Equity Bancshares Inc Q2 FY2024 Earnings Call

Hello, everyone, and welcome to the Equity Bancshares' Second Quarter 2024 Earnings Call. My name is Ezra, and I'll be coordinating your call today. I will now hand over to your host, Brian Katzfey, Director of Corporate Development and Investor Relations to begin. Brian, please go ahead.

Good morning. Thank you for joining us today for Equity Bancshares' second quarter earnings call. Before we begin, let me remind you that today's call is being recorded and is available via webcast at investor.equitybank.com along with our earnings release and presentation materials. Today's presentation contains forward-looking statements which are subject to certain risks, uncertainties, and other factors that could cause actual results to differ materially from those discussed. Following the presentation, we will allow time for questions and further discussion. Thank you all for joining us. With that, I'd like to turn the call over to our Chairman and CEO, Brad Elliott.

Good morning, and thank you for joining Equity Bancshares' earnings call. We're pleased to take you through our second quarter results, including setting new record high watermarks, integrating the Bank of Kirksville merger, and announcing our acquisition of KansasLand Bancshares. Joining me today are Rick Sems, our Bank CEO, Chris Navratil, our CFO, and Krzysztof Slupkowski, our Chief Credit Officer. It was another exciting quarter of improving operating performance for our company. Excluding the impact of BOLI, repositioning costs, and merger expenses, we outperformed market expectations. With the momentum of rebalancing our portfolio last year and the Bank of Kirksville transaction in the first quarter, we realized expansion in both net interest income and net interest margin. We closed the quarter with a loan deposit ratio below 80%. Strong capital ratios and significant liquidity continue to drive earnings growth in 2024, both organically and through strategic M&A. During the quarter, we completed the integration of systems from the legacy Bank of Kirksville locations and announced and received regulatory approval for our acquisition of KansasLand Bancshares. The KansasLand transaction officially closed on July 1, 2024, 71 days after the announcement. We continue to emphasize shareholder return through our quarterly dividend, as well as active participation in our share repurchase program. During the quarter, we repurchased 152,982 shares under our current authorization of up to 1 million shares. At the close of the quarter, we have the capacity to purchase an additional 637,427 shares under the authorization. During the quarter, we announced the promotions of Rick Sems to Bank CEO and Julie Huber to COO. These promotions strengthen the management team while reinforcing our operating structure. We're confident they will continue to excel in the expanded roles. As we emphasized at our Investor Meeting in June, we are bullish about where our company is positioned. We have an excellent leadership team, motivated producers, and an abundance of deployable capital to drive positive stakeholder returns. I look forward to continuing our positive momentum. I'll let Chris talk you through our financial results.

Thank you, Brad. Last night, we reported net income of $11.7 million or $0.76 per diluted share. Adjusting for merger expenses incurred related to the Bank of Kirksville and KansasLand transactions and the cost of surrendering a portion of our BOLI portfolio, net income was $15.2 million or $0.99 per diluted share. During the quarter, our realized effective tax rate was 28.1%, driven up by one-time BOLI surrender charges of $1.8 million. As Brad alluded to, we repositioned approximately $60 million in BOLI into higher-yielding contracts during the quarter. Realized losses are modeled to be recovered within two years due to non-interest income and tax lines. Without the repositioning, the tax rate for the quarter would have been 17.5%. Net interest income was up $2.3 million linked quarter, while net interest margin improved from 3.76 to 3.94. We will discuss margin dynamics in more detail later in this call. Non-interest income was in line with our outlook for the quarter and included a 6.3% linked quarter increase in service charge line items. Non-interest expenses, adjusted for one-time M&A charges totaling $37.0 million, were up linked quarter primarily attributable to Bank of Kirksville additions, including CDI amortization, technology and facility expenses. The purchase accounting for Bank of Kirksville was finalized during the quarter, resulting in an insignificant increase to the previously recognized gain on acquisition. As Brad noted, we announced our acquisition of KansasLand during the quarter and subsequently closed it on July 1. KansasLand has $50 million in assets operating out of two branches. We modeled $0.03 accretion for 2024 at announcement, which remains the expectation. Our GAAP net income included a provision for credit loss of $265,000. We continue to hold reserves for potential economic challenges. However, to date, we have not seen specific concerns in our operating markets. The June 30 coverage of ACL to loans is 1.26%. I'll stop here for a moment and let Krzysztof talk through our asset quality for the quarter.

Thanks, Chris. Asset quality metrics continue to trend at historically low levels with total classified loans closing the quarter at $49.6 million, or 8.8% of total bank regulatory capital. Non-accrual loans as a percentage of total loans remained below 75 basis points. Net charge-offs, annualized, were 14 basis points for the quarter. Recognized charge-offs have reflected specific circumstances related to individual credits rather than broader market concerns. The acquisition of KansasLand Bank, mentioned earlier, will have a negligible impact on the bank's problem asset position. We continue to utilize our portfolio monitoring tools to detect early signs of credit deterioration. At this point, we have not seen any systemic deterioration in any of our portfolios. Our continued stress testing confirms the resiliency of our CRE book. Our exposure to office space is very low and continues to perform well. Despite these positive indicators, we remain cautious in our underwriting and continue to monitor for any emerging risks while maintaining healthy levels of capital and reserves to face any future economic headwinds. Chris?

Thanks, Krzysztof. Average loans increased modestly during the quarter. Loan originations in the second quarter totaled $99 million with a weighted average coupon of 8.76%, compared to $116 million with a weighted average coupon of 8.61% in the first quarter. During the quarter, the coupon yield on loans increased to 6.96% from 6.84%. Overall loan yields improved by 30 basis points to 7.15%, driven by accretion from Kirksville, expiration of a pay-fixed interest rate swap, and higher coupon origination. During the quarter, our bond portfolio yield improved to 3.99% from 3.89%, reflecting the impact of repricing Kirksville's bond portfolio at the acquisition date. Cost of interest-bearing deposits were materially flat at 2.78%, while the contribution of average non-interest-bearing deposits to the average deposit mix increased to 22.7% from 21.7%. Net interest income totaled $46.4 million during the quarter, up $2.3 million from the prior quarter, as our earning streams benefited from previous periods' strategic decisions and continue to outpace rising funding costs. We continue to carry excess cash balances which are offset by wholesale borrowings. We are currently earning a positive spread on these positions, though it does have the effect of reducing margin. We calculate that the excess liquidity has the effect of reducing margin by 9 basis points for the current quarter. Non-interest expenses during the quarter were $37 million, excluding $2.3 million in realized merger charges. The integration of core banking systems following the Bank of Kirksville transaction took place in May. Kirksville operating costs, including CDI amortization, were the primary driver of expense expansion. Our outlook slide includes a forecast for the third quarter as well as full-year 2024. We do not include future rate changes, though our forecast still includes the effects of lagging repricing in both our loan and deposit portfolios. Our provision is forecasted to be approximately 12 basis points to average loans. Rick?

Equity has grown during the first six months of 2024, and we are positioned to continue to do so. During the quarter, our team was able to successfully integrate the Bank of Kirksville merger while also assessing, negotiating, and announcing our acquisition of KansasLand. Credit goes to Julie Huber and her operations teams for getting it done. Outside of M&A, our production teams remain focused on driving organic growth on both sides of the balance sheet. Following the company's annual meeting in late April, we rolled out a producer incentive program that is designed to award our team with ownership for hitting higher growth goals. The program kicked off in the quarter, and we anticipate it will yield benefits over the remainder of the year. We have also rolled out a comprehensive training program to help improve our commercial banking capabilities. In Q2, all of our commercial bankers successfully completed round one of their training. In addition, the team identified 1,200 prospect companies, which they called upon in Q2. We expect this expanded calling effort to lead to pipeline expansion in Q3 and Q4. During the quarter, we were able to grow average loan balances by 2.3%. We expect pipelines to continue to grow and our sales teams are motivated to meet the needs of our customers and communities, which will drive organic growth. During the quarter, customer deposit balances were generally flat, with immaterial levels of expected runoff from the Bank of Kirksville customer base. Our team continues to focus on net interest margin and managing a challenging yield curve. This focus has resulted in us passing on loan opportunities at lower yields as well as higher-cost transactional deposits. As discussed in our investor materials from June, we believe there is meaningful opportunity to both maintain and grow our deposit base in our current markets. Total deposits closed the quarter at $4.34 billion. Loans as a percentage of deposits closed at 79.6%, positioning our bank to be a capable lender for new and current customers in our footprint. As indicated in our outlook slide, we expect to drive mid-single digit organic loan growth in 2024. We have the strategy, discipline, tools, and people in place to realize this expectation. I look forward to assisting the team in execution. Service revenues improved quarter-over-quarter, including increasing contributions from cards, treasury and Wealth Management, service charges and mortgage. Under the leadership of Andrew Musgrave, Trust & Wealth Management saw its best revenue quarter in over three years as the team has been able to drive both AUM and pipeline growth. Our company is well capitalized. Our asset quality metrics continue to run at historic lows. Our balance sheet structure is solid. Our team is experienced, and we have a granular deposit base. We look forward to continuing to redeploy assets into customer relationships that build franchise value. We see a lot of momentum on the M&A front and expect that to continue. Equity will remain disciplined in our approach in assessing these opportunities, emphasizing value while controlling dilution and the earn-back timeline. Thank you for joining the call, and we're happy to take your questions at this time.

Thank you very much. Our first question is from Jeff Rulis from D.A. Davidson & Co. Jeff, your line is now open, please go ahead.

Thanks. Good morning. The question on the margin front just looks flat to down for the second half, and I wanted to confirm, I think there was a mention of the lagging effect of repricing deposits. Is that the genesis for the kind of conservativeness on margin? I just wanted to double-check that.

Yes. I think it's two things, Jeff. One of them is always that continuing potential pressure on deposits that we're recognizing in that number. But it's also the purchase accounting adjustments as it relates to Bank of Kirksville. That particular transaction, we realized the level of purchase accounting accretion about 10 basis points alone, a 7 basis point contribution to margin during the quarter. If that normalizes down to 5 or 6, if not, drops down margin a little bit. So, it's a little bit of both those things. We believe there is a little bit of conservatism in that number.

Okay. And just wanted to make sure you do not have rate cut expectations in that margin guide, and if not, what would that net effect be from your perspective?

That's correct. We don't have any in the model itself or in that outlook. As our balance sheet sits today, we're in a modestly asset-sensitive position. So, for small rate cuts, we expect a small adjustment down in terms of margin. But at the same time, we think we have ample opportunity on the liability side to be moving rates down to maintain or nearly maintain where we are from a margin perspective. So, we think there are small movements as we go forward. We won't see meaningful degradation in margin. If we start to see larger cuts, that's where there could be some challenge. But we're not forecasting or looking at that at the moment.

Okay. And then, hopping over to the loan growth outlook, I think you covered it well, and the outlook looks fairly muted for the second half, despite some of that positivity in those incentive plans. But I think you mentioned some cautiousness on underwriting and loan yield discipline. Poking through those second half, I think you talked about pipelines building, but yet a flattish outlook. Any more color on the loan growth front in the second half? And maybe trying to get the timing of when you see that kick in.

Yes. I'll just say one thing, Jeff, in terms of the outlook, the average balance depiction is part of what's driving that. So, the slower first half, we do think there's some meaningful opportunity going into the second half and expect year-over-year loan growth of mid-single digits, 5% to 8%. So, that's a little bit of that dynamic, but I'll let Rick further address expectations.

Yes. I mean, our expectations are we are going to see some growth here in the second half. We've gotten to a point where we think what we're seeing is some borrowers are just a little slow to break loose and commit to doing a deal. But we expect that to kick in during the second half. So, we see loan growth into the middle-late in this quarter, but probably into the fourth quarter, and then really trying to drive it into 2025 with what we're focused on with the incentives and the calling effort that's going on right now.

Okay. And just the last one on the loan balances from KansasLand, that is in the guidance and maybe confirming also, just what were the 6/30 loan and deposit balances at KansasLand?

Yes, approximately $35 million on the loan side and around $40 million on the deposit side.

Thank you. We've got another question from Andrew Liesch from Piper Sandler. Andrew, your line is now open. Please go ahead.

Hi, thanks. Good morning, guys. Just a question on the swap that expired; just curious what basis point benefit to the margin did that generate?

Yes. Thanks, Andrew. The benefit for the quarter on that derivative transaction was 8 basis points, and potentially slightly greater as you look forward. So, 9 basis points on a go-forward basis. That expired in the middle of April.

Got it. All right, that's helpful. And then, the excess liquidity that you mentioned, 9 basis points last quarter, does the guide include that excess liquidity on the balance sheet?

Yes. The guide includes, it includes the cash and it includes the margin impact.

Got it. All right. Okay, that's helpful. And then, Brad, just on the M&A front, just curious if you could provide some more commentary on what's gone on maybe over the last six weeks or so? How have your conversations been tracking with prospective targets?

Yes, we've had several new conversations kicking up, Andrew. And so, there's lots of conversations going on. As you know, that doesn't mean that anything concrete is going to happen. But we take a lot of time, have a lot of conversations, model a lot of deals, and then see if we're the partner they want to pick. I'm encouraged by the standpoint that I think there are a lot of opportunities that we're able to talk with right now. I think people have realistic expectations. I think conversations are going well. So, stock price moving up probably helped some of those transactions. Some of those transactions are all cash, so that doesn't influence them at all, but I think there's a lot of positive momentum in the second half of the year for conversations.

Great. All right. You've covered my other questions. I'll step back.

Thank you very much. We've got another question from Terry McEvoy from Stephens. Terry, your line is now open. Please go ahead.

Great, thanks. Good morning, everyone. Chris, maybe a couple of questions for you. When we were together last month, you raised the outlook for the net interest margin, and I think you commented that there was some accretion behind the increase. Could you just maybe quantify the accretion last quarter? And how are you thinking about the second half of this year from an accretion perspective?

Yes. So, through the second quarter, Terry, the accretion recognized through margin was 7 basis points. As I look forward, I think it will range between, I expect for this year, 5 and 8. So, the higher end is the more meaningful accretion from BOK plus some additional KansasLand. The lower end would just be slower accretion on the BOK side as well as KansasLand. So, it’s maybe between 5 and 8 basis points, I think the rest of the way.

And then, just one other, what are your thoughts on the tax rate in the fourth quarter and 2025?

Yes, so for the rest of this year, the way the BOLI transaction works is basically factored into the effective tax rate for the year. So, without any additional tax planning, we would see the tax rate realized year-to-date, which is about 24% to 24.5%, that would be consistent for the rest of the year. As you look at the outlook, we've put 20% to 22% in there for the quarter end of the year. The reason for that is we do have some tax planning strategies we're working on that we think can lower that rate. So, if we realize those benefits, we'll see that tax rate somewhere closer to 20%. If we don't, it'll be where it is today on a year-to-date basis, which is about 24.5%.

Thanks, Chris. And then, Brad, going back to the M&A discussion, what's the profile of a potential M&A partner today? What are the reasons for having a conversation with Equity? And are there any similar characteristics among some of those potential partners?

There are similar characteristics. Some reasons are their age of ownership is in their 70s, management is in their 70s. Some of the reasons are they're fighting the headwinds of margin compression and it's continuing to get worse. They don't look like it's going to get better. Others face some regulatory pressure from different things—not in high-risk areas, but just things that their board is tired of dealing with. There are various reasons. Each one's different. There's not a theme across the board. The only common theme is several of them are fighting the headwinds of margin compression. Even if the Fed starts cutting rates, it's not going to improve their margin enough to make a difference, and deposits have repriced on them faster than their assets have, and the assets are still two or three years out.

Perfect. Thanks for taking my questions. Appreciate it.

Thank you. And we've got the next question from Damon DelMonte. Damon, your line is now open, please go ahead.

Hi, thanks. Good morning, everyone. So, quick question on the outlook for provision; credit trends have been pretty stable, as Krzysztof provided a good overview. Do we think of the reserve as just being flattish and provision just being driven by loan growth if net charge-offs are relatively modest?

Yes, Damon, I think that's a good way to put it. Always pending other things, right? If we had some charge-offs work through, if we had some deterioration in credit quality, that's obviously going to drive provisioning and reserve levels. But if things continue on their current trajectory, that statement is correct. We would see really any meaningful provisioning coming through loan production and growth.

Okay. And then, with regards to the buyback, again, active this quarter, we've seen a rally in the shares and the sector as a whole. I'm curious about your updated thoughts on current prices and if it's still attractive for you guys to remain active?

I think we have to be strategic in thinking about that. We always are. We have a certain buyback and earn-back that we do. And so, we'll continue to look at that, Damon, to see if it still fits us. We're getting to a level where it probably doesn't, which is a positive thing from the standpoint of stock performance. But we'll evaluate on a daily basis within the parameters that the board sets on whether we should be buying shares back or not.

Got it. Okay. Everything else I had was asked and answered, so thank you very much.

Thank you. And the next question is from Brett Rabatin from Hovde Group LLC. Brett, your line is now open, please go ahead.

Hi, guys. Good morning. I joined a little bit late, but I just wanted to get a little flavor for what you're seeing on the competitive side on deposits and if you're adding new money. Have the expectations come down at all in some of your markets? Just a flavor for what you're having to pay to add new money to the balance sheet?

Yes, so this is Rick. We're seeing the pressure abate a bit. I mean, every once in a while, you get requests and things like that for an exception. They come through, but we're clearly seeing the velocity of that decrease. That's good because in a lot of the markets that we're in, there aren't as many competitors, so we're able to keep those rates down. It still happens, and the issue is really more on the individual circumstances of those banks. That's more of what we're seeing. So, banks struggling with their loan-to-deposit ratios suddenly find themselves facing a rate that might be in the fives for some money market or year out rate. We're just really not playing in that market at this point in time. As far as the outlook, I think we'll continue to see sporadic or one-off competitors doing things like that. We just take them one at a time.

Okay. That's helpful. And then, just thinking about M&A as a strong topic for you guys. With your stock a little bit higher, I know cash is something that you typically use in deals, but would we expect you to maybe use more stock in a transaction from here, and how are you guys thinking about tangible book dilution, payback, etc., at this point?

Yes. So, our metrics haven't changed since we started the company, and so they're not going to change today. We're still going to be under a three-year earn-back. Stock does come more into play, although we've had a lot of conversations with people about taking shares all along the way. Some of it has to do with the fact that the smaller companies generally want cash because they're less sophisticated, and they've had 90% of their assets tied up in the bank. One of the reasons they're selling is to get liquidity later on in life. So, that's why the cash usually comes into play. But there are conversations currently happening with stock, and I think it will increase with the stock market recovery.

Okay, great. Thanks for taking my questions.

Thank you very much. We currently have no further questions. Thank you everyone for joining. That concludes today's call. You may now disconnect your lines.