Bank7 Corp. Q4 FY2023 Earnings Call

Welcome to Bank7 Corp's fourth-quarter and full year earnings call. Please note this event is being recorded. Before we get started, I'd like to highlight the legal information and disclaimer on page 24 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 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 effects 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 eight K that was filed this morning by the company representing the company. On today's call, we have Brad Haines, Chairman; Tom Travis, Vice Chairman and CEO; J. T. Phillips, Chief Operating Officer; Jason Estes, Chief Credit Officer; Kelly Harris, Chief Financial Officer, and myself. I will turn the call over to Tom Travis. Please go ahead.

Thank you. Good morning, everyone. It's a beautiful day here in Oklahoma City for those of you that are around the country. We've had a cold spell of weather that's nice to be over with. As you can see, we had signaled in our last earnings call back in late October that we had subsequent events post the third-quarter closing that were going to significantly affect the fourth quarter numbers. And as you can see, that in fact, did happen. And so I suppose that it reminds me of a comment I've heard before, and I think everyone on the call has heard before, and that is, except for the one event, how was the play, Mrs. Lincoln? And not to be morbid, but that's pretty much how we view our company today because when you look at the totality of the fundamentals of the company for the year, but for that one event, it was a phenomenal year. Even with the large charge related to the one credit, we're still at almost 19.5% return on tangible common equity. We did some analytics about three weeks ago, and we found that about 90% of the banks in the country did not make 19.5% return on average tangible common equity. So, as you can see, and as we mentioned in the last earnings call, in a perverse way, the strength of the company is highlighted by the fact that we took this one-off negative event out of character and just kept right on moving forward. So that's the way we view it, and we take comfort in that. If you look at the other components of the company, not just the earnings and return on equity, you can see that the company has done an excellent job of managing its net interest margin. The historical averages of the net interest margin are pretty much where we are today, and we did that through a difficult rate environment, but not for that one credit. The credit metrics are really strong and even better than they had been for the prior year or two. We feel good about the book. The operating expenses for the company are very much intact as far as maintaining our efficiency ratio. The company, as a part of that one credit, acquired specific working interests in oil and gas wells. As a result, you'll see a slightly inflated non-interest income number and a slightly inflated non-interest expense number. If you remove those two items out of the income statement, you would have seen that the efficiency ratio would still be in that 33% to 34% range instead of a 39% range. When we look at the fundamentals of the company, we feel really good about it. With regard to the one particular one-off credit, we are in the seventh or eighth inning of the bankruptcy process in litigation. We have real strong clarity and good optics into where we think it's going to end up. We feel good about the amount of money that's been either expensed or set aside with some certainty. Clearly, we don't feel good about having to do it, however, we are confident that we've accounted for what we need to account for. We're a very transparent company. We always answer every question we can. However, we cannot really speak much to it except to be respectful of the fact that some details and specifics are in the public realm today. We're not going to comment much beyond what's been said today, other than we feel like we've accounted for it properly. With all that being said, we feel really good about our company, and we're excited to move forward into this new year. With that, we'll open it up for questions.

Our first question will come from Brady Gailey of KBW.

Thank you. Good morning, guys, or anyone. So I understand the impact of owning these energy assets, and it's pushing up the income, pushing up expenses. How long do you anticipate owning these assets? Is this going to be a short term thing? Or is this something that you anticipate holding for a while?

This is Tom and I've got approximate numbers, but I have the exact numbers in my lap, but just to make it easy for you. So we booked approximately $16.9 million of an asset value on the balance sheet, and the effective date and cash flow of the wells started September the 1st of last year. When you look at the starting point of the balance sheet of $16.9 million for the first four months, we will have collected $4.5 million. So the new asset or the actual cash flow that results from that is about $12.4 million. We will have collected for the first four months, most of which we have collected 27% of that asset value. The cumulative cash flow for at the end of this year is projected to be 60%. This means we will have collected $10.2 million of the 16.9. If you roll that forward through 2025, we will have collected 13.2 of the 16.9 which is about 78% of the cash flow. Cash flows from producing oil and gas wells are not a linear decline curve; it's skewed more heavily towards the recent months. As you collect cash flow, the asset value will come down much more quickly in the early months and then smooth out. The bottom line is that we will have collected a little over 25% of the cash flows of that beginning asset value by now and then by the end of the year, 60%. We expect it's already not a material amount relative to the company, but we expect by the end of the year to be pretty immaterial.

That's the plan. And there's not a thought of just simply selling these assets more near term, if possible.

I will tell you that we have hedged about 62% of the oil joint venture from oil revenue. This is predominantly oil and not natural gas. We have hedged to make sure that we can receive most of the cash flows, if not all of it. It's possible we could sell if there’s an increase in commodity prices in the market that would value the assets higher.

And then maybe back or looking at the core fundamentals of the bank, which were pretty impressive in the quarter. How are you guys thinking about loan growth from here? And what's the outlook for the core net interest margin?

Hi, Brady. This is Jason. Again, kind of like last year at this time, we were sitting here coming off a really rapid growth in 2022. We signaled that this is going to be a different year; we think it will be more like a mid moderate single digit. I think we ended up at 7%. I think something in that range is probably reasonable to expect for this year. We have a fair amount of known payoffs coming in the first half of the year. The deal pipeline is still nice. We booked about $90 million of new fundings in the fourth quarter, which was a solid quarter. The first quarter pipeline looks decent, but with those known payoffs, I think we'll be pretty muted in the first half of the year and picking up in the second half.

I would also note that the large energy credit paydown and payoff has been delayed somewhat because of the bankruptcy. So you could likely see a little bit higher payoff amount in the first quarter than you would normally see.

Right, that's helpful. The core margin has been pretty consistent around 4.50% for the back half of 2023. Is that how we should think about it going forward? Or do you think that there could be some slippage there?

Hey, Brady, this is Kelly. If you look at December NIM, we were at 4.45% average, 4.50% for the quarter. We do have a large tranche of U.S. treasuries maturing at the end of February that will move to a higher yielding asset of 5.33%, assuming the Fed. There are some positive events that should lift NIM during the quarter, and that's it. There's no color on what the Fed's going to do in March as well as fighting paydowns.

That's a good recap, Kelly. I would say I would use the word 'delighted' but not surprised. We are pleased with our company's ability to manage the NIM through the interest rate cycle. We're not surprised about it; we've purposely worked very hard to match the balance sheet so that we're not caught with interest rate swings and wild fluctuations. We're pleased with our ability to illustrate a NIM that's very steady irrespective of the changes in the interest rate markets, and we don't see that changing.

And then just finally for me, Kelly, what's the size of those treasuries that are rolling off and what's the rate there?

$100 million at 1.5%.

Next question comes from Nathan Race of Piper Sandler.

Hey, good morning. Sorry again, I just want to clarify on the last point around the securities that are maturing in the first quarter. Is the plan just to leave those in cash? Or do you plan on redeploying that into securities in the first half of the year, just leaving it for some dry powder to redeploy into loans? As Jason described earlier, we're not going to speculate.

It's tempting to believe that we're at the end of a rate cycle. However, as we all know, the wise thing for anyone to do is to not speculate. We're going to take advantage of the yield curve inversion. I think today the 10-year is around 4.1%, and the Fed's still over 5%. Our belief is that we'll put it at the Fed and stay away from any kind of a fix and try to anticipate rates dropping. Remember that liquidity is an important function of the bank and part of the Rubik's cube. $100 million sounds like a lot of money, but it's really not relative to the movements on the balance sheet relative to loans and liquidity. Keeping it short, cash will benefit us on the yield curve side while also maintaining that strength and flexibility for liquidity and cash.

Okay. Got it. That's helpful. Tom, I'm just curious how you guys are thinking about deposit betas and pricing on the way down when you have to get a few Fed rate cuts at some point this year. How do you see that impacting the margin and overall trajectory over the course of 2024?

Kelly or Jason, do you want to talk about it? We've budgeted pretty similar for where we are.

Yes, I think if you look at our historical NIM through various rate cycles, we’ve managed it down, and I foresee that being no different this time. If the Fed cuts, we’ll be able to push down deposit rates in tandem with the asset side.

Do you want to add to that, Jason?

No, other than we spend a lot of time on these calls talking about growth rates, and they’re very important. If you look at our history, we’ve proven that we’re not willing to sacrifice margins for the sake of growth. We are going to work hard to maintain top-tier profitability while we grow this company.

Got it. Very helpful. Makes sense. Just one last one for me on excess capital priorities this year. You guys are operating with pretty healthy capital levels across the board. What are you seeing in terms of acquisition opportunities and your optimum capital level on that front?

We are laser-focused on acquisition opportunities. There's still a healthy amount of what we call zombie banks. We continue to have conversations. We are making calls on people who are not for sale. We're planting seeds and constantly evaluating everything we can. It’s probably going to be a tougher environment for the next two to three or four months, but if rates start coming down, some of the zombie banks may have an ability to sell. You might see a flurry in the back half of the year if rates come down. Our goal is to position ourselves to be there when we can to buy in. We definitely have a mindset to do that.

Got it. That's great. If I could squeeze in one last one, Jason, regarding overall migration trends in criticized and classified in the quarter outside of the one energy loan that we discussed?

Yes, the credit quality of the book has actually improved outside of this one credit. The metrics have been positive. We had another charge-off that paid in full during the quarter. We also had another non-performing asset about 34% of the NPA balance at the end of the year. We are optimistic that it could come off the list even in the first quarter. We’re not seeing stress throughout the portfolio, although we had a medical relationship that has migrated down about $10 million altogether; however, it's more positive than negative in the last couple of quarters outside of the one credit.

Got you. Within that context, do you envision the reserve remaining where it was at the end of the year relative to loans? Or do you see it as kind of an inflated level, considering some of the credit events that occurred late last year?

I would say it's probably overinflated of our historical range, where we strive to keep it. However, it's warranted based on what's transpired in the last couple of quarters.

Okay, great. I appreciate the color. Thank you.

Next question comes from Matt Olney of Stephens.

Thanks, guys.

Good morning.

Do you guys have the dollar amount of the charge-off for the fourth quarter? I didn't see that one.

This is Kelly. The total NCO for the quarter was $16.5 million.

Okay, perfect. Thank you, Kelly. And then on the deposit side, really strong non-interest bearing deposits in the fourth quarter, any color on the growth there? You hit on the betas earlier, but just the appetite to grow deposit balances for the year?

The non-interest bearing will come down a little bit in the early part of the year. We have a few large, significant non-interest bearing deposits that occurred later last year, and we expect some to run off. We don't believe that the interest-bearing deposits will show much absolute growth from the prior year because of that inflated number. We expect to continue our nice, steady growth in our deposit book and our relationship deposits. Our bankers are doing a really nice job of making loans when we have new deposit relationships. We don't expect there to be much different going forward. We're still seeing some migration where people are moving non-interest-bearing accounts to some interest-bearing products.

Okay. That makes sense. As far as rate sensitivity, you give us some good details there. It looks like about 78% of your earning assets reprice in that first year. It seems like most of those that are priced at first will be floaters that reprice in the first few weeks after a Fed cut; is that right? Or any insight on the percent of those loans that are floaters?

Yes. If you look at the first footnote on that same page, Matt, of that $1.043 billion in loans due in less than a year, $901 million are daily floaters. And of that, you've got $86 million at the ceiling.

So roughly 90% of that total of which you said was $1 billion in loans are floaters. We always have to remember that we are very active in managing our floors. That's part and parcel to the stability in the NIM; the historical illustration shows our ability to maintain that. So yes, they’ll float down, but at some point we start hitting floors, and that’s a big component of our bank.

Yes. Okay. Good points. And then on expenses and fees, any color on how you're thinking about that in 2024?

If we just remove the oil and gas assets that we mentioned before, if you look at the expense load for the bank, the efficiency ratio was 33%. The expenses due to the size of the bank are well managed, and I think that's been proven over the years. We're spending a little bit of money to upgrade and relocate a few fixed assets, but that really won't show up until very late this year, probably not until next year, because it takes a while to construct a few branches. Even with that, we don’t expect the expense load of the bank to change in a meaningful way.

Okay, guys, thanks for your help.

Yes, this concludes our question and answer session. I would like to turn the conference back to Tom Travis for any closing remarks.

Thank you. Again, we're pleased with our position of our company and our results. We are especially pleased to move past that one-off event; it's in the rearview mirror, and we've shown the ability to manage through that and still produce good results. We're excited about this year and eager to get right back on track to those truly strong numbers. We appreciate everyone's participation and involvement.

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