Earnings Call Transcript - BSVN Q3 2023

Operator, Operator

Welcome to the Bank7 Corp's Third Quarter Earnings Call. Before we begin, I want to point out the legal information and disclaimer on page 25 of the investor presentation. For those who do not have access to the presentation, management will discuss certain topics that include forward-looking information based on their beliefs, assumptions made by management, and currently available information. While management considers the expectations in these forward-looking statements to be reasonable, they cannot guarantee that these expectations will be met. These statements are subject to various risks, uncertainties, and assumptions, including the impact of economic conditions on interest rates, credit quality, loan demand, liquidity, and the policies of banking regulators. If one or more of these risks occur or if the underlying assumptions are incorrect, actual results may differ significantly from what is expected. Please note that this conference will refer to non-GAAP financial measures, and you can find a reconciliation of these non-GAAP measures to GAAP measures in our 8-K filed this morning. All participants will be on listen-only mode. After today's presentation, there will be a chance for questions. This event is being recorded. 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. Now, I’ll turn the call over to Tom Travis.

Tom Travis, President and CEO

Thank you. Good morning and thank you for joining us today. We recently celebrated our five-year anniversary of our IPO and we're happy with our results over the last five years and how we've had consistently strong earnings and compounded our shareholder value. And we've done that far better than just about any other financial institution. Our equity compounding and total shareholder returns are in pretty rare air and I'm sure in the top few percent of all banks. You can see these dynamics on page six of our deck as it shows the doubling of both of our EPS and tangible book value metrics. You can also see our total return when including dividend payments. Essentially, since the IPO, we've doubled our equity and our earnings and on top of that provided competitive dividend yields while doing so. Our recent quarter was strong, clearly negatively affected by a one-off large credit event. We'll touch on that shortly. In the meantime, we report record PPE, continued disciplined expense management, NIM strength, stable liquidity, properly matched balance sheet and we also note the absence of a meaningful AOCI adjustment. And with the exception of one adverse credit, our asset quality strength is consistent with our history. We take comfort knowing that our fundamentals carry the day. Before we move into Q&A, let's spend some time on that one large one-off credit first. This is clearly a one-off situation as the rest of the portfolio is very strong. We do not see any weakness. In fact, excluding that one credit, our past due loans and adverse credit grades are even better than the prior quarters and those quarters were strong as well. So, our team has been together for decades and we've never experienced anything like what we are faced with on this one credit. And I'll tell you on a personal level, it's an extreme letdown for sure. The credit in question is in litigation, the underlying borrowers in bankruptcy, so we have the need to be cautious with our comments. In addition to the specific reserve we took in Q3 shortly after closing the books, we became aware of a few significant new bankruptcy-related claims and we became also aware that the borrower and their consultants will take a significant amount of additional time to wrap it up, all of which costs money. And so, it required us in good faith to include a subsequent event note. In Q4, we will make an additional ACL increase or will take an actual write-down. The amount will exceed the $3 million reserve we made in Q3; the range of possibilities is wide. And while it's difficult to provide specifics due to the bankruptcy process, the outside larger possible amount could soak up much of the Q4 earnings. We would still expect even if that were to happen to report a strong return on equity year, based on information available today, even using the large possible lost amount. Our ROE would still be somewhere in the industry average and a little bit better. So really in a perverse way, it illustrates the strength of our core earnings to be able to take a meaningful hit and still perform where the industry performs. Regarding the one troubled credit again, we're involved in litigation, but I want to make it really clear that this situation is not caused by errors in underwriting or collateral perfection or collateral valuation. Rather, it is a case of we believe severe management failures which were then compounded by outside consulting and legal fees that are being paid from the cash collected, from the sale of our collateral. It is unfortunate to be in a position, where the sale of our collateral will generate almost twice as much as what the senior secured lender is owed, yet that won't be sufficient enough to avoid a loss. The bottom line is the bankruptcy process is slow. It's very expensive and it's very lucrative for consultants and attorneys. And so without further commenting on that one situation, we're moving forward. We have a very strong company. Our fundamentals are very good, and we expect to do what we've always done and that is to continue compounding equity in a very meaningful way. And we're really excited about our company, in spite of the one event. So with that being said, we're here to answer any questions we can. Thank you.

Operator, Operator

We will now begin the question and answer session. Our first question comes from Thomas Wendler with Stephens. Please go ahead.

Thomas Wendler, Analyst

Hi, good morning, everyone.

Tom Travis, President and CEO

Good morning.

Jason Estes, Chief Credit Officer

Good morning.

Thomas Wendler, Analyst

I just wanted to touch one time on the credit that moved on to nonaccrual. Can you give us an idea of when you're expecting resolution on this credit?

Tom Travis, President and CEO

We have reviewed information this week and believe that the resolution will likely occur in the second quarter of next year. The bankruptcy process is frustratingly slow, and while the final asset sale will happen in a couple of weeks, it will still take quite some time to complete everything.

Thomas Wendler, Analyst

Okay. Thank you for that. And then just kind of thinking about some of your other larger relationships, can you give us an idea of the size of some of your larger relationships and then kind of your internal policies around those relationships?

Jason Estes, Chief Credit Officer

Sure. I would say that there are several relationships exceeding $25 million with a single repayment source. For example, one group owes us about $35 million. They are involved in the quick-serve restaurant sector, operating over 100 locations. When I refer to a single repayment source, I'm indicating that most of these are tied to one brand, although they are spread across various metropolitan areas in the country. In total, there are five relationships with this single repayment source where balances exceed $25 million. Among these, one is in the QSR sector, another is a broadband group, and the bankrupt entity is the only one lacking strong personal guarantees backing the credit. Because of the substantial size of these credits, they are under considerable scrutiny. The outlier in terms of personal secondary support is the bankrupt entity. The other four include the QSR credit, a real estate entity with secondary support, another broadband operation also backed by significant individual support, and a manufacturing company that is well-secured and has additional secondary support.

Thomas Wendler, Analyst

That was great color. Thank you. Thanks for answering my question, guys.

Operator, Operator

Our next question comes from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race, Analyst

Great. Hi, guys. Good morning. Thanks for taking the questions. I'm sorry to go back to the large loan that moved to nonaccrual in the quarter, but can you just remind us all in terms of the size of your exposure there? Kind of what specific reserves you expect to take additionally on this credit in addition to what was allocated in the third quarter. I think the release alluded to some subsequent impairments in 4Q. And I know it's kind of a dynamic process at this point, and it could be prolonged in terms of the resolution to early next year. But any thoughts on just kind of the ultimate loss that you expect to take on this credit relative to the size of it?

Jason Estes, Chief Credit Officer

The loan amount can be viewed in two parts. There is the prepetition debt, which for us was just under $27 million as of September 30, and then there is the DIP financing. The remaining amount needed to reach $40.5 million is just over $13.8 million, or approximately $13.9 million. That represents our share of the DIP loans.

Nathan Race, Analyst

Okay. And then again I understand it's a fluid process but based on what you know today and what liquidity remains on the assets and the company any sense for kind of the overall loss given default on this credit as this process plays out?

Tom Travis, President and CEO

Yes. The recent events involve additional significant claims that will be contested. As I've mentioned, based on our current outlook, these claims could potentially impact our fourth quarter earnings. We're accepting this situation as it stands. A significant factor is the prolonged duration of the legal process, which allows the court to permit the use of some funds available for covering expenses related to winding down, including those of consultants and attorneys. We are preparing for the scenario where, if we do not generate earnings in the fourth quarter, we estimate our annual income might be around $27 million, similar to last year's figure. If this outcome occurs, it would suggest a return on equity in the range of 13% to 15%. That's the perspective we're taking, Nate.

Nathan Race, Analyst

Okay. Understood. And just to clarify on that outer bound expectation level I mean that would imply I mean you guys had about $14.5 million in pretax pre-provision earnings this quarter. Is that kind of the potential additional impairment we're thinking?

Tom Travis, President and CEO

I think so.

Nathan Race, Analyst

Great. I appreciate all that color. And maybe just kind of thinking about the margin outlook going forward. It seems like there was a little bit greater pressure than maybe we were looking for this quarter. So perhaps Kelly kind of any thoughts on kind of how you see the core margin ex-fees trending over the next few quarters if the Fed remains on pause and kind of, and perhaps for Jason, what does that contemplate in terms of kind of loan growth expectations as well as core deposit growth over the next couple of quarters as well?

Kelly Harris, Chief Financial Officer

Yes. Nate, this is Kelly. Our NIM has held up extremely well the past few quarters even with the deposit pressures. But I do see NIM; I think we've alluded to that $450 range in Q2 and Q3, and I think that that's maybe a more normalized NIM going forward. That said, I mean we still feel very comfortable operating in that range.

Jason Estes, Chief Credit Officer

Yes, on loan growth, you'll see some quarters where growth exceeds expectations and others where it falls a bit short. For the fourth quarter, I anticipate that we will align more closely with our guidance, which has indicated that we expect the loan book to grow in the mid single digits this year. That’s where I believe we will end up. Essentially, I foresee some contraction in the fourth quarter due to known exits or pending refinances.

Nathan Race, Analyst

Understood. And then just in terms of kind of deposit growth expectations over the years you guys have done a great job in terms of matching core deposit growth to loans as Tom described earlier in his comments. Just curious to kind of get an update on kind of the pipeline for client wins on the deposit gathering side of things?

Jason Estes, Chief Credit Officer

I think it's more of the same where there's typically a credit need and a chance for a transaction that's where we can typically target deposits and have a higher success rate. So I think if you look at just our normal loan portfolio churn I would think it will be in line with those loans or maybe just trailing a little bit based on all the deposit gathering pressure that's out there with all of our competitors. So it's a tough fight. We do a pretty good job of it every day of winning those awards. But I still think it's going to be a challenge in the deposit environment we're in.

Tom Travis, President and CEO

We could have increased our deposits at a faster rate this year by raising our money market and CD rates, but we chose not to because we didn’t need to. Instead, we have taken a more disciplined and measured approach, which allows us to avoid the costs associated with those higher rates. This decision also impacts the growth of our deposits.

Nathan Race, Analyst

Got it. Understood. And if I could just ask on expenses. I know it's probably early in the budget process for next year. But perhaps Kelly any thoughts on just kind of the overall expense growth trajectory that we should expect for 2024. It looks like you guys are on pace for 5%, 6% growth this year in expenses. Any thoughts on how we should think about the 2024 growth rate?

Kelly Harris, Chief Financial Officer

Yeah. I think that's probably a good projection for 2024. I know Q4 historically has been a little bit heavier expense load than the prior three quarters. So we anticipate non-interest expense to trend up in Q4. That said, I think we've done a really good job. If you look at our historical range with non-interest expense to really control that. But I think a 5% increase for 2024 is probably a good projection.

Tom Travis, President and CEO

It may be a little bit more than that late in the year. If we are going to build some new branches to replace existing facilities in a couple of locations, it will add to our depreciation expense, but that probably won't start until the end of next year. So that's really more of a 2025 issue.

Nathan Race, Analyst

Got you. And I think you guys alluded to this earlier just going back to credit quality, but outside of the one loan that we've discussed, just in terms of overall criticized classified trends in the quarter. Any thoughts there across the broader portfolio?

Jason Estes, Chief Credit Officer

Gradual improvement over the last couple of quarters. I mean, positives look good as Tom mentioned adversely graded credit trends look good outside of the one credit.

Tom Travis, President and CEO

We highlighted our historically low NCO numbers in the presentation. I feel compelled to mention again that we are encountering a unique credit issue that I have never seen in my career since 1981. Our team has thoroughly analyzed the situation, and this is not due to any significant policy exceptions; it's just an unusual occurrence. Despite this, we remain confident in our company, NCOs, and NPAs, and we expect to continue our successful track record. Unfortunately, this is a challenge we are currently facing, but it is important to note that we haven't made any drastic changes or brought in any unconventional lenders. It's simply one of those rare situations that can occur in this business, and we hope this is ours.

Nathan Race, Analyst

Yeah. Truly sounds like an idiosyncratic event this quarter. I appreciate you guys taking the questions and all the color.

Operator, Operator

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

Tom Travis, President and CEO

Thank you for your understanding. It's disappointing for us to face this significant credit issue, but we will remain focused on the strong positive fundamentals of our company. Despite this setback, we believe we will be delivering results that meet or even exceed industry standards. We are committed to maintaining our strong company fundamentals and continuing to achieve better growth than our competitors, ultimately providing a good return for our shareholders. We appreciate everyone's support. Thank you.

Operator, Operator

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