Bank7 Corp. Q2 FY2023 Earnings Call

Good morning, everyone. Welcome to Bank7 Second Quarter Earnings Call. Before we get started, I'd like to highlight the legal information and disclaimer on Page 25 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 the management's beliefs as well as assumptions made by and information currently available to management. Although management believes that the expectations reflected in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove to be correct. Such statements are 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 an 8-K that was filed this morning by the company. Representing the company on today's call, we have Brad Haines, Chairman; 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 would like to turn the floor over to Tom Travis.

Thank you. Good morning, and welcome, everyone. We were pleased with our quarter and pleased with our year-to-date. If you boil it all down to why we were able to again have record profits and earnings per share, it's really a story of sticking to your fundamentals, our fundamentals and relationship banking. And we're proud of the banking team that we have, the bankers, the executive management all the way down to the front line. We're just going to continue to stay focused on our fundamentals, and we are also mindful of what's going on in the market, and we're carrying excess liquidity just in case. We're happy with the position of that balance sheet that continues to have no debt, extra liquidity and plenty of money for turbulence should it come into the markets again. It's not sexy and fancy, but fundamentals just don't go out of style as they say, and we're really pleased about it. If you look back at the prior 2 quarters, earnings call commentary – maybe 3 quarters, the year has kind of shaped up the way we thought it would. With the Fed continuing to increase rates, clearly, funding costs have gone up, but we've managed our margin within our historical ranges and are very happy about that. So with all that being said, we're happy to take any and all calls or questions you may have. Thank you.

Our first question today comes from Tom Wendler from Stephens Inc.

I just want to start off with expenses. We saw the decrease this quarter. Can you maybe give us some color on your expectations for expense growth moving forward?

Yes. We did have a slight decrease in Q2 versus Q1. From a run rate perspective, I like the second quarter better going forward, maybe a little bit higher at $7.5 million.

Perfect. And then just moving on to credit. We saw a step-up in your allowance this quarter even with the decreasing nonperforming loans and loan balances remaining relatively flat. Can you maybe give us some color around the reserve build?

Yes, I think that it's just kind of our DNA whenever you have what we believe to be some economic headwinds or potential headwinds to continue to build. The portfolio has held up very well. Past dues are down; you'll see positive trends, credit trends throughout the book. If you're comparing to the last couple of quarters, it's looking good. We're not oblivious to the impact of higher interest rates and what that's going to look like in the economy as the year goes on, and you're starting to see some of those effects in the economic data. Regardless of what the Fed does in the next couple of meetings, we just think it was prudent to get ahead of that.

And then one last one for me. Loan balances remained flat this quarter. Can you just maybe give us some color on your expectations for loan growth? And if there’s any sort of segments you’re looking to grow more than others?

Yes. From a segment standpoint, we’re pretty consistent, I think. You see us in hospitality, energy, C&I, and then the same segments that we’ve been working with. I think we expect the same in the future. As far as growth, if you go back to the last couple of calls, the commentary has been that this won’t be a year like last year, where growth was probably a little bit more than we had anticipated. This year we expect single-digit growth. I feel confident in that. This will be the third call in a row where we've talked about what does this year look like? We're unchanged, even though March was a little turbulent and caused some uncertainty; it’s still looking like that’s a good number for the overall year.

Jason, am I correct that construction is actually down?

It is. It is.

So that’s one segment that we would point out that – I don’t know the numbers, but our construction lending has definitely slowed as we expected it would.

Our next question comes from Nathan Race from Piper Sandler.

Question on just kind of the margin outlook ex fees and accretion. It looks like it came down about 6 basis points versus the first quarter. It looks like the increase in deposit costs was actually less than what we saw during the first quarter. So just curious to kind of get your expectations in terms of perhaps the magnitude of future pressure that we can expect during 3Q and 4Q of this year?

This is Kelly. I think from an ex-fee perspective, 4.55% is a good number. I’ll highlight the fact that we are carrying additional liquidity. You could see a shift potentially if we do fund up loans when we do fund up loans, some of that cash leads down, and that could prop up NIM a little bit as well. The Fed is meeting next week, and so that will have an impact on NIM going forward as well. But I think from a core NIM perspective, 4.55% is a good number.

That's kind of real time, isn't it Kelly?

It is.

Okay. Got you. And perhaps maybe a larger kind of more broader question on the NIM going forward. In a theoretical kind of higher for longer interest rate environment, what are you guys going to see your margin kind of subbing out ex fees over that kind of longer-term period?

We're delighted and proud of the efforts of the team with regard to negotiating and walking away from transactions that don't meet our hurdle. We've consistently said that we're going to operate within our historical ranges. I believe if you look back in history, I'm not sure we've ever dipped below about 4.25% or 4.3%. There's nothing that we see today that would lead us to believe that we're going to operate outside of those ranges. I'm not saying we're going to go from 4.55% real time today to 4.30%, but if it happens, it happens. A lot of it depends on the Fed and what they do. Everyone is expecting a rate increase next week. However, if they do take a pause and don’t do any more, then I think you're going to keep your NIM from dropping to the absolute loan historical range. We'll just see. As we point out in our deck, 51% of our loans are daily floaters, and we have about $80 million or so that are at the ceilings. When the Fed increases next week, a few more loans will go to the ceiling. We're going to be within those historical norms. Additionally, we’re carrying a heavy treasury note position, 7 months away from the actual maturity on that instrument. If we chose to do so today, we could liquidate that and pick up earnings. Some things we have will offset that NIM pressure.

And if I remember correctly, that large maturity in the securities book that occurs in the first quarter of next year?

February, I think it's the end of February.

And perhaps just changing gears, thinking about the energy portfolio in particular. It didn't appear that you guys had much growth. In fact, it looks like balance has shrank a little bit versus the first quarter. So just curious kind of what opportunities you're seeing in that space? And perhaps just if you could kind of touch on what you're seeing from a credit quality perspective across your energy portfolio as well.

Yes. Outside – there’s one large credit that's out there in the public realm that we really can't talk about because there's ongoing litigation. Outside of that line of credit, the energy book is performing very well. The deal flow there has slowed quite a bit from last year’s pace, and we did contract about $10 million during the quarter. I wouldn't be surprised if there's a little more contraction as the year goes on in that book, but overall, credit quality there is very strong with primarily companies we’ve banked for a long time.

And Jason, just any update on those kind of 2 large nonaccrual loans that I believe constitute a large majority of the existing NPA balances coming out of the second quarter?

Yes. One of them had consistent, nice continued improvement for 12 months, maybe a little more than 12 months. We used to refer to it as the green shoots, but it’s just a nice recovery story. We’re optimistic that one may come out of that bucket in the near future. The other credit involves litigation, well-secured, and we don’t expect any loss, but we have to work through the corporate system to get that money back.

Okay. Great. Thank you for the added details on the office commercial real estate exposure in the slide deck. Any additional color you can provide on that portfolio in terms of kind of the maturities that are expected over the next year or so? Just generally how you're feeling overall about the office portfolio, given this is an area of focus these days for investors?

It is, we're unique, I think, compared to maybe other banks of our size and especially the bigger banks because the majority of our office, are going to be owner-occupied deals. They aren't downtown locations. We're talking suburban, smaller loans that amortize rapidly, and we just don’t expect stress in our portfolio. We don’t see a single loan in there that we have expected issues on.

Nate, I would add to Jason's comments that we all know that the news is dominated and emanates from New York to Washington and some on the West Coast as well. We hear these drastic stories about the situation in areas like downtown San Francisco and some other cities. But it has nothing to do with how we loan money and what goes on in Texas and Oklahoma markets. It's nice to reinforce your comments about concerns we anticipated. It seems in the world we live in, you’re guilty if you have one office loan. We anticipated the questions, which is why we provided additional disclosures.

Got it. That's very helpful. One last one for Tom about capital management priorities. You're continuing to build TCE, and regulatory capital ratios increased in the quarter. You have what I think is a premium currency on tangible book basis relative to peers. We discussed potential acquisition opportunities previously. What are your thoughts on prioritizing excess capital deployment?

Well, I guess we could be kind of smart and say, gosh, we're sorry that we're making so much money that capital is piling up so quickly. But with all seriousness, that's the fact. We're clearly very interested in acquisitions. We’ve always been consistent in looking for opportunities that make sense. In the meantime, we’re going to continue to pile up capital. We have some flexibility. Our dividend payout ratio is around 18% or 19%, while the industry average is 35%. This earnings machine is a beast, and we have options if we chose to reduce capital in other ways. For now, we’re going to steady as she goes, and maybe we'll find something to buy.

Understood. Are you seeing any more opportunities on the acquisition side? A lot of smaller competitors are presumably experiencing margin pressures similar to yours. Is that leading to more discussions?

Well, you would think it would, but I think what we're seeing is this phenomenon where many banks made the decisions to extend way out in their durations, and now they’re just stuck and unable to sell their institutions due to that big MTM issue. I don’t see that changing unless rates go higher, which would worsen the situation. That’s taken a lot of opportunities off the table.

Our next question comes from Brady Gailey from KBW.

I just wanted to circle back to the energy credit that was recently in the media. I think this was an energy company that you guys were involved with that went bankrupt. I was just wondering if you could talk about the size of that credit, and it doesn't appear that, that credit moved into NPAs. So do we think that will be more of a third-quarter NPA increase?

Yes. The loan is approximately $33 million on our books. It's a club deal with multiple banks involved, four total. The loan is current, and there’s litigation going on, so I don't want to get too detailed. We are a senior secured lender and believe in the asset value and the cash flow that the assets produce. We do not expect at this time that there would be a loss on that credit. The good news is, with it being in this bankruptcy process, this isn't going to linger. I see it being an issue into the fourth quarter, but I don’t think it will be an issue past the fourth quarter.

Okay. And then I think that energy company was into natural gas. I know the price of natural gas has been pretty depressed here. Are you all seeing any other weaknesses in any of your other nat gas borrowers?

This is Tom, Brady. The answer is no, we're not seeing issues. This was just a management issue of the company dropping the ball. We see management teams operate through down cycles and up cycles; those who stick to fundamentals and manage their liquidity don’t get caught in traps. It’s less about the commodity prices and more about management and oversight.

Okay. And then my final question, you've talked about capital piling up and you’ve mentioned M&A. Your stock trades at 1.45% at tangible book value. Given your current ROE, that seems like a compelling valuation. Do share buybacks ever make sense as a way to return capital to shareholders?

I think the answer is we've always felt the market hasn't properly valued the company based on our consistent performance. Unless that dynamic changes, it's hard to see any change materially. Are you a short-term investor or a long-term investor? If you appreciate compounders, there's no better stock. We love what we're doing and don’t feel pressure to do any share buybacks. Even with capital piling up, our ROE is 23% or 26%. Until we dip down into a much lower ROE, we're proving that we can grow the company and carry substantial capital while still outperforming on returns. No immediate or near-term pressure to repurchase shares.

And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the floor back over to Tom Travis for closing remarks.

Thanks again for your interest and participation. We like where we're at with the company's dynamics. We've got a wonderful team of bankers and management, and we're really blessed to be in this part of the country. We'll keep doing what we've been doing. Thank you.

And ladies and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.