Earnings Call Transcript - EQBK Q2 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the Second Quarter 2023 Equity Bancshares Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, Chris Navratil.

Chris Navratil, Speaker

Good morning and thank you for joining Equity Bancshares conference call, which will include discussion and presentation of our first quarter 2023 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 refer to Slide 2, including important information regarding forward-looking statements. From time to time, we may make forward-looking statements within today's call and actual results may vary. 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 it over to our Chairman and CEO, Brad Elliott.

Brad Elliott, CEO

Good morning, and thank you for your interest in Equity Bancshares. I am pleased to introduce Ric Sems, our new President, who joined us in May. Ric has a strong banking background with 30 years of experience. He's been a leader in the industry on technology delivery in regional bank operating structures. We are confident he will help us drive efficiency in our delivery channels. You will hear more from him later in the call. Let's look back at the second quarter. Our balance sheet strength, strong capital, high levels of liquidity, and interest rate risk management have all contributed to stability in a dynamic and challenging operating environment. With Ric joining the team, it's a perfect time to reassess our operating and strategic stance. I am proud of the Equity Bank team and their commitment to delivering products and services to our customers. One of our values is entrepreneurship. Evaluating how we do things and finding better ways to respond to our customers reflects our entrepreneurial approach. As a team, we've been focusing on the drivers of value creation. We know that creating shareholder value starts with generating and delivering value to our customers. To deliver customer value, our employees have to be engaged and developed. These elements complete a solid three-legged stool of customers, shareholders, and employees. Adapting to a changing environment and delivering to our customers the products and services they need is crucial for Equity's long-term growth, sustainability, and competitive advantage. Value creation is directly linked to customer satisfaction and loyalty. We must understand and meet the needs and expectations of our customers to differentiate ourselves from our competition. Being there for our customers through good and bad times builds trust. Through those relationships, our customers become advocates for Equity Bank and assure future business growth. Our entire executive management team is working to build a culture and environment that fosters the behaviors necessary to deliver a superior customer experience. Also joining me today is Eric Newell, our CFO, and Chief Credit Officer, John Creech. I'll let Eric walk you through our financial results.

Eric Newell, CFO

Thank you, Brad, and good morning. Last night, we reported net income of $11.5 million, or $0.74 per diluted share. During the quarter, we completed a repositioning of $51 million from our investment portfolio into higher-yielding assets, resulting in a reduction of income of $1.3 million pre-tax. The repositioning has an earn-back of about 10 months at current interest rates. Without the loss, net income would have been $12.4 million, or $0.80 per diluted share. We reported $0.77 per diluted share in the first quarter. When removing the securities loss, non-interest income was $8.3 million, down $300,000 linked quarter. However, during the first quarter, we had an $834,000 one-time beneficial impact. When excluding one-time items from both quarters, we have an improvement in fee income totaling approximately $500,000. Non-interest expenses totaled $33.1 million and were relatively flat from the linked quarter. Our GAAP net income included a provision for credit loss of $298,000. To understand the attribution of the inputs, you can reference our earnings deck, which shows the calculation. We've yet to see economic trends in our markets that are of specific concern, and more importantly, we have not seen any declining asset quality trends in our portfolio. While we continue to have qualitative reserves set aside for this market uncertainty, our asset quality has remained stable. The June 30th coverage of ACL to loans is 1.34%. I'll stop here for a moment and let John talk through our asset quality for the quarter.

John Creech, Chief Credit Officer

Thanks, Eric. As of the end of the second quarter, non-performing assets as a percentage of total assets hit its lowest level since our company went public in 2015. Net charge-offs remain low, with second quarter net charge-offs totaling $857,000 as credit quality continues to improve. The balances of all non-pass categories improved, declining to $47.1 million at June 30 from $59.9 million at March 31. Non-owner-occupied office is an ongoing area of concern for the banking industry. Equity Bank's office portfolio totals $91.3 million and represents just 2.7% of the total loan portfolio. The average loan size is $1.7 million. $77 million, or 85% of our loans secured by office properties, are located in Kansas City and Wichita, our two largest markets. The unemployment rates are favorable in Kansas City and Wichita at 3.5% and 3% respectively. The Midwest has not yet experienced the same level of remote or hybrid work as some of the larger metro markets in the US. All loans in the office portfolio remain pass rated. The average loan-to-value is 47% and the average weighted loan-to-value is 54%. 88% of the office portfolio has an LTV less than 70%. The average debt service coverage is 2.09 times. The average occupancy in the portfolio is 91%. 95% of the office loans have recourse to individuals with favorable levels of liquidity and net worth.

Eric Newell, CFO

Thanks, John. End-of-period loans declined modestly in the quarter. During the quarter, management made the decision to exit our remaining shared national credit exposures, and we had some customers that had asset dispositions that resulted in payoffs. Total loan originations in the second quarter were $153 million with a weighted average coupon of 7.8%. This compares to $143 million with a weighted average coupon of 7.71% in the first quarter and $330 million with a weighted average coupon of 5.04% in the second quarter of 2022. We continue to successfully originate loans at higher interest rates, and we are seeing higher yields. With an analysis completed at May 31, 2023, over the last 12 months, we repriced $1.2 billion of our loan book and originated $676 million of new loans at market rates, which has driven an increase in coupon of 204 basis points. The average change in rate for the repricing was 360 basis points. We have $1.2 billion of our portfolio that is either floating or adjusts monthly. Over the next four quarters, we have $407.7 million of loans with a contractual repricing with a weighted average coupon of 6.56%. Making a simple assumption that this reprices to prime, this adds an annual $7 million of revenue. During the second quarter, the yield on the loan portfolio increased 40 basis points to 6.34%. The cost of interest-bearing deposits increased 41 basis points to 2.14% in the quarter. This slowed from the first quarter, where we experienced a 68 basis point increase. Net interest income totaled $39.4 million in the second quarter, up $318,000 from the first quarter, driven by an increase in average earning assets. We continue to have enhanced liquidity on our balance sheet from actions we took to respond to market dislocation in the first quarter. Average Fed funds sold increased to $185 million from $120 million in the first quarter. While we continue to have $140 million outstanding at the Federal Reserve Bank's term funding program, we are currently earning a positive spread on that borrowing, though it does have the effect of reducing margin. We calculate that the excess liquidity has the effect of reducing margin by seven basis points. Salaries and benefits decreased $1.5 million in the quarter. Of this decline, about $730,000 of it is one-time in nature, with a reduction in expense of forfeited, unvested, restricted stocks. Data processing increases are due to higher volumes on both credit and debit card platforms, repricing of contracts, exhibiting some inflationary pressures, and a new deposit processing system that will provide an enhanced customer experience. Professional services are driven by some legal expenses that we anticipate will be covered by insurance in future periods. Marketing is higher due to advertising to continue to attract deposits. Our outlook slide includes a forecast for the third quarter. We do not include future rate changes, though our forecast still includes the effect of lagging deposit rates. Our provision is forecasted to be closer to 10 basis points to average loans on an annualized basis. This is a more optimistic view than the street, mainly because of our existing coverage level to loans, the lack of recognized losses, and our previous qualitative reserve built for recognizing economic uncertainty. Ric?

Richard Sems, President

I'm excited to have joined the Equity Bank team. I've spent my first month visiting our regions and meeting with our teams. I've seen an abundance of opportunities to leverage the experience and relationships our sales teams exhibit and continue to drive organic growth while meeting the needs of our customers. My goal over the next several months will be to better understand the behaviors of our frontline team members and then adapt in ways that will improve our execution approach. The end goal will be to ensure that we provide information to the sales channels that help guide behaviors to ensure higher yields while holding ourselves accountable. Successful execution will allow us to deepen our existing relationships, acquire new relationships, and continue to improve the customer experience, all while being mindful of spread and expense management. During the quarter, non-broker deposits increased by $46 million or 4.7% annually as our bankers continue to emphasize customer service while serving as a resource to our communities in turbulent times. As Eric previously mentioned, we've been successful in originating higher-yielding loans and the repricing characteristics of the loan book are favorable. Our pipeline continues to hold. Our 75% probability or higher pipeline stands at $366 million. This represents deals that are fully approved and underwritten. Our 50% probability, which consists of loans submitted to underwriting, is $376 million, and the opportunity pipeline, which we assign a 25% probability to, stands at $367 million. Our trust and wealth management team has been booking new business year-to-date. Assets under management have grown by 21%. The team has developed a strong pipeline as we look forward to continuing to expand their contribution to fee income in future periods.

Eric Newell, CFO

Thanks, Ric. Our company is well-positioned in this uncertain environment. Our asset quality metrics are the best they have ever been. We have limited exposure to commercial office concerns. Our balance sheet structure is solid, and we have a granular deposit base and a strong capital base. We continue to augment our leadership team, which will support continued growth. We've recently hired Ann Knutson as our Chief Human Resource Officer this spring. She is an innovator with over 20 years of human resource leadership experience. And just last week, we added David Pass to the team as our new Chief Information Officer. David has over 20 years of technology leadership experience, most previously at UMBF. Our regional leadership teams are led by Josh Means, Brad Daniel, and Mark Parman, and they give us the foundation for growth in all our markets. Equity will continue to execute on our strategy, efficiently growing core earnings through increasing operating leverage and prudent underwriting, all while looking to build our franchise through selective and opportunistic M&A. We are seeing more activity on the M&A front, and we expect that to pick up over the next several quarters. The execution of our mission increases the value of our organization for all stakeholders. And with that, we're happy to take your questions.

Operator, Operator

Our first question comes from Jeff Rulis with D.A. Davidson. You may proceed.

Jeff Rulis, Analyst

Thanks and good morning. Just a question on your loan growth guidance. It looks like it's tilted to the downside next quarter, but for the full year, the average suggests maybe ending the year a little stronger. If you could just kind of walk us through your expectations for the second half.

Richard Sems, President

Hey, this is Ric Sems. Thanks for your question. So we're seeing a potential uptick on this. The first part is probably just borrowers settling into the new rate environment. So, we think that there'll be a little bit more demand from them that way. The second part of it is our Tulsa market led by Ryan Morris. We see that looking really strong right now for the second half of the year. In addition, we'll see some upticks probably on the consumer side from both private banking, as we're moving a little bit more into that area, and then also on the mortgage side. Finally, we think that within the market where we are, we have the capacity to lend. As we get more into the second half of the year with our strong deposit franchise and strong deposit potential for growth, we'll be able to continue that consistency in lending where maybe some of our competitors will struggle a little bit more. So that's really kind of why we're seeing that uptick.

Jeff Rulis, Analyst

Okay. Thanks, Ric. I guess just to follow up. So it sounds rather customer-driven in terms of that behavior. Anything kind of in-house in terms of is the bank somewhat guarded on further originations, whether that be credit concerns or funding concerns? It sounds like it's led by the customer, but just wanted to get a sense for in-house, are you willing to lend?

Richard Sems, President

No, in fact, John right here, we're looking at each other. We want to continue to lend consistently, and we don't really see anything stopping us from being able to do that in the second half of the year.

Jeff Rulis, Analyst

Thank you. I wanted to revisit the expense line. Eric, you mentioned there was a benefit this quarter from some departures. Do you anticipate that returning, with that benefit potentially increasing expenses back to around $16 million on the comp line? Additionally, considering those departures, are you planning to hire? Are there specific areas where you have openings that you're looking to fill?

Eric Newell, CFO

Yeah, Jeff, I agree that the $16 million number is probably a good run rate there. The one-time benefit that we recognized in the quarter was about $700,000 due to forfeited, unvested, restricted performance shares. And no, we are not looking to backfill those areas.

Jeff Rulis, Analyst

Could you clarify which specific areas those departures came from? Were they related to redundancies, the back office, or something else?

Eric Newell, CFO

So, those are some of the restructurings we announced in May with Greg and Craig departing and us hiring Ric Sems to replace him.

Jeff Rulis, Analyst

Okay. Got it. I'll step back. Thank you.

Operator, Operator

Our next question comes from Terry McEvoy with Stephens. You may proceed.

Terry McEvoy, Analyst

Maybe just start with the 40% of the portfolio CRE; it's been in the news a lot about an area of stress. So, I don't know, John or somebody, can you just talk about or provide maybe more insight into the portfolio in terms of what you're seeing as interest rates rise and in any segments you're watching closely today? And I do appreciate all the details and the prepared remarks on the office portfolio.

Eric Newell, CFO

Yeah, thanks, Terry. It's just an interesting time, right? You would think that you were most concerned about home builders and hotels and things like that. We come off of this COVID cycle and we've got a real travel reemergence and it has seemed to cure a lot of concerns about hotels. We have a very small home builder portfolio. When you look across that portfolio, the housing conditions, the supply of housing is very constrained and there's still high demand. So, the traditional things that you would look at are still pretty strong. We just finished a credit exam and did really well in the credit exam. We have just completed or updated our rate stress testing. While rates have continued to move up, the performance of the stress testing has continued to tell us that our customers are keeping up with the rate environment in terms of how they're able to manage their business and the cash flow that they're able to produce. The one thing you do see, and it's a little favorable, I think, is that the real estate credits that we are able to put on have extremely strong levels of cash going into the projects, which shows that those developers and investors who finance those types of projects are optimistic about their ability to overcome this environment that we're in. The levels of cash that we see going into new projects are 40% and 50%. So, the credit book is very strong. We have net migration improvement, net improvement across all categories. We just finished the exam. It was favorable. It's hard to find weakness in the credit book, but there are things that you would traditionally be concerned about.

John Creech, Chief Credit Officer

And we have our eyes wide open for those things. We just aren't seeing those weaknesses materialize at this point. Even with those types of paydowns, we're still booking new originations and approving new originations. I'd say 75% to 90% of them are floating, and they're in the eights and nines.

Terry McEvoy, Analyst

That's great color. Thank you. And then maybe as a follow-up for Eric, what do you think deposit betas go from here, and what type of assumptions on the deposit side do you have within your NIM outlook for the second half of the year?

Eric Newell, CFO

In our earnings deck on Slide 12, we do show our cumulative betas for deposits. We're showing 30% cumulative beta for deposits. I think we, from a modeling perspective, Chris, what's our terminal beta? Is it 40%?

Chris Navratil, Speaker

It's a little bit north of 40%, still rolling it in over the next, about 12 months left in runway in terms of when we think the potential for the peak of that beta would be.

Eric Newell, CFO

When we do our forecasting and modeling, we're currently using a terminal beta of 40%, and it's ratable in nature probably another 12 months out. So that said, in another way, there's still some expectations in our forecast slide there, even though we don't model in increased market rates. I know there's a growing expectation that the Fed's going to move here at their next meeting, but we do model in the cumulative beta increasing ratably up to 40%, probably around June 30th of 2024.

Terry McEvoy, Analyst

Great. Appreciate that. Thank you.

Operator, Operator

Our next question comes from Andrew Liesch with Piper Sandler. You may proceed.

Andrew Liesch, Analyst

Hey, everyone. Good morning. Question on the shared national credits and the larger loans that paid off. Do you have the aggregate dollar amount of all those payoffs?

Eric Newell, CFO

Yeah, I don't have an aggregate dollar amount. I would say, from the number I do have is on the originations. We originated $153 million in the quarter. There was a little bit of lumpiness on larger credits paying off. Shared national credits contributed to it, but the larger part of it was some of our customers having liquidity events where they were selling the underlying asset and paying us off.

John Creech, Chief Credit Officer

What I would say, Andrew, is we had a book of business we bought 24 months to 36 months ago that we had been reinvesting back into. It was never large, it was never $50 million, but it was south of that. We just took a stance over the last several years that we just don't need that book of business any longer. It had a low yield on it, I think, in the fives, and it wasn't core to us. We do have some shared national credits in relationships that we understand that are in our market and our customers, but not when we think of traditional shared national credits. We think of brokered shared national credits that are big credits that trade openly, and we are out of all of those now.

Andrew Liesch, Analyst

Got it. All right. That's helpful there. Then shifting gears over to the margin, the midpoint here suggests a little bit of the midpoint of your guidance range for this quarter suggests a little bit of expansion. I guess, what gives you that confidence? Is it really just where the new loans are being added and the repricing that you see ahead?

John Creech, Chief Credit Officer

Definitely, our new originations have eight and nine yields on them, as we mentioned earlier. The repricing characteristics of the loan portfolio and even with rates moving up continue to show expectation of redeploying cash flows out of the investment portfolio into the loan portfolio.

Andrew Liesch, Analyst

Got it. So, we'll see some more of that remixing continue then. I guess, one last question there. How is the balance sheet sensitivity right now to further rate changes by the Fed?

John Creech, Chief Credit Officer

I was reflecting on our situation compared to a year ago, and there hasn't been much change in margin over that period. Our approach has been to maintain a neutral or balanced stance on interest rate risk management. Certain parts of our balance sheet will show varying degrees of asset or liability sensitivity. If the Fed makes a move this quarter, we could see a small increase in NIM right away. Ultimately, it will depend on how our deposit portfolio responds during repricing. Recently, we've noticed a slowdown in repricing within our deposit portfolio, evident in the cumulative beta change from the fourth to the first quarter, and from the first to the second quarter. We aren’t having many discussions with customers about exception deposit pricing. I believe that as the Fed shifts away from larger moves of 75 and 50 basis points, it reduces the likelihood of customers reaching out to their bankers here at Equity regarding rates. I anticipate this trend will be beneficial for us in the latter half of 2023.

Andrew Liesch, Analyst

Got it. That's really helpful. Thanks for taking the question. We'll step back.

Operator, Operator

Our next question comes from Damon DelMonte with KBW. You may proceed.

Damon DelMonte, Analyst

Hey, good morning, guys. Thanks for taking my question. Just a couple of points of clarification here. So, the margin guide that's in the outlook slide, that takes into account the seven basis points of liquidity drag. Is that correct, Eric?

Eric Newell, CFO

It actually excludes.

Damon DelMonte, Analyst

I'm sorry. That's what I meant. So, you'd add back in the seven basis points to the 3.38. So, our starting point is like 3.45 for the quarter.

Eric Newell, CFO

Correct. Yeah.

Damon DelMonte, Analyst

Okay. Great. Regarding the guidance on the provision, was the 10 basis points based on average loans, or are you projecting a 10 basis point net charge-off rate?

Eric Newell, CFO

Average loans on an annualized basis.

Damon DelMonte, Analyst

Okay. Great. And then lastly, you mentioned about M&A. Can you just give a little bit more color and perspective on that? Have you been having more conversations? Are you optimistic that you could find a transaction in the back half of this year? Or do you think that's more of a 2024 event?

Brad Elliott, CEO

We're engaging in more discussions and currently have active talks with institutions. These conversations are motivated by previous delays in finalizing deals due to management or ownership challenges. I anticipate some deals being announced in our sector this year. If we successfully bid on those, we’ll make that public; if not, it will be announced by others. I believe there will be transactions in our market, and we have a strong probability of being involved. We are opportunistic but remain disciplined with our pricing, ensuring it aligns with our criteria. I see promising opportunities ahead. What excites me the most is our organic growth, supported by an excellent leadership team among our regional CEOs. The executives they’ve appointed over recent years have excelled in originating new business. In addition to the organic growth, the potential M&A opportunities present us with significant prospects this year and moving into the next.

Damon DelMonte, Analyst

Great. Okay. That's all that I had. Thank you very much.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.