March and the most recent time, which I guess is today, to fill up the floors on some of the daily floaters. I don't believe that the second half of the year depends solely on loan growth. I think it has a lot to do with the fact that we will now be fully benefiting every day from higher interest accruals because we reached those floors mainly in mid-June.

Correct.

In the second quarter, you may not have had the benefit every day, or even on half the days, due to the floors not being filled up. However, this situation will not persist as we are now in the third quarter.

Next question comes from Sam of Coley and Partners.

I'm looking here at Slide 10 under asset quality, and it shows the energy portfolio as a percent of total loans. Perhaps I should look at the energy portfolio as a source of nonperformers at some point or another. But could you talk a little bit about how the underwriting and the competition might be different or better since you were back at 15% in 2017, 2018, please?

Can I ask a question for clarification? Sam, you said something about energy and nonperformers.

Yes, you have a slide on asset quality, and the energy portfolio represents a percentage of total loans. The energy portfolio should be an area of focus for assessing asset quality.

My response is that I certainly don't want to speak for the Street, but we believe that the Street thinks energy is inherently more risky. Without getting into a debate about whether that is true or not, when you compare historical losses across segments, we have come to realize that after becoming a publicly traded company, we will get questions about energy, partly because we are located in Oklahoma and Texas. We should include this information in our presentation so that people can see the status of the portfolio and its performance. I think that’s why it’s included regarding asset quality.

What I'm really looking at is the raw percentage. My perception is that underwriting and competition have a more favorable backdrop than they did 3 or 4 years ago, mainly because many banks have left the industry. That's what I was trying to convey.

That's correct. You are correct. I would use the word remarkable that the opportunities in the energy space are really great. At the same time, because of the exit from investment vehicles and certain lenders, the energy borrowers understand the pricing power that the banks have. The underwriting requirements are really strong; I'm not sure they've ever been stronger. Fair to say in this space. I think the thesis you're presenting is totally accurate; the energy loan quality today is probably the best it's been since I can remember, and the terms are very favorable for the banks. That’s why we haven't left the space. We're going to continue to extend energy commitments, and we think it's a real strength of the company.

Right. Well, I appreciate that. And as a shareholder, if that's the case, then I'd have no problem if you got back to or even above your 5-year average of 15%.

Well, Jason and I have had this discussion many times. Over the last, what, 30, 60 days, Jason?

Yes, sir.

Part of it is driven by the number of opportunities we have. Part of it is running our business in a prudent manner and trying to respectfully ignore the chatter, Sam.

This concludes the question-and-answer session. I'd like to turn the conference back over to Mr. Tom Travis for closing remarks.

Thanks, everyone, for their interest, and we look forward to the rest of the year and hope to see you all soon. Bye-bye.

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