Earnings Call Transcript - BSVN Q4 2022

Operator, Operator

Welcome to Bank7 Corp.'s Fourth Quarter and Full-Year Earnings Call. Before we get started, I'd like to highlight the legal information and disclaimer on Page 22 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 direction and direct 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, Chief Executive Officer; J.T. Phillips, Chief Operating Officer; Jason Estes, Chief Credit Officer; Kelly Harris, Chief Financial Officer. With that, I'd like to turn the call over to Tom Travis.

Tom Travis, CEO

Thank you very much. We are excited about our year and our recap. For those of you that have been on the call with us before, we generally don't spend a lot of time on comments, but since we're recapping the year, we'll take a few minutes here to highlight some of the things that excite us. So, once again, we delivered strong results. We're very happy about that, and we must acknowledge and thank our team members for their contributions. They not only grew our loan and deposit portfolios in a meaningful way, they did it while satisfying our customers. As we recap our results for the year, we began with record earnings. And again, we acknowledge our commercial banking team. We have to give credit where credit is due because our record earnings are a function of loan growth, and it should not be confused or attributed to the Fed rate hikes. That's pure organic loan growth. We didn't buy loans. The team went out and captured new loans and deposits. So to best understand what occurred last year, we look back to the quarterly timeline, and we start with the first quarter. The first Fed rate increase didn't occur until mid-to-late March and then was followed by the next few rate increases during the second quarter. So, in those first two quarters, we had very little benefit from the rate hikes because we had many loan floors. Also, at the same time, our loan growth had not yet materialized in a meaningful way. In essence, we spent the first quarter and most of the second quarter filling up our loan floors. Beginning in late May and early June and continuing into the third quarter, loan growth was exceptional, and we posted a strong third quarter. Although we finally did start seeing some benefit from the rate hikes in the third quarter, it was not much. In fact, we refer you to Page 35 of our prior third quarter 10-Q as it illustrates the nine-month period ending September 30, and it clearly shows that our income increase was attributable to the growth in the loan portfolio, which had grown significantly compared to the prior period end. In fact, the data shows that our gross loan yield through that period was actually 3 basis points lower than the prior period, further highlighting the growth contribution and component that caused the income lift. We cannot emphasize enough how pleased we are with our commercial banking team and all the people who support them. Wrapping up the year, as you look into Q4, we continued to increase the loan book. When combined with the Fed rate hikes, the full benefit of a higher loan book and strong rates in the NIM can be seen, and you can see how well we've done. Regarding our NIM and reflecting back on the full year, it's a similar story regarding a steady increase throughout the year. In late 2021 and early 2022, we had signaled and discussed the expected NIM compression associated with our December 2021 acquisition, due largely to the low yield on the incoming bond portfolio. Our expectation of a lower NIM was realized, and we began in Q1 with a core NIM of 3.91%. As the loan book began to grow in the late spring and into the summer and fall, the NIM began to recover, then late in the year, the Fed rate hikes were being more fully realized, we grew our loans even more and the core NIM returned to exactly where it was for the prior year. From an earnings and NIM perspective, it was a great story and a story based on our commercial banking team and their ability to price loans properly and to grow loans. I think that's a good start with the income and the NIM component. And I'd like to ask Jason if he would cover the asset quality aspect of that loan portfolio.

Jason Estes, Chief Credit Officer

Thanks, Tom. We're very pleased with our loan portfolio as the calendar turns. We've not seen a change in past due levels of problem credits as rates have increased. NCOs were minimal for the year. Our disciplined underwriting combined with seasoned lending teams will continue to serve us well as we operate in this higher interest rate environment. Construction loan balances have started to decline. Our hospitality construction activities have significantly reduced. The homebuilding industry has started to lower their inventory levels to match current demand. Just as a reminder, our homebuilder portfolio is primarily starter homes in the Oklahoma City and Dallas metro areas with very little locked and land lending activity. We're not concerned with this segment. Our energy portfolio has grown over the past year, but we continue to closely monitor that growth as we selectively remain active, originating high-quality new loans. Overall, we continue to lend money the same way we have for decades. The economies in Oklahoma and Texas are healthy, and our credit quality continues to benefit from both. Tom, I'll hand it back to you.

Tom Travis, CEO

Jason, thanks for that report. And again, just a real shoutout to the commercial banking team and all those efforts. So, as we move into our capital, we're pleased to have quickly reestablished our risk-based capital. We're back to our higher levels, especially considering it was done while at the same time experiencing record growth and a 33% increase in our dividend. Regarding our dividend, even with the 33% increase, our dividend payout ratio is still significantly below the average payout ratio for all dividend-paying banks. It's especially comforting and gratifying that Bank7 has top 5% earnings. I believe once all the numbers come in for the year, we might even be in the top 1%. Because of those strong earnings and consistently strong earnings, it enables us to build capital rapidly. It is a real source of strength for our company as it provides flexibility for acquisition, dividend payouts, or share repurchases or simply to support growth. We will refer you to Page 15 of this IP as it shows the great earnings strength and the buffer based on industry and examiner-based DFAST stress parameters. Moving into liquidity, it's remained strong, and our Cornerstone acquisition provides additional meaningful runway for future growth. Our team members from Cornerstone have done an outstanding job of retaining and, in some cases, growing our core deposit base, and we thank them very much. Our bankers rarely take a day off from their focus on core deposit gathering, and it's evidenced by our healthy non-interest-bearing component of core deposits, even when our growth was so strong in 2022. In conclusion, we had a very strong year, and we're pleased to provide exceptional returns to our shareholders. We're blessed to have such great team members at Bank7, and we benefit from being located in a dynamic part of the country. Therefore, despite the current macroeconomic headwinds, we remain cautiously optimistic for the near future. With that, we'll stand by for any questions you might have. Thank you.

Operator, Operator

Thank you. Our first question comes from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race, Analyst

Hi guys, Good morning and congratulations, Jason, on the promotion to President.

Jason Estes, Chief Credit Officer

Thank you.

Nathan Race, Analyst

First question, just maybe, kind of thinking about the loan growth and overall kind of balance sheet trajectory from here. Obviously, you guys had nice core deposit growth in the quarter, and your loan deposit ratio is still south of 90%. So, just curious how you guys are seeing the pipeline right now entering 2023 and just kind of overall expectations for both loan and core deposits in 2023?

Jason Estes, Chief Credit Officer

Yes, Nate, thank you for the question. I would just say that we wouldn't expect the growth to be exactly what we did last year. That was an exceptional year. There are some known payoffs coming in the loan portfolio that we think will be able to overcome and show growth for the full year. It wouldn't surprise me if we had a quarter or two that were flat or probably even down during this year, but overall, I think you should—most years, we're saying low double-digit growth on the loan book. This year, I'd probably couch it as a high-single-digit that maybe even a mid-single-digit growth, but we do expect to grow throughout the year. On the deposit side, we have several initiatives that we're continuing to focus on to continue to generate enough deposit growth to keep up with the loan side. Hopefully, we could do as well as we do on the loan side with the deposits this year. The banking team is very, very focused on both, and they've been very successful over the last few years at grabbing both new loans and new deposits from existing and new relationships. So, I'm optimistic we'll be able to grow this year, but it won't be as much as last year. I wouldn't expect it to be as much as last year.

Tom Travis, CEO

And I would say, Nate, this is Tom. Jason is spot on. We've remarked over the last four to five weeks that this is probably the most difficult budget environment that we have faced. We have budgeted for more muted growth based on those economic headwinds and just the uncertainty around the Fed and what they're going to do. Even with that, we're still budgeting a nice increase as we always do, but I do echo Jason's comments regarding the budget matching up to slightly lower expectations given all those factors.

Nathan Race, Analyst

Got it. That's great color. One theme I think a lot of investors are thinking about these days on banks is just the timing of kind of peak margin and peak NII? Assuming the Fed raises by another 50 basis points between now and the next couple of months, how are you guys thinking about just the trajectory for NII and margin over the next couple of quarters? If the Fed pauses in the middle of this year, give or take, how do you guys think the margin trajectory plays out thereafter?

Tom Travis, CEO

What margin are you talking about?

Jason Estes, Chief Credit Officer

Net gross margin. NIM.

Tom Travis, CEO

Oh NIM. Do you want to take that, Kelly?

Kelly Harris, CFO

Yes. So, we ended the year fourth quarter at 4.87% core NIM, and we're projecting, obviously, we're already seeing that the cost of funds is increasing at a faster clip than the loan side. We are seeing some NIM compression. You know where that ends in Q1 is to be determined based on what the Fed does, but I would say we reached peak NIM in Q4 unless something else changes.

Tom Travis, CEO

Yes. I would add to that the challenge we've had relates to really quality and long-time loan customers that across the industry push back and say enough is enough. It's not just a matter of loan and deposit beta; it's about strategically and tactically negotiating with customers to keep those customers. When we did our budget, we actually budgeted a certain percentage of the loan portfolio; even though the loans would not mature this year, we budgeted for a certain percentage of those loans to be priced downward a bit for retention of customers. That factor is in addition to the factors that Kelly uses when calculating loan and deposit beta, and it kind of goes back to Jason's comments regarding the tougher year and the slower growth, which is why we're hedging instead of the usual low-double-digit growth; we're back into the high-single digits just in case. But it's very comforting to us because another side of the coin would be a group telling you we're not sure we can match earnings from last year because of these factors, and we're absolutely not saying that.

Nathan Race, Analyst

Okay. Understood. Just maybe thinking about a potential more dovish Fed later this year into 2024, are you guys having success maybe getting loan floors on new originations, or are you exploring any hedging or derivatives that may lessen the impact in terms of loans repricing lower if the Fed were to cut later this year or into 2024?

Tom Travis, CEO

We've looked at some of those programs. As you know, Nate, and your firm does a great job presenting us with material. There's still a bit of speculation involved in that. Yes, some of it is 'hedging and buying insurance,' but it could also be money that you don't need to spend. For us, because we are so asset-sensitive and we're starting with a high book of loan floaters and a really nice healthy margin that's higher than where we would normally be, we don't feel like we need to aggressively pursue some of those instruments and take on that cost for that what-if. Now, we say that with the expectation. We actually budgeted more of a 75 basis point increase versus the 50. I think the 50 didn't really emerge until the last two weeks. If we get into the March and April timeframe and it looks like those instruments could really help the bank based on the current landscape, we will reevaluate, but for right now, it's not something that we need to worry about because we have some built-in defenses.

Jason Estes, Chief Credit Officer

I think it's worth mentioning as well that the concept of loan floors is nothing new for our portfolio because it's so heavy on variable interest rates; the floors have been long established. Some of those, as you get into a higher rate environment, yes, the floors get lifted. In the past, you may have to renegotiate some of those on the way down if we end up back in the same kind of rate environment we've operated in the last few years, but for now, the floors are moving up with rates.

Nathan Race, Analyst

Okay. Great. That's helpful. If I could just ask one more, just in terms of the reserve outlook from here. You guys are adopting CECL, I believe, in the first quarter, which complicates the reserving methodology to some degree. Charge-offs were zero last year, yet you guys still adjusted the reserve at a pretty healthy clip to support loan growth. So, I guess I'm just curious if you see anything on the foreseeable horizon that would cause a meaningful increase in charge-offs and just how you're thinking about the reserve trajectory on either an absolute dollar basis or just relative to loans within that kind of high single-digit loan growth outlook that was described earlier?

Tom Travis, CEO

Let me start with the macro, and then Jason can get into specifics. Listen, we'd be foolish not to understand the headwinds that are out there. Yes, it's a loan growth story, which motivated us to ensure that we increased our reserve, and we're really in that low 1.2 to 1.25 area that we're comfortable operating in. From a macro perspective, we're going to keep our eye on the ball relative to those overall conditions, and of course, CECL. I think Jason may have some color on a few credits on what we might see.

Jason Estes, Chief Credit Officer

Yes. The important thing, if you go back and look over the last five to seven years, we really had one credit that stung us twice, and that deal is looking better. There's a new team in there. They've got some positive developments. For the last two quarters, it's been positive and encouraging results, but we're still not 100% sure that that's totally behind us. Anything that would be left has been well reserved for. We don't have a specific reserve on the remaining loan balance, but that's the one that's out there that would cause me some level of concern for the future. For the rest of the portfolio, as I stated earlier in my comments, the portfolio is performing very well. We continue to see a healthy deal pipeline, and we just feel really good about the book overall.

Tom Travis, CEO

I would just follow up on that loan credit. It's really about that further out tail risk in spite of the green shoot. We feel they're greener and healthier than they were two quarters ago. We're encouraged, but we're still keeping an eye on non-accrual, and we're doing that as a matter of prudence relative to that unknown tail risk, which we've always said was close to 1%, and we haven't hit that 1%, but if that tail-end risk didn't materialize and things went the other way on that credit, it's a small number, but that's really it.

Nathan Race, Analyst

Understood. If I could just ask one last one on that specific credit that we were just discussing. Can you remind us kind of what the specific reserves that exist on that credit today relative to the total?

Jason Estes, Chief Credit Officer

There is no specific reserve on that credit today.

Nathan Race, Analyst

Got you. But I believe you charged off already a good chunk of it?

Jason Estes, Chief Credit Officer

Yes.

Nathan Race, Analyst

Can you remind us what that amount is relative to the total originally?

Jason Estes, Chief Credit Officer

It's approximately $7 million in total that has been charged off related to that credit.

Nathan Race, Analyst

And that credit was how large, Jason?

Jason Estes, Chief Credit Officer

$14.5 million, $15 million.

Operator, Operator

Our next question comes from Thomas Wendler with Stephens Inc. Please go ahead.

Thomas Wendler, Analyst

Hey, good morning everyone.

Jason Estes, Chief Credit Officer

Good morning.

Thomas Wendler, Analyst

Most of my questions have already been asked, but one final one for me is we saw a pretty large step-up in salary expense last quarter; can you give us some commentary there? And then maybe how you're thinking about expense growth for 2023?

Tom Travis, CEO

We did a—we'll call it a one-off. When you look at our year, at the end of the year, we were very close to a 30% increase in net income, and we evaluated that relative to, I think, our best estimate was that the industry was going somewhere around 5% to 6%. When I say industry or competitive set, we were so pleased with the banking team and the employee base. It was a function of organic loan and deposit growth, and everyone hitting on all cylinders. We made a decision towards the end of the year to expense money and pay people for sharing the fruit of that labor. We would expect to—we're already reverting, I don’t know what our number is, but we don't have disjointed increases or decreases in our salary expenses. We've managed the company. This was purely a payout based on that phenomenon.

Thomas Wendler, Analyst

Alright. I appreciate the color. That was my only question. Thanks, guys.

Operator, Operator

Our next question comes from Woody Lee with KBW. Please go ahead.

Woody Lee, Analyst

Hey good morning guys.

Jason Estes, Chief Credit Officer

Good morning.

Woody Lee, Analyst

I was just hoping if you could give some color on just, sort of the deposit pricing competition in your local markets. I mean is it—are you competing more with other institutions? Is it more the treasury market, just any dynamics there?

Tom Travis, CEO

It's really all over the board. You have to segment it when you think about it. You've got your older, more retiree-based customers that are more in that CD space. The CDs are a real small portion of our funding; I think only about $100 million or $110 million or $120 million—it’s a smaller portion. When you roll into and think about the bank and our profile, we're a commercial bank. We have a lot of high-net-worth individuals and entrepreneurs, and they tend to be in money market accounts. When you segment the liability section of the balance sheet, there are different factors. It's really hard to nail down one competitor or not. I mean, I'll tell you, Raymond James constantly runs newspaper ads in the small towns and so they're paying high rates, and the retirees look at that and they come into the bank lobbies. Fortunately for us, the data shows that our ability to maintain our cost of funds and do a good job with deposit betas is centered around the fact that a great percentage of our deposits are based on credit. When we have customers that we're very responsive to on the credit side, they don't push us as hard on the deposit side, but it's something that we fight every day on a relationship-by-relationship basis and it's just across the board.

Woody Lee, Analyst

Yes. That's great color. Then switching to the loan growth outlook, it makes sense that the growth would be coming down a little bit. Are there any segments you're seeing a pullback in growth? Any concentrations you expect to drive growth in 2023?

Jason Estes, Chief Credit Officer

I would say that you can see a clear pullback in our construction activity. Part of that is driven by cost; part of it is driven by the home-buying market. You can see that pretty clearly in the change for this last quarter; those numbers are starting to show that change. Our energy concentration is one that I mentioned that we watch very closely. There’s a little bit of growth room left there, but we're still sticking to not getting too far into the energy markets. We're doing that on a very selective basis with rapid amortization. I would say those are two areas you're seeing a pretty good shift. Our hospitality activity, if you look at the last three years, that's been a pretty high growth. That balance has changed significantly. It'll move more in line with the whole portfolio at this point, and we intend to keep that in that range it’s at as a percentage of the overall portfolio mix. Those are the few areas I would highlight.

Tom Travis, CEO

That's one of the delightful parts of the story on the loan growth. We have that slide in the deck, and it's got the broad and deep loan growth as the header. As Jason said, we are very disciplined on our concentration. When you get to where you're almost at your max in your few categories, you're always concerned about how can I grow the portfolio or how can we grow the portfolio. When you look at that slide, you can go back to 2018, and you can see that in 2018 energy was 18% of the book. As of year-end, it was 14% of the book. Then you look at hospitality and it stayed exactly where it was. It's comforting to know that the bank has the ability to continue to grow in other segments, which is a testament to the team to stay disciplined and focused. If we didn't have discipline and focus, Jason, I would argue that it would have been really easy for us to run our energy book to 20% or 22% in hospitality to 25%, and we're just not going to do it.

Jason Estes, Chief Credit Officer

Sure. Very easy.

Woody Lee, Analyst

Alright. That’s very helpful. That’s all from me. Thanks, guys.

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, CEO

Thank you again. We're really pleased. We're excited about the year. Despite the headwinds, we're really blessed to be in this part of the country. We're excited about the year. We're continuing to look at opportunities in the acquisition space. They're more limited due to the mark-to-market issues in the securities portfolio, but we're truly excited, and we've reverted back to our good-old-fashioned NIM numbers and our efficiency ratio. Even with the increase that one-off in salary, we're still below 40% on the efficiency ratio. So, delighted with these new records; they're comforting, and our team is committed to, I would say, more of the same, and we're excited about it. Thank you.

Operator, Operator

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