Earnings Call Transcript - BWB Q2 2024

Operator, Operator

Good morning, and welcome to the Bridgewater Bancshares 2024 Second Quarter Earnings Call. My name is Cole, and I will be your conference operator today. All participants have been placed in a listen-only mode. After Bridgewater's opening remarks, there will be a question-and-answer session. Please note that today's call is being recorded. At this time, I would like to introduce Justin Horstman, Vice President of Investor Relations, to begin the conference call. Please go ahead, sir.

Justin Horstman, Vice President of Investor Relations

Thank you, Cole, and good morning, everyone. Joining me on today's call are Jerry Baack, Chairman and Chief Executive Officer; Joe Chybowski, President and Chief Financial Officer; and Nick Place, Chief Lending Officer. In just a few moments, we will provide an overview of our 2024 second quarter financial results. We will be referencing a slide presentation that is available on the Investor Relations section of Bridgewater's website, investors.bridgewaterbankmn.com. Following our opening remarks, we'll open it up for questions. During today's presentation, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We caution that such statements are predictions and that actual results may differ materially. Please see the forward-looking statement disclosure in the slide presentation and our 2024 second quarter earnings release for more information about risks and uncertainties, which may affect us. The information we will provide today is as of and for the quarter ended June 30, 2024, and we undertake no duty to update the information. We may also disclose non-GAAP financial measures during this call. We believe certain non-GAAP financial measures, in addition to the related GAAP measures, provide meaningful information to investors to help them understand the company's operating performance and trends and to facilitate comparisons with the performance of our peers. We caution that these disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP. Please see our slide presentation and 2024 second quarter earnings release for reconciliations of non-GAAP disclosures to the comparable GAAP measures. I would now like to turn the call over to Bridgewater's Chairman and CEO, Jerry Baack.

Jerry Baack, Chairman and CEO

Thank you, Justin, and thank you, everyone, for joining us today. I'm pleased to share our second quarter results, which showed a stabilized net interest margin, a return to revenue growth and continued superb asset quality. After seeing the pace of margin compression steadily slow over the past few quarters, we saw it hold steady in the second quarter. When coupled with average earning asset growth, we were able to drive net interest income and overall revenue growth for the first time since the third quarter of 2022, resulting in stabilization across our profitability metrics. As we have said in the past, Bridgewater is well-positioned to benefit from future interest rate cuts and a normalizing yield curve. Reaching a point of margin and overall profitability stabilization bodes well for us, especially as we witness more encouraging macro data, including the continued slowing of inflation. After strong balance sheet growth in the first quarter, loan and deposit growth were more muted in the second quarter. Loan growth was impacted by higher levels of payoffs, while deposit growth continued to be chunky given the nature of the deposit base. As expected, on a year-to-date basis, loan and deposit growth were still in the low to mid single-digit range. The team continues to participate in good conversations with new and existing clients, keeping us abreast of market opportunities. Asset quality continued to be very strong in the second quarter with no net charge-offs and very low levels of non-performing assets. Our consistent underwriting standards, active credit oversight and experienced lending and credit teams have always been differentiators for us. And we are seeing the discipline pay off in the current environment. While commercial real estate and multifamily continue to be a focus across the industry and for us, given our high concentrations, we've been pleased with how these portfolios have performed. Nick will provide more insight into these portfolios and what we are seeing across the Twin Cities later in the presentation. In the meantime, I think it is worth reminding everyone that our teams are exceptionally talented at making commercial real estate and multifamily loans. We have a lot of experience and expertise in the Twin Cities, which is why we are so comfortable with our current loan mix. Finally, this marks the 30th consecutive quarter of tangible book value per share growth, up 9.8% annualized from the first quarter. On Slide 4, you can see our tangible book value is up nearly 200% during those 30 quarters compared to sub-70% median for banks with $3 billion to $10 billion in assets. We continue to believe this is a true differentiator for Bridgewater and how we will provide shareholder value going forward. Before I turn it over to Joe, I want to highlight a few other things we've been working on. On the client front, as part of our commitment to win, retain and grow our network, we launched a new CRM platform. This will be a game changer for us in terms of how we interact with clients, while also enhancing efficiencies across the bank. Our product team is also working diligently on a new online banking solution for our retail and small business clients, ultimately enhancing the overall user experience. More to come in future updates on this client-centric initiative. Finally, our culture has always been something we take very seriously. And so, we are thrilled to be recognized as a top workplace by the Star Tribune for the fifth year in a row. This further demonstrates how our unconventional corporate culture is appreciated by our diverse employee base and ultimately allowing us to attract and retain top talent. We happen to be unconventional with an inclusive and empowering culture. Just a few weeks ago, we hosted an all team happy hour capped off with a meat raffle. All proceeds went to support local charity. It's activities like this that bring our team together and encourage collaboration at every junction. We truly have a great team. I'll now turn it over to Joe, who in addition to being our Chief Financial Officer, has recently been elevated to the role of President. Joe is well suited for this role and we are excited about what Joe can bring in this capacity.

Joe Chybowski, President and CFO

Thank you, Jerry. I'm really excited about the new role and it's been great to collaborate with the team so far. Turning to Slide 5, you can see the net interest margin held flat at 2.24%. The stabilization during the quarter was driven by a more meaningful increase in the portfolio loan yield, which offset continued deposit pricing pressures. As we mentioned last quarter, we felt like we were reaching an inflection point on net interest income given the stronger balance sheet growth even if the margin compressed a bit further. As it turned out, balance sheet growth was a bit weaker than expected in the second quarter, but the margin was stronger, ultimately still driving that net interest income inflection up 1.5%. This was also supported by higher loan fees as we saw an uptick in loan payoffs. Slide 6 provides more visibility into the trends of the margin components. The portfolio loan yield increased 12 basis points in the second quarter to 5.50%. While we expect the loan portfolio to continue repricing higher, even in a lower rate environment, the pace of the increase may vary based on the loan yields coming on and off the balance sheet in a given quarter. During the second quarter, the weighted average yield on new loan originations was in the low 7s, while loans paying off were in the low 6s. The securities portfolio is also supporting our overall asset yields and securities yields increased another 14 basis points to 4.94%. Note that our period-end securities balances declined in the second quarter following a security sale. While asset yields have picked up, deposit costs have continued to increase, up 14 basis points in the second quarter. This continues to be due to elevated competition and overall mix shifts within the portfolio. We would expect to see additional deposit pricing pressures albeit at a slower pace until we start to see some relief on rates. As Jerry mentioned, our balance sheet remains well positioned for a rate-down environment and a more normalized yield curve. We have over $1 billion of adjustable funding tied to short-term rates and a loan portfolio that is positioned to continue repricing higher even in a lower rate environment. While the potential for rate cuts appears more likely today than it did three months ago, we would still expect net interest margin to remain relatively stable near current levels in the near term, with expansion coming after we see potential rate cuts take effect. Turning to Slide 7, we saw quarter-over-quarter revenue growth for the first time in nearly two years, driven by higher net interest income. As a result, return on assets and pre-provision return on assets both stabilized while return on tangible common equity increased by 16 basis points. Noninterest income grew during the second quarter, primarily due to a $320,000 gain on the sale of securities. However, total revenue would have grown even when excluding the securities gain. Turning to Slide 8, our ability to manage expenses while making investments in the business continues to be a real strength of the organization. Expenses so far in 2024 have tracked in line with what we expected. After a 3.5% decrease in expenses in the first quarter, which is typically our low point, we saw a 2% increase in the second quarter. The increase was primarily due to higher salary and employee benefits, technology and occupancy expenses, partially offset by lower FDIC expense. The trajectory is similar to what we saw in 2023, and we would expect that to continue with expenses increasing throughout the back half of the year. Overall, we would expect full year expense growth to remain relatively in line with asset growth in 2024. With that, I'll turn it over to Nick.

Nick Place, Chief Lending Officer

Thanks, Joe. Turning to Slide 9, total deposit balances were relatively flat in the second quarter with core deposits down $53 million. As we've always said, our core deposit growth tends not to be linear due to the nature of our client base, which includes higher-balance client relationships, longer acquisition and onboarding times, and timing of larger inflows and outflows. In addition, the second quarter tends to be seasonally lower for deposits due to tax season and industry cyclicality. It's not unusual for us to see larger inflows and outflows from quarter to quarter. For example, we generated $90 million of core deposit growth in the first quarter. On a year-to-date basis, total deposits are up 5.3% annualized, while core deposits are up 3%, both in line with the 4.1% loan growth we have generated so far this year. We also continue to see various deposit mix changes specifically as we leverage more broker deposits to supplement core deposit growth during the second quarter. On the other hand, we are pleased to see noninterest-bearing deposits grow at a nearly 4% annualized pace. These deposit mix changes have contributed to funding costs continuing to slowly move higher. However, from a broader funding perspective, we have ample repricing opportunities even if rates move lower. Overall, we feel good about our ability to drive core deposit growth and moderate deposit costs over time. Turning to Slide 10, similar to deposit balances, annualized loan growth moderated a bit in the second quarter to 1.7% after stronger growth of 6.5% in the first quarter. Elevated payoffs, which increased nearly $50 million from last quarter, contributed to the slower growth. On a year-to-date basis, loan balances were up 4.1% annualized, which is in line with our expectations. Also, our loan to deposit ratio remains just under 100%, which is in the middle of our target range. We are continuing to see good loan demand in the Twin Cities and are getting in front of strong deals. However, the continued high-interest rate environment and challenged equity market have caused some borrowers to delay projects, while other deals just haven't penciled out. We still expect full year loan growth to be in the low to mid single-digit range; however, we expect more robust payoff levels to continue into the back half of the year, which will continue to be a headwind, while other factors, including overall demand, economic conditions and core deposit growth will influence the pace of loan growth. Overall, we feel like we have the ability to turn on our loan growth engine when appropriate, but we are continuing to take a disciplined approach. That said, we've been active in adding new talent to our lending teams to support our long-term growth initiatives. You can see the increase in loan payoffs on Slide 11. While higher payoffs may limit our overall loan growth, there are potential benefits as well. For example, payoffs create liquidity that we can redeploy into higher yielding loans as the payoffs are generally rolling off below new production yields, as Joe mentioned earlier. In addition, payoffs can generate loan fees, which support net interest income, which we saw here in the second quarter. New loan originations also continue to be strong, exceeding loan advances for the second consecutive quarter. We do not see any meaningful changes to the loan mix during the quarter. Construction and development balances continued to decline, as deals completed their construction phase, while growth came primarily in our commercial and industrial, commercial real estate and multifamily portfolios. Slide 12 shows how our loan portfolio is positioned to reprice higher even if rates decline. This is primarily due to our large fixed rate portfolio, which makes up 69% of total loans, and our smaller variable rate portfolio, which makes up just 15% of loans. We have $633 million of fixed and adjustable rate loans maturing or repricing over the next 12 months with weighted average yields of 5.29% and 4.75%, respectively. We would be able to redeploy these funds into loans with meaningfully higher yields even if we see rate cuts over the coming months. The repricing impact of our larger fixed and adjustable rate portfolios should outweigh the repricing of our smaller variable rate portfolios as rates come down. Also, we have been diligent increasing loan floors on variable rate transactions, with over 70% of our floors now being above 5%. This should provide loan yield support if we see a meaningful drop in rates. We are confident that our overall portfolio yields should only continue to rise even as rates come down. Slide 13 highlights our multifamily and office portfolios. Over 90% of our multifamily loans are in the Twin Cities and we have only experienced $62,000 of net charge-offs in the portfolio since we started the bank in 2005. The Twin Cities multifamily market has historically been a stable market with less volatility than some of the coastal and high-growth markets. While vacancies increased throughout 2023, we have seen signs of vacancy rates stabilizing and even starting to tick down a bit over the past few months. Couple this with absorption levels exceeding deliveries as new construction remains slow and you have a more favorable outlook for occupancy levels and rent growth in the Twin Cities. We have been proactively testing covenants across our multifamily portfolio and have been very pleased with the results. For any issues that we have found, we have action plans in place, including principal curtailments, pledges of additional collateral or other risk mitigants. We continue to closely monitor the portfolio as the economic and interest rate environments remain challenging. However, we have been pleased with the performance to date and remain bullish on multifamily over the long term. Looking at our non-owner occupied commercial real estate office portfolio, our exposure remains quite limited at just 5% of loans. This includes only four loans located in central business districts totaling $35 million. As a reminder, in previous quarters, we placed one of these central business district office loans on watch and moved another to substandard, both due to potential lease rollover risk. We will continue to monitor these transactions closely given the headwinds facing this sector. That said, we feel good about the office portfolio as a whole given the lower average loan amount, diversified client base and primarily Midwest suburban office exposure. Turning to Slide 14, we continue to see strong performance across our entire loan portfolio as we had no net charge-offs again in the second quarter and non-performing assets were just 0.01% of assets. We remain well reserved at 1.37% of gross loans, which is well in excess of peer levels. Reserves included $600,000 of provision during the quarter, which has generally been tied to loan growth. Overall, we continue to feel good about our loan portfolio. That said, as this higher interest rate environment continues to put pressure on businesses, we still expect to see some credit normalization over time.

Joe Chybowski, President and CFO

Thanks, Nick. Slide 16 highlights our strong capital ratios, which have continued to build, including common equity tier 1, which increased from 9.21% to 9.41%. In addition, we repurchased nearly 253,000 shares during the second quarter at a weighted average price of $11.48 per share for a total of $2.9 million. We still have $15.3 million remaining under our current authorization. We will continue to evaluate future repurchases based on a variety of factors, including capital levels, growth opportunities and market conditions. Share repurchases are just one of our capital priorities. Our primary capital priority remains organic growth. Beyond that, we continue to review and monitor potential mergers and acquisitions opportunities. Turning to Slide 17, I'll recap our near-term expectations. We expect full year loan growth to remain in the low to mid single-digit range, although as Nick mentioned, anticipated higher levels of loan payoffs will likely be a headwind over the remainder of the year. We are pleased to see the margin stabilize in the second quarter. We'd expect that stability to continue in the near term until we see some interest rate cuts and a normalized yield curve. While the loan book is repricing higher, there's still pressure on deposit costs. As we have mentioned, we are well positioned to benefit as rates come down. On the expense side, we expect full year noninterest expense in 2024 to track relatively in line with asset growth, similar to prior years. This includes a similar trajectory throughout the year as we saw in 2023 with expenses starting out low in the first quarter and building in subsequent quarters. The provision expense will likely be tied to our pace of loan growth and the overall asset quality of the portfolio. I'll now turn it over to Jerry.

Jerry Baack, Chairman and CEO

Thanks, Joe. Finishing up on Slide 18, I'll provide a quick update on our 2024 strategic priorities. First, as we look to optimize our balance sheet for longer-term growth, both loan and deposit growth are tracking as expected on a year-to-date basis. Second, we continue to focus on expanding our client base through additional affordable housing efforts, as well as hosting successful networking events at our corporate office for local women business leaders and entrepreneurs. Third, we have continued to invest in the business, including the launch of our new CRM tool, which is creating efficiencies in how we engage with our clients. Finally, our credit teams are working hard to monitor our loan portfolios, especially commercial real estate and multifamily. This has been evident through our continued strong asset quality. With that, we'll open it up for questions.

Operator, Operator

And our first question today will come from Brendan Nosal with Hovde Group. Please go ahead.

Brendan Nosal, Analyst

Hey. Good morning, guys. How are you doing?

Jerry Baack, Chairman and CEO

Good, Brendan.

Brendan Nosal, Analyst

Maybe just to start off here on credit. I mean, your asset quality remains completely pristine, but we've been hearing that regulators are increasingly using tools at their disposal to increase individual capital requirements for CRE-heavy banks. So, maybe just take us through your relationship with your regulators and their understanding of your business model, especially considering how clean credit has been for you historically?

Jerry Baack, Chairman and CEO

Hey, Brendan, it's Jerry. I mean, we've had basically the same platform since we started in 2005. We continue to have conversations with our regulators. They have continued to be comfortable with what our overall enterprise risk management system is and how we monitor our concentrations. And although our concentrations have come down, that is certainly not something that they've asked us to do. So, we continue to feel comfortable. We have another exam here in August and our last exam was kind of business as usual. So, I don't expect anything different.

Brendan Nosal, Analyst

Okay. That's great color. Thank you. And then, maybe can you update us on your appetite to continue repurchasing shares just given the pricing has firmed up above tangible book value?

Joe Chybowski, President and CFO

Hey, Brendan, this is Joe. Yeah, I think it's like we always say; I mean, there's a variety of factors that we consider. Obviously, the share price being one of them, but I think in the context of everything else, whether it's future growth opportunities, the environment itself, we consider all of that. So, I think we're really pleased and happy that we're as active as we were over the last three quarters, just given the blended costs that we were able to buy back shares at and then considering where the stock is today. But again, we'll continue to evaluate that going forward, and that's kind of a fluid analysis.

Brendan Nosal, Analyst

Yeah, makes sense. All right, maybe one more for me before I step back. Really great to see the margin finally level out. Do you happen to have spot rates for both deposit costs and the margin at quarter-end just to give us a sense of how trends played out across the quarter?

Joe Chybowski, President and CFO

Yeah. So, June was 2.20%. And then, spot rates for deposits were 3.50%.

Brendan Nosal, Analyst

Okay, perfect. Thank you for taking the questions.

Operator, Operator

And our next question will come from Jeff Rulis with D.A. Davidson. Please go ahead.

Jeff Rulis, Analyst

Thanks. Good morning. Regarding the acceleration of loan yields, that's an encouraging statistic. I wanted to know if the 12 basis points versus 5 basis points is more about timing, or do you expect it to fluctuate, and might we see further acceleration?

Joe Chybowski, President and CFO

Hey, Jeff, this is Joe. I believe we experienced significant growth in the latter part of the first quarter, especially in March, which I think really boosted the loan yield for the second quarter. As we consider overall loan yield growth, it's clearly interconnected. As Nick pointed out, regarding payoffs, this aspect is certainly beneficial. It allows us to recycle debt effectively. While yields from payoffs are lower compared to the yields from new money, this process is both margin-accretive and advantageous for the overall loan yield. So, I expect growth to be a key driver. In previous quarters, when growth wasn't as strong as in the first quarter, we observed an increase of 5 to 7 basis points on a linked quarter basis. Given the robust growth in the first quarter, we are confident that it has significantly impacted the loan yield in the second quarter.

Jeff Rulis, Analyst

Got it. And then, Nick sort of mentioned Q2 more of a headwind from business cyclicality from a deposit gathering. Now kind of through that, and I know you're kind hugging that low mid single-digit balance sheet growth, but do you feel better about deposit gathering in the second half of the year? Is that typically seasonality becomes a tailwind?

Nick Place, Chief Lending Officer

Yes, this is Nick. We've noticed that our deposit balances have started to increase again, which is typical for us in the second quarter. This period usually represents a lower point for our deposits due to the tax season and the usual cyclical nature of our business clients. We're pleased with the progress we've made in acquiring new clients and the recent new hires in our treasury management team. We feel confident about the bankers we've brought on, and this should contribute positively over time, as we're already seeing some impact on our growth pipeline. The second quarter was somewhat slower for us, which is not unusual. We have historically experienced variable performance in our quarters. The first quarter showed excellent growth in both core and overall deposits, while the second quarter, as anticipated, was more subdued. We expect these patterns of inflows and outflows to persist in the long run.

Jeff Rulis, Analyst

Thanks. And last one for me. I think you touched the buyback area pretty well. I guess just might as well check-in on M&A and thoughts about as the share prices run up here and conversations on that side, interested in the recent updates.

Jerry Baack, Chairman and CEO

I can discuss M&A, Jeff. Similar to last quarter and previous years, we continue to have discussions with other local banks, and these conversations have consistently gone well. It's important for us to stay engaged with potential targets. While I hear that M&A activity is picking up nationwide, it remains somewhat slow in the Twin Cities, but we’ll see how it develops.

Operator, Operator

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

Nathan Race, Analyst

Hey, guys. Good morning. Thanks for taking my questions.

Jerry Baack, Chairman and CEO

Hi, Nate.

Nathan Race, Analyst

Just as we think about the potential increase in deposit costs in the third quarter, curious just in terms of the CDs that you have maturing in 3Q and 4Q, how that stacks up to kind of your replacement rates today?

Joe Chybowski, President and CFO

Hey, Nate, this is Joe. Yeah, I definitely think we've seen an inflection point. I'd say over the last couple of quarters, we've really been mindful to kind of shorten up the ultimate maturity of those CDs, in anticipation of potential rate cuts. So, I think really we've seen inflection where the 12-month CD at 5.25% is now pricing in the low 5s. And so, I think that while we had maybe a longer duration CD portfolio a couple of years ago, as that stuff rolls off and shortens up, it certainly provides a lot of repricing opportunities, and there's definitely an inflection from that perspective. I'd say the other thing too is just on the brokered front, we've really been able to put on longer-term CDs that have optionality in our ability to call those CDs. So, I think, while it might feel like a longer term and certainly gets disclosed that way, there's definitely a lot of optionality from our perspective that allows us to call and reissue or supplement with core growth. So, feel good about that time deposit portfolio and really hitting inflection point in terms of cost.

Nathan Race, Analyst

Okay, great. And then, I think we touched on earlier, but just in terms of the elevated payoffs in the quarter, curious if these are kind of as expected and if you have any kind of visibility into potential payoff levels over the course of 3Q and 4Q?

Nick Place, Chief Lending Officer

Hey, Nate, it's Nick. We expected the payoffs to increase slightly. Towards the end of last year, we noticed a decrease in rates that helped some transactions move toward closing for refinancing, which does take time. We saw some of these begin to materialize in the second quarter. There have been further reductions in rates recently, leading to a rebuilding of our payout pipeline. Much of this involves transactions we originated in 2021 and 2020, which were meant to pay off. A significant portion was from our construction book that transitioned into our multifamily book, so this aligns with the lifecycle we anticipated for those transactions. Even so far in the current quarter, the trend of payoffs has continued, and we've already seen almost two-thirds of the payoffs we recorded in all of Q2 up to July. We are actively working to recover from this situation, and we expect it to remain a challenge for us. However, we are optimistic about the opportunities this creates. It allows us to reinvest that cash into new transactions, which is crucial for driving new loan yields and fees. Additionally, some of the older transactions from 2020 and 2021, which have faced difficulties due to the changing rate environment, are finding appropriate exits, like agency takeout. This ultimately helps improve our credit risk metrics as well. While we are not overly concerned, it does pose a challenge for loan growth as it counterbalances some of our new origination efforts.

Nathan Race, Analyst

Got it. Very helpful, Nick. Thank you. And then maybe just one last housekeeping question. The securities yields on the taxable portfolio increased nicely over the last quarter. Any repositioning there of note or any other items to keep in mind there?

Joe Chybowski, President and CFO

Yeah, Nate, this is Joe. No, nothing out of the ordinary, more of the same just from a composition standpoint. We're definitely active in portfolio management from our perspective. We did sell some securities this last quarter, which were more of a floating rate nature in kind of reorienting in conjunction with the rest of the balance sheet. So, nothing out of the ordinary there, just really ordinary course and similar composition as we've had over the last couple of quarters.

Nathan Race, Analyst

Okay, great. I appreciate all the color.

Operator, Operator

And this will conclude our question-and-answer session. I would like to turn the conference back over to Jerry Baack for any closing remarks.

Jerry Baack, Chairman and CEO

Thanks for joining the call today. We continue to be encouraged by our margin stabilization, overall revenue growth, our superb asset quality, and continued growth in tangible book value. And I guess, I'd just close by, I want to thank our team members. We have a phenomenal team here. We brought on some more real key hires in this last quarter on the treasury and banking side. So, we're excited for that. Hope you have a great day.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.