Earnings Call Transcript - EQBK Q1 2022

Operator, Operator

Good day and thank you for attending. Welcome to the First Quarter 2022 Equity Bancshares Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. I’d now like to hand the conference over to your host today, Chris Navratil. Please go ahead.

Chris Navratil, Host

Good morning. Thank you for joining Equity Bancshares conference call which will include a discussion and presentation of our first quarter 2022 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 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, Chairman and CEO

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. I'm pleased with the operating trends we showed in the quarter. Our earnings were both very strong and surpassed expectations. With excellent loan growth and reported strong net interest income, our EPS was $0.93 per share versus a consensus of $0.63, and Eric will discuss in a few minutes. Our hard work has yielded significant credit quality improvement with a decrease in our classified and non-performing assets. Our credits purchased in both the Almena and American State Bank mergers and our previously disclosed aerospace-related credit all saw improvement. In some cases, elimination through payoff or disposition of assets. This resulted in a meaningful reduction of our criticized asset ratio. The continued execution by our special assets and credit teams is a reflection of the addition a year ago of counsel personnel's expanded role in this area. This team has transformed our process management of this area. Our fee-based businesses continued to add to our income stream. After several years of focus on improving and introducing new products and services, we continue to see improved trends. We are just in the beginning phase of many of these businesses. So it is very encouraging to watch these teams of Christian Humphries, Andrew Musgraves, Ben Morris, and all our commercial and retail staff increasing sales. We'll continue to keep an eye on our expenses and find ways to uncover positive operating leverage. We will start implementation of our ITM network over the next several quarters, and our operations teams are always looking at ways to automate processes. We remain committed to our capital management measures in the first quarter. We are well positioned to take advantage of downward pressure on financial stocks with our stock repurchase program and declared a common stock dividend in the quarter also. We have many other positive items to note, but I will leave some of those for Craig, Eric, and Greg to talk about. I will let Eric take you through the numbers and then we'll walk you through some of the other areas of focus for 2022.

Eric Newell, CFO

Thank you, Brad, and good morning. Last night we reported net income of $15.7 million or $0.93 per diluted share. Non-interest income decreased slightly linked quarter to $9 million and non-interest expenses less merger costs decreased $4.1 million linked quarter to $29.1 million. We calculate core EPS to be $0.94 per diluted share. To reconcile GAAP earnings to core earnings this quarter, we remove merger expenses of $323,000 and a benefit of $134,000. I note that in the first quarter, we recognized $827,000 of PPP fee and interest income compared to a peak of $8.2 million recognized in the third quarter of last year. We haven't been excluding PPP from our core numbers, given its contribution to our financial results for the last eight quarters. But its contribution is now minimal, and we are pleased about the improved quality of our first quarter earnings. Our GAAP net income includes a net release of allowance for credit losses totaling $412,000. The uncertainty of the economic environment and continued impact on the economy of previous stimulus measures are reflected in our qualitative and economic components of the calculation. The March 31 coverage of allowance for credit losses to non-PPP loans is 1.48%, down from 1.55% the previous quarter. The decline in the coverage is driven by allowance that was being held against specifically analyzed loans. If we normalize one-time benefits, normalize the provision expense to approximately 10 basis points on average loans on an annual basis, and zero out the release of reserves for unfunded loans, we get an EPS of $0.70 per share, which beats the consensus of $0.63. The beat is primarily in the expense line with consensus at $31.6 million and our normalized level at $30.1 million. I'll stop here for a moment and let Greg talk through our asset quality for the quarter.

Greg Kossover, Chief Operating Officer

Thanks, Eric. As we anticipated during the fourth quarter of 2021 earnings call, other repossessed assets declined $20 million in the first quarter of '22 based on the resolution of the largest of our aviation assets, which was sold at an attractive price and above where it was marked. There remains one smaller asset tied to this relationship; Equity Banks portion of that participated total is approximately $1.1 million. Overall, non-accrual loans declined $8.6 million quarter-over-quarter and now stand at just 64 basis points of total loans, the lowest level since we went public. As a reminder, our non-accruals were driven mostly by acquired assets, and the teams are constantly evaluating these for upgraded status as credits improve. The allowance for credit losses stands at 1.48% of non-PPP loans, as Eric has discussed, and net charge-offs are muted at just five basis points annualized. I'm proud to report that through the hard work of our special assets and credit teams, we now have a classified asset ratio of approximately 17%. Without the required gross-up for GAAP of the remaining participated repossessed aviation credit, that ratio would be lower by 160 basis points. We expect this ratio to continue to decline as we see improvement in classified assets acquired in mergers, and we have done this in the face of great uncertainty driven by the pandemic.

Eric Newell, CFO

Thanks, Greg. I do think it's worth commenting on our general reserve. While we had significant improvement in our asset quality during the quarter, resulting in a large release of specific reserves, we did build allowance for credit losses to general reserves. During the quarter, we saw significant growth in our loan portfolio and important model input that drives general reserving. In assessing the economic landscape, we first acknowledged that our customers experienced a great benefit over the last quarter with some of the headwinds as public safety measures in place during the pandemic have largely or entirely been lifted. The COVID concern has been replaced by the uncertainty of inflation, supply chain disruption, and input cost escalation that our customers are starting to experience, in part due to the stimulus pumped into our economy since the start of 2020, as well as the geopolitical situation. To be clear, we've yet to see our customers experience any specific difficulties from these concerns. But in assessing the landscape, we believe the risk of an economic slowdown, coupled with inflationary pressures, presents uncertainty that supports our general reserve build during the quarter. Craig, why don't you take everyone through your thoughts on the quarter?

Craig Anderson, President

Thanks, Eric. Organic originating loans totaled $304 million in the first quarter, with 92% of the total originations in commercial, CRE, and agricultural loans. These originations resulted in linked quarter loan growth of $87 million. When excluding the change in our PPP loan balances, loan growth in the quarter was $111 million or 14.3% annualized. I am proud of the work that the sales teams have put in over the second half of last year that helped us notch a very successful first quarter. We have renewed our focus on speed to market. Over the last couple of years, our attention was rightly focused on helping our customers get access to PPP and Main Street lending programs to assist with pandemic-related challenges and uncertainties. Thankfully, we have turned a corner. We are working with the shared service and credit administration teams to further streamline our underwriting process. By finding ways to better automate and enhance our loan processes, we provide a service to our customers and prospects that our competition cannot match. Better yet, it allows our sales teams to focus on being trusted advisors to our customers, helping them find solutions and products to make their businesses more successful. Our fee income did show a modest decline from the fourth quarter, but this is clouding some very positive news. First, we have seasonality in our crop insurance sales that peaks in the fourth quarter and is not repeatable in the first quarter. Second, the contribution of mortgage banking revenue declined this quarter due to rising mortgage rates and a slower selling season in the winter. We continue to emphasize putting commercial cards in the hands of our clients and driving debit card utilization through marketing campaigns. The build-out of our HSA platform is nearly complete. We have growing pipelines that our healthcare services team has developed that will allow us to service their employees' HSAs and other tax-advantaged flexible spending account needs. In time, this will contribute fee income through interchange and accounts that use a brokerage option. We have recently had two changes in regional leadership that I am very excited about. We recruited a new leader for our Tulsa region who has spent much of his career in the region working for a top national bank. We are excited about his leadership and potential to continue to develop our Tulsa footprint and enhance its contribution to our results.

Eric Newell, CFO

Thanks, Craig. Net interest income totaled $39.3 million in the first quarter, increasing from $37.2 million in the linked quarter, representing a $2.1 million increase. During the first quarter, the yield in the loan portfolio, excluding PPP, increased approximately 32 basis points. We added a $1.5 million benefit to interest income in the quarter from loans previously non-accrual being moved to accrual. Excluding one-time benefits and PPP impacts in both comparable periods, net interest margin (NIM) in the first quarter increased 19 basis points to 3.2%. Slowed premium amortization in our investment portfolio contributed approximately 7 basis points of improved yield in the quarter from the linked period. Our interest-bearing liabilities also experienced continued improvement, declining two basis points from the fourth quarter. Origination fees recognized from forgiven PPP loans continue to decrease. NIM was benefited by PPP loan fees in the first quarter by five basis points, compared to 12 basis points in the fourth quarter. We recognized $755,000 of fee income and $71,000 of interest income related to PPP loans in the first quarter, down $1.9 million from the fourth quarter. At quarter end, we had $500,000 of net unrecognized fee income associated with PPP loans, which totaled $20.3 million. The team has been focused on ensuring we proactively position the balance sheet for a rising rate environment. Over the last 18 months, we've been quite conservative about originating loans that were priced out further than three to five years on the curve. We've recently seen some customers opt to accept a variable rate because the steepness in the front end of the curve is causing fixed rates to be significantly higher. We recently took advantage of the record increase in two-year yields and swapped a part of our portfolio from variable to fixed for two years. While that may seem counterintuitive, our modeling and analysis showed that there was great value to capture that will benefit our NIM. In the event that interest rates don't rise as the market currently expects, we do even better. Our outlook slide does show a moderate decline in NIM in the second quarter. There is some conservatism in that number due to some uncertainty with the cost of funds. Currently, our competitive landscape in our community markets remains very rational, which should allow us to lag any rate increases. However, if the Federal Open Market Committee follows through with a 50 basis point increase in May and even June, it could alter the competitive landscape on rates. On the asset side, we're seeing improvement in origination and renewal yields. C&I origination yields increased 14 basis points in the first quarter, which accounted for about 40% of the quarter's origination volume. We expect premium amortization in the investment portfolio to remain slower, which should assist in yields from that portfolio. And as I have said in prior calls, we're working to move earning assets away from the investment portfolio to the loan portfolio, which will assist in higher asset yields.

Brad Elliott, Chairman and CEO

I'd like to point out our progress and our strategic goals for 2022. We are focused on the continued improvement of operating performance. We saw progress in the first quarter on our goal to achieve a return on tangible equity in the mid-teens. We continue to look for opportunities to reduce excess liquidity on our balance sheet and increase fee income in our revenue mix. We saw our loan to deposit ratio increase; as I mentioned before, tailwinds from our credit and loan growth will help drive us towards greater operational efficiency. We're excited about the build-out of our HSA business, which provides cross-selling opportunities to our commercial and municipality clients, as well as a state-of-the-art platform to our existing HSA client base. Our commercial credit card product continues its positive momentum and contributes to fee income. We are looking at several other opportunities to add to our suite of services and products for our customers that will support our goal of increasing fee income as a part of our revenue mix.

Eric Newell, CFO

I wanted to turn your attention to the forecast slide upon the earnings deck, which will put some specifics on our expectations for the remainder of 2022. As Brad mentioned, our long-term goals remain unchanged: improving our revenue mix, increasing the contribution to that mix, driving positive operational leverage off of our expense base, and driving our loan to deposit ratio to levels we saw pre-COVID. This last goal is dependent in part on economic factors in the markets we serve. Successfully shifting excess liquidity to the loan portfolio from cash and investments is critical to improving our pre-tax, pre-provision return on assets.

Brad Elliott, Chairman and CEO

We're in active conversations with several different companies about partnering. Equity continues to be ready and willing to act as a partner to banks that fit and complement our organization, provided they assist equity in making progress towards our stated financial profitability goals. As I emphasize, we will stay true to our requirements on earn back, cultural fit, and geographic strategic fit. We will maintain our focus on organic growth efforts, and as always, look for opportunities to rationalize our branch footprint while improving the digital experience for our customers. And with that, we're happy to take your questions.

Operator, Operator

Our first question comes from Terry McEvoy from Stephens. You may begin.

Terry McEvoy, Analyst

Hey, guys. Good morning. Maybe, Eric, just to start with a question. If the Fed raises rates 50 basis points in May, can you just kind of walk us through both sides of the balance sheet and what you think that would mean for the net interest margin?

Eric Newell, CFO

Yes, I mean, on the funding side, we don't have a lot of dependence right now on wholesale funding, so the impact there would be fairly minimal. Given our liquidity and loan-to-deposit ratio, we have been looking at letting some customers that might be rate-sensitive and are only here for one product, and we don't have a relationship with them. We might let that weed the bank, but we would be competitive with the customers that do have a relationship with us, particularly if they are providing or using a service that has fee income or contributes to fee income. At this point, we haven't seen a lot of irrational pricing in our markets yet, and I'm hoping that even with a 50-basis point increase, we'll continue to see that not change. On the asset side, based on our loan pricing model, we've seen market rates already pop up on the expectation of increases. We've been seeing that already in what we've been originating, for example, in C&I being about 14 basis points higher in the first quarter compared to the fourth quarter. So, putting that all together, I think it'll be a fairly balanced outcome.

Terry McEvoy, Analyst

Thank you. And, Brad, maybe as a follow-up, you talked about just conversations with potential M&A partners. How have pricing expectations changed as rates have gone up, but then you also have to balance some economic uncertainty and inflation? And could you talk about the size of the potential partners that you're having conversations with as well?

Brad Elliott, Chairman and CEO

Yes. We've got three or four active conversations going on, and some are in modeling stages. What I would tell you is everyone understands how they have to fit into a box, and how they have to work on an earn back. They are sophisticated organizations with good bankers on the other side. So, expectations are in line with where things need to be to get deals done. The question is, which ones are the best strategic fit, and which ones bring the right opportunities to us? We passed on a deal that was sizable for us because it had a lot of cleanup work in the portfolio still. We determined that at this time in the cycle, it wasn't the right time to pursue that opportunity. We're still looking for strategic fits that must meet economic criteria and that we believe will move the needle for our shareholders.

Terry McEvoy, Analyst

Appreciate that. Thank you both.

Operator, Operator

Our next question comes from line of Jeff Rulis from DA Davidson. Your line is open.

Jeff Rulis, Analyst

Thanks. Good morning. Just a couple of follow-ups on the outlook slide, the loan growth guide and average balances. Could you frame up the outlook kind of the low and high end of the 3, 2 to 3, 4 billion in average loans?

Brad Elliott, Chairman and CEO

Yes, just kind of a nuance with that; that's a full year average balance, so that $3.2 billion is taking into account the actual average for the first quarter. I wouldn't expect we have any anticipation that our loans are going to shrink from where we're at right now. I would look more towards the midpoint there for the average for the year, which I think gets to about another 8% annualized growth from where we're at $331 at the end of the year, which I think is a bit stronger than where we started our expectations for 2022, where we were looking for about 4% growth.

Jeff Rulis, Analyst

Got it. So the low side is basically economic uncertainty influencing the outlook?

Eric Newell, CFO

Yes, that's a fair statement, Jeff. Given we feel good about the remainder of the year based on what we know now and what we see in our pipelines. However, again, if the Fed moves 100, 150 basis points here in the next couple of quarters, that could alter the dynamics of the market and uptake from our customers. But we're not seeing that at the moment.

Jeff Rulis, Analyst

Sure. And to that end, Eric, three to 310 margin guide, both for Q2 and the full year. Can you clarify that assumes no further rate hikes? Or does it account for expectations out there?

Brad Elliott, Chairman and CEO

Yes, we don't really build any rate hike features into our modeling. It's not like we put that into consideration for however many rate hikes the Fed is expected or what the market is expecting. For the second quarter outlook, however, it seems like the market has coalesced around the fact that there is going to be a rate increase in May. So, we have looked at some modeling with that in mind, and I think there's probably a little bit of an expectation of rate hikes in Q2, but not so much beyond that in our outlook.

Jeff Rulis, Analyst

I wanted to clarify your intentions regarding the buyback. If you consider the activity from the first quarter alongside what remains authorized, you could reach the end of that. I'm interested in your thoughts on potential further buyback activity and whether the board might consider increasing or extending the authorization.

Brad Elliott, Chairman and CEO

Yes, I think our board understands the capital markets and the use of capital markets tools. I can't ever see a time when our board wouldn't have an available appetite to be in a stock buyback as long as it's prudent. We will always have an authorization available unless we're not allowed to do that for some regulatory purpose. But I can't see any time in the foreseeable future where we wouldn't have a standing open buyback available to help increase earnings per share and do the right thing for all shareholders.

Operator, Operator

Our next question will come from the Group. Your line is open.

Unidentified Analyst, Analyst

Hey, guys, good morning. I wanted to first talk about the loan utilization in agriculture.

Eric Newell, CFO

I'll take part of this question and turn the rest of it over to Craig. The agricultural utilization remains down, which is positive from the standpoint of our customers sitting on lots of cash. Our ag customers are sitting with lots of cash and so they're not utilizing lines of credit. We think that's positive and puts them in a very healthy position and gives them lots of flexibility. There is a change in commodity prices, with input prices going up, but grain sales prices are also increasing faster. At this point, they're on pace to make a lot of money again this year, and they're starting to forward sell some of that crop. We have very stable crops in our area because we use irrigation, so we're not as dependent on Mother Nature as other places. I think that bodes well for us.

Craig Anderson, President

Yes. The results of our first quarter loan growth were primarily driven by significant activity in both Wichita and Kansas City, where we were able to win a couple of very significant C&I opportunities. We also had a large CRE transaction in Q1. Our pipelines right now are very strong, consistent with where we've been over the last four quarters, and we are very excited about the opportunities to continue to increase our loan portfolio, with a significant focus on smaller middle market credits primarily from our territories in Western Missouri, northern Oklahoma, and Southeast Kansas.

Unidentified Analyst, Analyst

Okay. That's helpful. I wanted to ask about the conservatism regarding the margin on the funding side and get an update on the potential for a higher beta on MMDA.

Eric Newell, CFO

I agree with your observation about the factors contributing to that conservatism. We've noticed rational pricing in our community markets, particularly regarding competition for deposits. There's significant liquidity available, and some competitors likely share our perspective. If a customer lacks a strong relationship with us beyond a single product, we are prepared to let them go to a competitor. I believe that if the Federal Reserve implements more than one interest rate increase—while I am not very concerned about just one—there are market analysts suggesting a potential follow-up increase of 50 basis points in June. If that occurs, it could change some dynamics and lead to increased betas from our current levels.

Unidentified Analyst, Analyst

Okay. And then, just lastly for me, I wanted to talk about credit leverage from here, and nice to see the decline in classified assets. Can you give us any color specific to reserves on the commercial real estate book and the C&I portfolio? What do you see going forward?

Brad Elliott, Chairman and CEO

Yes, we kind of budget as if we are seeing growth. We might have credit leverage, as you suggested, with asset quality improving and potentially no further losses. We continue to expect loan growth, and that's one of the reasons why we budget around 10 basis points on an annualized basis on average loans through the year. We did have that release in the first quarter, driven by what Greg discussed. But I would say, moving forward, I'd probably expect a 10 basis points of provision going forward on an annualized basis.

Unidentified Analyst, Analyst

Okay, great. Appreciate all the color.

Operator, Operator

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

Andrew Liesch, Analyst

Hi, guys. Good morning. Just kind of following up on this last question here. So, the reserve building from the economic and qualitative factors here in the first quarter—that's just more of what you're seeing currently and more of a one-off event?

Brad Elliott, Chairman and CEO

Yes, I kind of look at it from a coverage perspective. We are hovering around 150 basis points for our allowance for credit losses to non-PPP loans based on the uncertainty in the economy. I would expect that coverage to remain close to that 150 basis points. It's not a fixed anchor in our modeling; it just happens to be where we're landing. The 10 basis points is just expecting further growth to maintain that around 150.

Andrew Liesch, Analyst

Okay. That’s helpful. And then just on the expense guidance on the outlook slide, that looks a little conservative at the high end. What would happen for expenses to reach $128 million this year?

Eric Newell, CFO

The biggest contributor to expenses is our people. We've done a good job in limiting our increases in the context of wage growth. From a budgetary perspective, we had between 3% and 4% growth, which is currently in our numbers. But if we need to respond to something unexpected, that could be one source of an increase. However, at this point, we feel comfortable that we won't reach that $128 million.

Andrew Liesch, Analyst

Got it. Okay, that's helpful. My other questions have been asked and answered. Thanks so much.

Operator, Operator

And our next question will come from the line of Damon DelMonte from KBW. Your line is open.

Damon DelMonte, Analyst

Hey, good morning, guys. Hope everybody's doing well today. Thanks for taking my question. Can you talk about the broader picture on the loan growth outlook?

Brad Elliott, Chairman and CEO

Yes, at this point, we don't see a lot of slowdown in our marketplace. Our region has some oil and gas dependency, and with oil and gas being around $100, the Oklahoma, Kansas, and Missouri markets are doing incredibly well. Arkansas's economy is also doing well, driven by retail, with the influence of JB Hunt's trucking technology and Walmart. Everything in our marketplace is performing well. We have some uplift from the aerospace industry, with huge backlogs right now in that field, indicating good demand. There are some supply chain issues, but they are simply holding back the ability to produce more jets. As of now, we don't have any indicators pointing to problems or a slowing economy in our area.

Eric Newell, CFO

Damon, I would also emphasize that our four-state geography has a sizable amount of diversity. Western Kansas is propped up by a healthy agriculture economy, Kansas City's economy is healthy, and there are differences in each area as you mentioned—Wichita is different from Tulsa.

Damon DelMonte, Analyst

Got it. Okay, that's helpful. I appreciate that. And regarding the fee income, Eric, the last couple of quarters, the other non-interest income line has been higher than earlier periods. Is there anything in there you lack confidence in being repeatable?

Eric Newell, CFO

I think the high $1 million to low $2 million range is appropriate going forward. One of the contributions in that is mark-to-market for derivatives; with higher rates, that's a positive benefit for us.

Damon DelMonte, Analyst

Got it. Okay, that's helpful. All right, that's all I had. Thanks a lot guys. Appreciate it.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes our first quarter Equity Bancshares presentation. Have a great day.