Equity Bancshares Inc Q3 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the Equity Bancshares Q3 twenty twenty one Earnings Call. At this time, all participants are in a listen-only mode. Later, we’ll have a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to hand the conference over to your host, Mr. Chris Navratil with Equity Bancshares. Mr. Navratil, you may now begin.

Good morning, and thank you for joining the Equity Bancshares conference call, which will include discussion and presentation of our third quarter twenty twenty one results. Presentation slides to accompany our call are available via PDF for download at investor.equitybank.com by clicking the Presentation tab. You may also click the Event icon for today’s call posted at investor.equitybank.com to view the webcast player. If you are viewing this call on our webcast player, please note that slides will not automatically advance. Please reference slide one, including important information regarding forward-looking statements. From time to time we make forward-looking statements within today’s call, and actual results may vary. Following the presentation, we will allow time for questions and further discussions. Thank you all for joining us. With that, I’d like to turn it over to our Chairman and CEO, Brad Elliott.

Thank you, Chris, and good morning. Thank you for joining our call and your interest in Equity Bancshares. Joining me is Eric Newell, our CFO; Greg Kossover, our Chief Operating Officer; and our President, Craig Anderson. We've had a busy quarter working on many different objectives and staying focused on attracting new customers and retaining our current customers. This effort has translated into our financial performance. We closed the American State Bank & Trust merger on October first as we anticipated. Not only that, we also successfully completed our data conversion on the same weekend. I view our ability to announce a merger and close it while converting as a core competency of Equity Bank. We cannot do it without the dedication of countless members of our team. While most of our shared service teams worked throughout the weekend to ensure our customers experienced limited interruptions, I wanted to especially recognize the efforts of Jesse Nienke and Jim Brunsell, who both led our technology and system teams throughout the entire summer and the closing weekend with dedication and commitment to excellence. They have been involved in most of the M&A transactions we have completed to date, and their efforts, along with the leadership from Julie Huber, Jeremy Allen, Mary Potter, and over twenty other leaders who met constantly throughout the planning process, ensured this transaction went smoothly. With the data conversion behind us, we can quickly start to realize the savings we modeled, and expect most of it to be achieved in this quarter. We continue to experience non-PPP loan growth in the quarter, growing seven point three percent on an annualized basis, thanks in part to the leadership of Mark Parman’s Metro Market Group and Brad Daniel and his Ozark Mountain region teams. I anticipate the new ASP and T markets will present us opportunities for organic loan growth in addition to our legacy markets growth. Eric, please take everyone through the numbers for the quarter.

Thank you, Brad, and good morning. Last night we reported net income of eleven point eight million dollars or zero point eight zero dollars per diluted share. We calculate core earnings at zero point nine six dollars per diluted share, beating street consensus. Core results this quarter were driven by the recognition of origination fee income from PPP loan forgiveness and improvement in fee-based drivers across many of our categories. Non-merger related expenses slightly increased linked quarter, impacted by lower deferred expenses in the period. There are several items to call out that will help reconcile our GAAP number to core earnings. First, we had ten million dollars of previously non-accrual loans from our Almena State Bank transaction with the FDIC that moved to accrual during the quarter, resulting in one point three five million dollars of interest income recognition. We recognized a four hundred and eighty-six thousand dollar debt benefit, reduced other income due to adding seven hundred and seventy thousand dollars to repurchase obligations related to Almena loans, recognized a three hundred and eighty-one thousand dollar gain on securities transactions and an associated three hundred and seventy thousand dollar loss on extinguishment of debt. Finally, merger expenses of four million dollars associated with the October first closing of the American State Bank & Trust merger. Our GAAP net income includes a provision for the allowance for credit losses totaling one million dollars. There are many factors influencing the provision this quarter. First, another successful quarter of mitigating losses led to a reduction in historical loss ratios within our calculation. Next, as we continue to move away from the peak of the pandemic without noted loss experience, the economic and qualitative components of the calculation have improved. That said, with the delta variant, supply chain concerns, and the yet unknown long-term impact of stimulus efforts, management has maintained a reserve of approximately one hundred and twenty basis points on the general reserve for loans. Finally, specific reserves increased four point eight million dollars in the quarter, which Greg will discuss more in a moment. The September thirty coverage of ACL to non-PPP loans is two point zero four percent, unchanged from the previous quarter. Net interest income totaled thirty-nine million dollars in the third quarter, increasing from thirty-four point six million dollars in the late quarter, representing a four point three million dollar increase. During the third quarter, the weighted coupon in the portfolio, excluding PPP, increased approximately thirteen basis points. Origination fees recognized from forgiven PPP loans increased notably again in the third quarter. We recognized seven point seven million dollars of fee income and four hundred and fifty-six thousand dollars of interest income related to PPP loans in the third quarter. Comparing to the second quarter, total PPP fee income and interest income totaled five point eight million dollars and nine hundred and eighty-four thousand dollars, respectively. At September thirty, we had three million dollars of net unrecognized fee income associated with PPP loans, which totaled ninety-five point seven million dollars. Removing PPP fees and interest income from net interest income in both the third and second quarters results in a pro forma net interest income of thirty point eight million dollars and twenty-seven point nine million dollars, respectively. Loan yield, earning asset yield, and net interest margin in the quarter ending September thirty are four point three three percent, three point five five percent, and three point one nine percent, respectively. This compares to the quarter ending June thirty of four point four one percent, three point five five percent, and three point one three percent, respectively. I would note that one point three five million dollars of interest income recognized from the previously non-accrual loans during the quarter positively impacted NIM. If you exclude it, NIM during the third quarter was three point zero five percent, which was within the range of our outlook. Craig?

Thanks, Eric. Organic loan growth totaled forty-six point five million dollars, representing an annualized seven percent growth during the quarter. PPP loans declined one hundred and seventy-six million dollars through the forgiveness our customers are experiencing from the SBA. Year-to-date, we've recognized sixteen point six million dollars of fee income from this forgiveness activity and have had five hundred forty-six million dollars forgiven. At the end of the quarter, we had only three hundred twenty loans remaining to submit to the SBA, and all of our twenty twenty PPP loans have been submitted and forgiven. Organic originated loans totaled two hundred and seventeen point six million dollars in the third quarter, down slightly from the two sixty-one million dollars originated in the second quarter. Of the total originations in the third quarter, eighty percent were in commercial, CRE, and agricultural loans. Our pipeline remains strong and is consistent with what we have been reporting over the last several quarters. With the addition of ASP and T and their seasoned bankers, I expect that we will continue to show a growing pipeline. Our sales teams continue to successfully grow our fee-based businesses. Our service charges are benefiting from the product realignment put in place in the first quarter of this year, better allowing us to charge fees for services offered to customers and account types. We also continue to experience increases in fee income for merchant services, commercial credit cards, and treasury management products offered to our commercial customers.

Before I turn it over to Greg, I want to highlight the continued pressure excess liquidity is placing on our NIM. Securities and cash totaled thirty-one percent of average earning assets in the third quarter, up from twenty-eight percent in the second quarter. While there continue to be a loss in deposits, we are seeing customers use some of our excess liquidity. Looking at our most popular consumer account, which makes up sixty percent of the total number of transaction accounts, the average balance continues to be one thousand two hundred forty dollars higher than pre-COVID levels. The peak average balance occurred around March thirty-one of this year. When compared to that peak, average balances have declined six hundred seventy-eight dollars. We don't expect average balances to decrease to pre-COVID levels anytime soon, but for context one hundred twenty-five percent of pre-COVID levels, we anticipate another forty-five million dollars decline in overall balances in this account type. Positively, we’ve grown our number of checking accounts in this type by over seventeen percent through the pandemic, which is a testament to our operational approach during this time by always being open for our customers' financial needs. Greg, why don't you take everyone through your thoughts on credit?

Thanks, Eric. During the third quarter, we continued our work to successfully position our customers and the bank for successful outcomes. First, we had some movement of Almena assets out of non-accrual during the quarter, which Eric briefly mentioned. Last year, we took a conservative approach on certain Almena loans due to the pandemic. As we close in on the first year of watching the performance of these loans and gathering information that was not readily available to us when we completed the transaction, we've been able to develop cash flow expectations and assess performance against those expectations. The result was moving thirty-seven loans totaling nine point seven million dollars back to accrual. In addition, our hotel portfolio has continued to show improved operating performance, as has our Ag credits. Neither of these portfolios has emerged with the weakness the industry feared one year ago. Loans with deferred payments in twenty twenty have performed well in twenty twenty-one as the environments we operate in have stabilized and returned to a degree of normalcy. Net charge-offs were just one hundred and twenty-nine thousand during the quarter, and paydowns on legacy non-accruals were approximately four million dollars during the quarter. OREO continues to trend flat to down without any significant net losses as asset values remain stable. We were notified in the last week of the quarter that a shared national credit going through the review process was moved to sub-standard. The tenants of this credit remain positive, including a positive EBITDA, no missed payments, adequate collateral coverage, as well as being in a recovering industry. We have discussed in recent quarters an aircraft parts manufacturer we have been banking for over ten years and a credit we have with them in twenty seventeen, and we have carried it in our special mention category for several quarters. This borrower has struggled to keep its customer base intact following 737-Max issues and continued on through COVID, and we are in discussions with all parties to determine the best course of action. In early October, the borrower missed its payment for the first time, and as such, we have moved the relationship to sub-standard non-accrual status and have placed a credit mark on it. The collateral, which consists of highly desirable machines designed for the aircraft industry, remains in high demand and we are in discussions with several interested potential buyers. We look to resolve this credit in the next two quarters. We are also closely monitoring and in discussions with leadership who have a credit in the magazine and health monitoring subscription businesses. The ownership and management team continues to be very cooperative and pay down principal through normal course debt reductions and with the sale of other assets. We are discussing with their management team a plan to continue retiring principal as they adjust the operations of their business. That credit remains on non-accrual status, has a credit mark on it, and we will continue to work towards a resolution in the next few quarters. Eric?

Thanks, Craig. Before turning the call over to Brad, I wanted to turn your attention to the forecast slide on the earnings deck. Here you can see our thoughts on the forecast for the fourth quarter and preliminary twenty twenty-two. We are in the middle of our budgeting process for next year as well as integrating the American State Bank & Trust balance sheet into that process. Our long-term goals remain unchanged: improving our revenue mix, increasing fee contribution to that mix, driving positive operational leverage off of our expense base, and building our loans to deposit ratio to levels we saw pre-COVID. This last goal is dependent in part on economic factors in the markets we serve. Supply chain issues, the labor market, and inflation each add a level of uncertainty to our customers and in turn to loan demand. Successfully shifting excess liquidity to the loan portfolio from cash and investments is critical to improving our pre-tax pre-provision return on assets. Barring any new stimulus programs, we do not expect PPP income to influence our twenty twenty results. Brad?

Thanks, Eric. We continue to anticipate a December close with Security Bank on their sale of branches in St. Joe, Missouri. Our teams are working diligently on another successful integration into Equity Bank's products and services. We expect the branches to add seventy-eight million dollars of deposits in a market that we believe we can grow under Josh Means and Greg Duran’s leadership. Last week, Equity Bancshares paid its first common stock dividend to shareholders. As I've said previously, the dividend will broaden our institutional and retail investor base and be a tool for capital management when the stock repurchase program does not meet our earn-back needs. The Equity Bank team continues to work every day to help our customers achieve their goals and dreams by helping them access our products and services. Our shared service teams continue to find ways to make it easier for our customers to engage with Equity Bank. Being a trusted and valued partner to our customers is our value proposition. In turn, we’ve built shareholder value. And with that, we are happy to take your questions.

Our first question comes from Jeff Rulis with D.A. Davidson. Your line is now open.

Thanks, good morning.

Good morning, Jeff.

I wanted to clarify on slide twenty-six, those fourth quarter and full year twenty-two projections, do they include both American State and the Missouri Bank acquisition? Is that correct in the fourth quarter numbers?

Yes to American State, no to Security. Correct.

Okay. Well, I guess the only real impact would be the deposits and maybe some moderate expenses. Is that how you'd adjust if you were to roll that in?

Correct. It would have a very de minimis impact to Q4.

Got it. Okay. So, I guess, based on those assumptions, looking at the sort of the fee income growth, I mean strong in the third quarter and your expectations for ten percent to twenty percent growth in twenty-two. I guess that leads it to kind of a high thirty million dollars for the full year on fee income. The biggest source of that growth, is that going to be sort of balanced on the service charges and debit card, or are there some other areas? I think you've talked about the product realignment on service charges, but just wanted to get into the need of that growth for those expectations?

Yes. To me, I think service charges will be one factor, given that we're going to have a higher level of DDA accounts we bring in from the American State balance sheet. So that will give us some opportunity to earn service fees off of those accounts, inclusive of overdraft charges, so there is an expectation that we will probably have a more normalized year on overdraft compared to this year. So that's a factor of growth. We also anticipate higher interchange from debit cards, and we are actively marketing campaigns behind that. Furthermore, initiatives we've previously talked about, focusing on trust and wealth management, our treasury management products where our commercial customers, including commercial credit cards and purchasing cards, have been trending positively throughout this year and will continue into next year.

Thanks, Eric. Maybe a question for Brad. You mentioned the impact of dividends, and I assume that serves as a more flexible capital tool. I'm curious about the buyback and your interest in it, especially following the initiation of the dividend and the American State transaction. I'm just trying to understand your stance on the buyback and the status of that authorization. Thanks.

Yes. So, as you know, we put out a K on the reauthorization of nine hundred thousand shares.

One million.

One million shares last quarter in September, as the Board authorized an additional million shares. I would tell you, Jeff, we are as active as we've always been, as long as it meets our criteria for the buyback. We'll continue to buy back shares as actively as we can, and the dividend will have no effect on that.

Got it. And Brad, I guess it's related. Just the last thing is on the additional deal appetite. You've closed this transaction and you've got the branch deal upcoming, but our conversations and thoughts on twenty-two regarding getting an additional deal done.

Yes. We have several active conversations ongoing today with companies of size, not necessarily mergers of equal size but similar to what we have just completed with American State. I believe we have a really good possibility of getting something across the finish line in twenty twenty-two for sure. So, we’re still very active in the deal space and we have lots of partners that are talking with us about the opportunity to partner. I think there are good franchises that fit well with what we do, and we fit well with what they do. Thus, I believe we have good opportunities to continue to move forward with those opportunities.

Got it. Thank you.

Thank you. Our next question comes from the line of Terry McEvoy with Stephens. Your line is now open.

Hey guys, good morning.

Good morning, Terry.

Maybe a quick question for Eric. When you look at your margin guidance for the fourth quarter or really into twenty twenty-two, what type of assumptions are you making in terms of the reallocation from cash and securities into loans? And maybe more importantly, are you assuming any higher short-term interest rates or a steeper yield curve to help the margin maintain that level?

Sure. The second part of that question I'll answer first. We do not model any change in the shape of the yield curve for the level of interest rates. The way our balance sheet is positioned at the moment, a higher level of interest rates would be moderately beneficial to us. We really try to avoid making any significant bets with the balance sheet in terms of interest rate positions. However, the shape of the curve's steepness would absolutely help us, but that is not modeled in. On the first part of that question, Terry, our cash and securities as a percentage of earning assets is currently over thirty percent, which is almost double where we'd like to be. I would say that there is room for a small transition out of the investment portfolio into loans, but we did not want to make too much of a bet there. So I believe that's an area of opportunity for us regarding margin in twenty twenty-two if we could get more of that portfolio into loans and just reposition that mix. But it's not a material factor in what we consider for twenty twenty-two.

Thanks for that, Eric. And then I guess any comments on the inflow of special mention credits last quarter. I ask because a couple of the loans Greg talked about earlier came out of that category.

The only special mention credit that came on, Terry, of any size in Q3 was a shared national credit that the governing bodies classified as special mention.

Was it special or sub-standard?

We had one in special mention and one in substandard.

Thanks for that. And then maybe just the last question. You mentioned the pipeline on the lending side was strong, over the next couple of quarters where do you see the best growth opportunities in terms of markets or specific areas across the bank? Thanks.

Terry, I'll take that one. This is Craig. We continue to see very strong pipeline activity and sales deals in our metro markets of Tulsa, which are all in Kansas City. Those economies are all doing really well, and we're starting to see some deals that we have not seen over the last couple of years. We built a new regional headquarters in Kansas City, which has really elevated our presence there and increased deal opportunities in that space. I would say that in our community markets, Western Missouri kind of leads our growth there, but we're also seeing very nice opportunities in our Arkansas market due to some transitions in leadership.

Thanks, Craig. Thanks everyone.

Hey Terry, before we finish your questions, I want to point out that the movement of the Almena assets, they were sub-standard; they moved to special mention, which might be central to your question. The shared national credit is actually pretty small. But we’ll park the Almena assets in special mention until we gain more experience about improving them further.

So we were actually moving up, not down, Terry.

Perfect. Thanks again.

Our next question comes from Andrew Liesch with Piper Sandler. Your line is now open.

Hey, good morning, everyone. How are you?

Good morning, Andrew.

Hi. I want to focus on the margin here. I would expect a bit more optimism for next year. Does this forecast include any potential benefits that might occur?

No.

Okay.

But keep in mind, that will flow through; a lot of that will flow through ACL.

All right, so I’m curious if there’s room on the funding side to get the margin back above this level. I was a little surprised to see it at this level. What would it take for you to go up further?

Yeah. So on the funding side, I do think there is some opportunity there. We're looking at quarter-to-date nine thirty cost of savings, and now you see sixteen basis points. We do have a fairly sizable public funds portfolio in that number, and that cost is higher, I think at this point, so we've been taking actions where we can, because a lot of that is driven by contractual periods. So every single time we see it come into our pricing committee, we take the opportunity to reprice that down. I think that will continue. We do take actions to reduce the cost of funds on our money market accounts as well, and we've done that throughout the year; there's probably a little bit more room there. I do think that there are some opportunities on the funding side, Andrew. On the asset side, much of it comes down to the mix; thirty percent of earning assets sit in cash and in the investment portfolio. So, we don't need to grow that denominator at all, but if we can move some of those funds out of those two categories into loans, that is a significant improvement to our NIM.

Got it. I'm sorry if I missed it earlier. What was added to the new loan coupons in the third quarter?

So, if you take our loan yield without PPP, which is four point three three percent. So I'm just taking out the effects of PPP. We're about twenty-five to thirty basis points below that.

Got it. Okay.

So just for context, the biggest categories that we originate, kind of our core categories C&I and CRE had a four handle in terms of originations in the quarter and also year-to-date. And then Ag, we're probably again at a high four handle year-to-date on originations there. Close to five. So, in terms of the origination trend on yield, we're actually a bit better now than we were earlier this year. So I think to answer your question, it really comes down to the mix of earning assets.

Got you. Makes sense. Great. Thanks, guys. I will step back.

Thank you. Our next question comes from the line of Damon Delmonte from KBW. Your line is now open.

Hey, good morning, guys. Hope everybody is doing well today? A lot of my questions have been asked and answered, but just wanted to follow up on the credit side of things with your outlook for the provision. I think, Eric, you noted you had one hundred and twenty basis points of kind of COVID-related reserve that's still embedded in there. This quarter you did take a one million dollar provision kind of tied to the credit that moves into non-performing. How do we think about the provision in the fourth quarter? And as we look into twenty twenty-two, do you think it's a near-term event to release some of that COVID-related allocation? Or do you think you need to keep providing for this loan growth you're having? Any color would be great.

Yes. Damon. I think it doesn't feel right to me just yet to release our COVID provision or ACL, just given some factors. One of the things I really look at or the management team is focused on, not just me, is the stimulus that is in the economy and it’s positively impacting our customers, and that's great. But I think we want to see how our customers perform without that stimulus in the economy. So, that’s one thing that we're very focused on. So it just doesn't feel right to release. However, regarding providing for loan growth, I don't think you're going to see a meaningful provision in the fourth quarter. Going into twenty twenty-one, I had indicated we were budgeting about twenty basis points of provision on average loans. Looking at what we know today for twenty twenty-two, I don't think that is the right number; it's going to be lower than that. And that's one of the reasons why we, actually, I don't know if we provide specifics. We don't provide specifics on our key business drivers, but our provision for twenty twenty-two, is definitely not twenty basis points.

Okay. Got it. That's helpful. That's good color. Yes, that's all that I had. As I said, a lot of other good questions. So thanks a lot. Appreciate it.

Ladies and gentlemen, I'm showing no further questions. Thank you for joining our Equity Bancshares conference call, and have a great day.