Earnings Call Transcript - MNSB Q1 2024

Jeff Dick, Chairman and CEO

Good morning, and welcome to our virtual earnings webcast. My name is Jeff Dick, and I'm the Chairman and CEO of Main Street Bank Shares, Inc., and Main Street Bank. I'm joined today with our CFO, Tom Schmellek; our Chief Lending Officer, Tom Floyd; our Chief Accountant, Alex Vari; and our Chief Risk Officer, Ben Baboval. This presentation will take about 15 minutes, followed by questions for the remainder of the hour. We have two analysts on the webcast with us today, Chris Marinac from Janney Montgomery Scott and Matt Breese from Stephens Inc. You can submit written questions throughout the presentation using the viewing portal. If we miss your question during the discussion, please reach out after the webcast. We do have a Safe Harbor page that describes the context of forward-looking statements. Finally, we use certain non-GAAP measures, which are identified as such within the presentation materials. Before I get started, I need to apologize for an error in the slide deck published this morning on slide number 38; we listed the weighted average loan to value for our multifamily portfolio as 90%. The correct number is 69%, which changes the weighted average of the entire loan to value for the whole investor commercial real estate portfolio to 63%. Again, my apologies. Having said that, we're changing things up a little this time, starting with avenue and then moving on to the company's performance. A lot has happened in the banking-as-a-service sector this year, and much has been written about the banks that offered banking-as-a-service through intermediaries. I'll highlight a few of the articles that sum up the situation. Starting with S&P Global Market Intelligence, who reported that U.S. banks with financial technology partnerships accounted for an outsized share of severe enforcement actions in 2023. The American Banker highlighted that banks are ultimately responsible for the activities their partners engage in. Financial institutions have been forced by regulators to heighten oversight of their fintech partners, strengthen compliance, and more. Banking Dive Financial Analytics reported that regulatory scrutiny will likely separate committed banks from those with just casual interest. Finally, Kate Drew writes in Forbes that the model using a banking-as-a-service provider as a middleman is all but dead, and in its place will likely emerge a more resilient banking-as-a-service proposition that puts the banks in the driver's seat when it comes to compliance and focuses on fintechs with sustainable businesses and realistic objectives in financial services. We agree, we absolutely believe that the opportunities are boundless for banks that provide banking-as-a-service in a responsible way. We've said it from the start; after gaining experience with a couple of fintechs early on, we realized that we needed to have a robust system with modern API connectivity to steer the fintechs down the proper path. The fintech uses our ledger as their core, which gives us real-time access and control. If something happens to the fintech, we have the ledger with all the transactions and balances. And there's no question whether the deposits are FDIC-insured. We integrated as much compliance as we could with customer identification, transaction monitoring, management, complaint management, monitoring systems, and strong security. We marry up that technology with hands-on training that includes helping the fintech to customize their policies that reflect their banking activities. The American Banker published an article on us emphasizing that our focus is to offer banking-as-a-service the right way. Avenue offers an embedded banking solution that connects fintechs directly to our fintech core. We aren't a sponsor bank or an intermediary; we provide a full solution for our fintech partners. Our one miss was underestimating the amount of time it would take to build and launch the technology that we designed. With hindsight, the timing is now perfect as we launch a solution that is purpose-built to meet the compliance, safety, and soundness needs required not only by us but also by the industry. Our first client is finalizing their integration and working fast to get up to scale. We have two more clients shifting from the sandbox into a pre-production phase. We have another fintech in the sandbox and one that recently signed their master services agreement with us. We have another that's negotiating now the fine points of the master service agreement, which will be our sixth fintech that enters the queue. The team is expanding to accommodate this activity; they are working hard to integrate fintechs and are still finding some time to focus on future functionality. We've capitalized $15.3 million on building the Avenue solution. The build has been done as efficiently as possible. Management and the board believe that this is the right strategy for the company to remain competitive. Low-cost deposits are becoming more and more scarce. This solution will allow the bank a much further reach into the consumer market than we could have ever achieved through traditional branching and marketing. And it's likely to be less expensive overall as well. Legacy Avenue deposits produced $619,000 in interest and fees over the first quarter, which covered almost two-thirds of Avenue's expenses. We estimate that we'll reach breakeven with Avenue once we get to about $225 million in deposits, and that remains our goal for 2024. Turning to the bank, we've done well during this interest rate cycle despite some taxing externalities. You'll see that we've had deposit cost challenges starting in the fourth quarter last year into the first quarter of this year. More about that later. We are a Virginia community bank celebrating our 20th year of business. We serve the Washington, D.C. Metropolitan area and have a great organic growth story using a branch-light strategy. We've always been a tech-forward bank with strong online and mobile banking technology. We trade on the NASDAQ Capital Markets Index. The D.C. market is a great place to do business. We always talk about the strengths of our market because we are in a region that hosts the federal government. But we also have world-class universities, hospital systems, airports, tourism, data centers, and at least 16 Fortune 500 companies. Let's not forget the Stanley Cup-Bound Washington Capitals. We also have low unemployment and a very high median household income for our workforce. As you're likely aware, the Class A office market within Washington, D.C. itself is weak, but those buildings are generally financed by real estate investment trusts and life companies. In contrast, Class A space in rest and town centers is near full capacity. Regardless of where we are; you'll see later in the presentation that we do very little pure office space lending. Demand for housing is high, and supply is very low. Our builders are selling homes as fast as they can be constructed. Condos are selling a little slower, but they are selling. We still do not compete on price; we compete on quality and service. For us, every day is game day. MNSB common stock is an undervalued opportunity. We closed the quarter with a market price at 77% of tangible book. Last Friday's close was at 73% of tangible book. Today is even less. Our asset quality is strong. Our risk management is robust. Our 2023 performance was overall superior to the peers. The one thing that's vexing us, deposit costs, is the very thing we are solving with our Avenue solution. Think about it. We have six branches. Most banks our size have 26 branches. If we built 20 more branches, we would spend substantially more per year on those branches than we'll spend on Avenue per year. And we'd still be paying market price for the deposits. Instead, we built a best-in-class solution to meet the fintech market where they are. Fintechs need a bank like us. For fintechs, we provide permanence with our partnership. We provide a solution that is faster to market. We provide our fintech partners with breakthrough regulatory technology and better pricing because there's no middleware to feed. Most important, we eliminate a fintech's need to have a backup bank because we're here to stay. We are the resilient solution fintechs have been waiting for. You have a choice, of course. You can wait to see our success. As the British say, the proof of the pudding is in the eating. At that point, will you get us at $0.73 on the dollar? Will you get us at tangible book? Or will our market price reflect the performance of a small-cap bank stock that has bridged the gap between banking, fintech, and regtech? This is an exciting time as we continue our transformative journey. At this point, I'm going to turn the presentation over to Alex Vari. Alex is our Chief Accountant; he works closely with Tom Chmelik to ensure the accuracy of our books and records.

Alex Vari, Chief Accountant

Thank you, Jeff. Slide 22 summarizes our financial performance over the past four quarters. This quarter is down slightly, due primarily to increased deposit costs. I'll summarize in the following five ratios. Our EPS for the quarter is $0.36; our efficiency ratio is 76%; our annualized return on average assets is 0.65%; our return on average equity is 5.97%; our net interest margin is 3.24%; our net loans increased $22 million for the quarter, and our total deposits increased $47 million. Total assets held relatively steady quarter-on-quarter, as did net charge-offs at 0.03% of a percent. Our liquidity remains strong with good ratios throughout. We have $507 million available in secure advances through the Federal Home Loan Bank of Atlanta and an additional $129 million in unsecured lines from six different providers. As you look at slide 24, you will see that our cumulative cycle loan beta is 52% and our cumulative cycle deposit beta is 61%. The graph tells the story best. Our earning assets were well positioned for the interest rate cycle, shifting in lockstep with changes to the effective fed funds rate. Deposit rates lagged nicely until the collapse of SVB, First Republic, Signature, and Silvergate. After that point, deposit rates became very competitive across the nation. This is depicted nicely in slide 25, which shows our quarterly net interest margin through the interest rate cycle. We are focused on controlling our deposit costs as we move forward. Our core deposits remain healthy at 76% of total deposits. Non-interest bearing demand deposits encompass 20%, and 26% of core deposits. The overall weighted average cost of core deposits is 3.32%. Non-core deposits represent 24% of total deposits, with a weighted average rate of 4.89%. It is important to note that $173 million of the term deposits have a weighted maturity of 42 months and are callable at our discretion. At this point, I'll turn the presentation over to Tom Floyd, our Chief Lending Officer, to discuss our loan portfolio and loan performance.

Tom Floyd, Chief Lending Officer

Thank you, Alex. As we look at the loan portfolio, it's worth remembering that so much of lending is about discipline. We have disciplined underwriting, which starts with an independent team of analysts. The team produces comprehensive credit memos that over the years have been commended by regulators, auditors, and loan review specialists. This is an important first step in controlling and minimizing the riskiness of the loans we underwrite. Equally important is the discipline of loan pricing. We are a commodity business. We don't set interest rates; we set a risk spread, which we define in our credit risk policy. Loan pricing isn't just about setting the rate; it's also about setting the duration for the rate. Just as we focused on writing floating rate loans during the low, flat interest rate cycle leading up to 2022, we've now shifted the portfolio so that 64% of the loans have fixed rates and 56% of the floating rate loans have floors with a weighted average of 6.29%. For the fixed rate loans, slide 29 shows a nice laddering of maturities over the next five years and beyond. We continue to proactively manage our portfolio, and part of that process is to engage our customers to learn whether they're having any cash flow or liquidity concerns and work to address them now, so that we maintain healthy relationships going forward. Slide 30 shows that we are managing our concentration on investor commercial real estate and construction. This is our best asset and continues to perform at a very high level for us. Slide 31 shows the results of our hard work. We charged off 0.03% of gross loans in the first quarter, and just half a percent of our total gross loans are non-performing. We're optimistic that 80% of the non-performing loan balances will be favorably resolved before the year ends. Just 2.12% of our total gross loans are criticized or classified this time. We originated $54 million of new loans during the first quarter with a weighted average rate of 8.37% and good loan-to-value ratios. Our office exposure has reduced from $23 million to $15 million. We had an $8 million office construction loan that was completed and became unoccupied. Slide 34 reflects the construction portfolio, which is diversified both by type and location. The construction book has a weighted average interest rate of 8.49% with good loan-to-values throughout. It's important to note that 86% of the construction portfolio loans have interest reserves, funded by the customer. The remaining 14% of construction loans are to customers with strong liquidity and a good track record of performance. Likewise, our non-owner-occupied commercial real estate is also diversified by type and location with a weighted average interest rate of 6.14% with good loan-to-values and good occupancy. Our owner-occupied loans also reflect good diversification and a weighted average rate of 5.97% and good loan-to-values. The Q1 stress test for all earning assets reflects a worst-case stress loss estimated at $38.7 million. The stress test includes loan-level testing for all construction investor commercial real estate. For all other loan categories, we use the balance in each call report category multiplied by our worst ever loss for that call report category. For investments, we use the market price, and for bank-owned life insurance, we determine the liquidation value. Slide 38 shows the trend in stress tests over the past five quarters and the resulting impact to capital. In all quarters, we remain strongly capitalized. That wraps it up for our loan presentation. As you can see, our goal is to be as transparent as possible. I'll turn it over to our CFO, Tom Chmelik, to wrap things up.

Tom Chmelik, CFO

Thank you. As Tom Floyd has indicated, we are very well capitalized. We also have a good capital stack consisting of a good mix of common, preferred, and subordinated debt. Finally, our accumulated and other comprehensive loss is just 3% of capital. As we look at the remainder of 2024, we offer the following guidance. The expense run rate will continue to average 1.2% per month through the remainder of 2024, as previously indicated. Our goal for Avenue is to reach $225 million in deposits and $2 million in fees, and we project low-single-digit loan growth for the remaining portion of the year. As Jeff said earlier, Main Street Bank has a very strong culture, and we've posted some excellent results. We are in the business of taking risks, and our team is well placed to identify, measure, monitor, and control those risks. We'll do our best to continue to prove that to you quarter-on-quarter. Despite our strong and consistent performance, we are trading at a discount to tangible book value. We are a great bargain today. We'll address the questions you've submitted through the portal after we hear from our analysts. Chris Marinac from Janney Montgomery Scott, we'll start with you.

Chris Marinac, Analyst

Oh, thank you very much for hosting the call. I wanted to start on just understanding the net interest margin and if we are near a bottom of that or do you think we still have a few more quarters to go before that kind of flattens out?

Jeff Dick, Chairman and CEO

My personal opinion on that is I think we're going to make good progress as we go forward. It's hard to say what the market is going to demand as we continue to look for whatever types of deposits we can to grow, but I feel like we should be starting to sort of get to that curve. If the things that we have in the hopper today materialize, I can't say that with 100%, but I think it looks positive.

Chris Marinac, Analyst

Great, and I guess my follow-up has to do with just the pace of loan growth where you don't have as much pressure or maybe any pressure on funding. Is there a happy medium on sort of a quarterly or annual growth pace?

Tom Chmelik, CFO

I think the rate of low to mid-single-digit loan growth right now is what we're looking at, as far as that goes, as far as not putting too much pressure on the funding side.

Jeff Dick, Chairman and CEO

Yes, Chris, a lot of it has to do with the availability of lower-cost funds. Our market has opportunities and good opportunities. We're just being cautious and careful right now because we don't want to fund everything at the margin. So it's a tightrope walk right now.

Chris Marinac, Analyst

Understood. And I guess just the last question for me has to do with Avenue. Should we see some deposit progress in the second quarter, or is it still pretty much a third and fourth quarter likelihood to get to this year's goals?

Jeff Dick, Chairman and CEO

So, I mean, technically, we're looking at the third and the fourth quarter. We're hoping that we see some small deposit growth in the second quarter. But it depends on how fast these fintechs can get their apps fully connected with our solution and then get them out there and start getting their market share. We think that the second quarter is going to be where they connect and get started, and then it really depends on how fast they can grow, and that's a bit outside our control.

Chris Marinac, Analyst

Great, thank you for taking my questions. I'll yield the floor.

Jeff Dick, Chairman and CEO

Thank you, Chris. Matt, do you have any questions for us today? I didn't check in with Matt earlier to see if he was going to be available for today's call. It was an assumption on my part. So he may not be available. If he does join us, we'll let him interrupt. Andrew, can you read off some of the questions that we've got from our viewers today?

Operator, Operator

Yes, the first question regarding the six Avenue clients that are underway, what are the revenue and deposit expectations timeline-wise?

Jeff Dick, Chairman and CEO

Good question. The first one that we have and that we had announced, Safari Pay, doesn't have a big deposit. I think it's $3 million to $5 million. It was a good one for us to start with. After that, they haven't shared that level of data with us. Like I said, it really, at least one of them, I know, depends on their success with market penetration. They have a very good opportunity. It's hard to say at this point, but I feel like the next wave coming in, our expectations are much better than the first. I know there's one relationship that has promised us fairly meaningful deposits that will get us that alone, I think close to 50% of the way to our $225 million goal. So we still feel like that is an achievable effort.

Operator, Operator

All right, Matt Breese is submitting his questions through the portal, so I'll jump to those real quick. He's asking, what happened on the credit front with a $9 million pickup and non-performing loans? What industry and what is the workout process timeline estimated?

Tom Chmelik, CFO

That is related to one project that is in construction. We're expecting the certificate of occupancy in any day at this point in time. That project is currently under contract for an amount that would fully repay our debt and interest. We're optimistic that will be resolved by the end of the year.

Jeff Dick, Chairman and CEO

And that actually, I think just went under contract very recently. So I think that's going to be a good story for us. It's a very high-quality builder. He's had years of success. I think it's one of those classic events where if anything could go wrong, it did, including getting finalized, power connected, which took about a year longer than anticipated. Some parts of the D.C. machine still move fairly slowly, but I think it's going to have a happy ending for us, and we'll definitely know before, hopefully, the end of the year.

Operator, Operator

All right, Matt's next question is, there remains a significant gap between where we stand with Avenue deposits and fees year-to-date versus the 2024 goals. Can you provide some color and confidence in achieving these figures this year?

Jeff Dick, Chairman and CEO

Yes, and again, we've said pretty much all along that it's going to be really a second-half of the year focus. I think we've got fairly good confidence that we'll get to $100 million. The team is very confident that we'll get all the way to $225 million, and it's our goal, and they're working very hard to get there. We're not letting up on that. Like I said, we've budgeted for those numbers. We've committed with the board that we'll get there and will be held accountable. We feel strong. I know it's, I'd rather be a little further along at this point, but I still think that we're going to get there. We've got the six that are pretty much working towards getting active, and then we've got a good number behind them that we'll continue to work with to get through. I think the other side of this is that once we prove it out in the industry, once we show how well it works, I suspect many other fintechs that may have had a relationship where middleware was involved will hopefully look to us to provide that more reliable solution. We have a great story to tell, and we're doing everything we can to achieve it. So we have a great outcome.

Operator, Operator

I guess one last question. Can you run through the expectations for the ROA for the remainder of the year as NIM is down 25 basis points this quarter and your expense is growing by 1.2% per month? Where do you expect ROA towards the end of the year?

Tom Chmelik, CFO

Yes, good question. Like we've said all along, we expect really good performance in the back half of the year. What you're seeing now is not where we want it to be right now, but as we get stronger performance in the back half of the year, you're going to see kind of outsized returns in those areas.

Jeff Dick, Chairman and CEO

I'll add one more thing to that is that the NIM will improve because of the non-interest bearing deposits coming in from Avenue in the latter part of the year. If rates stay where we are today and we don't see these rate decreases that we thought were going to occur, we will see an improved NIM.

Operator, Operator

All right. That's the last from Matt Breese for now. Next question, what are we doing to grow core deposits the old-fashioned way outside of the Avenue platform?

Jeff Dick, Chairman and CEO

That's also a great question. The business banking team is working very hard; they're going up, you know, on an individual by individual basis. I think there's 11 business bankers out there in the market. We do have six locations. They team together; every day they're seeing some forward progress. It's tough right now. It's interesting. I just saw a survey, and I don't remember the source, but only 1% of depositors across the nation have over $250,000. So it is a lot about doing it the old-fashioned way, one at a time. They're working hard on the business relationships. I know they've got a few different events planned to try to bring people together to tell our story. The team generally converts relationships once they get into the right people. The lenders are also working hard.

Tom Chmelik, CFO

To that end, we're focusing on taking care of our good clients because when we take care of our good clients, we meet more good clients through them. That's how we get a lot of referrals. So we're making sure that as we're focused on our core customer base, we're deepening those relationships and looking for ways to get in front of clients that we're excited to bring into the bank, albeit it's at a slower pace than we've brought on historically. It doesn't mean we're not adding net new good relationships to the bank.

Operator, Operator

The next question is, is the first quarter's decrease in tangible book value per common share an anomaly? How do you expect the remainder of the year to look?

Alex Vari, Chief Accountant

Yes, great question. As part of their equity incentive plan, the employees get shares awarded to them for bonuses in the year. So we added shares, which is a one-time event that we do in January. That's a one-time occurrence that will not continue to happen throughout the year.

Jeff Dick, Chairman and CEO

So yes, our bonuses are generally paid half in restricted shares that vest over three years. So that January vesting always increases the number of shares outstanding.

Operator, Operator

Another question, why are we seeking in the proxy to increase the total share count?

Jeff Dick, Chairman and CEO

In the normal course of business, just as good prudent corporate management of our overall corporate use of shares, we need to have that done for us on an ongoing basis. We have no plans for any use of those shares at this point in time; it's for general corporate purposes going forward. In the event that something comes up like a merger, we'd be prepared for it at that point in time, but we have no plans at this moment to use any of those shares.

Operator, Operator

We also have a lot of folks asking, what's the status of our buyback program today?

Jeff Dick, Chairman and CEO

The status of the buyback program right now is that there are 4.1 million remaining in the current buyback. In the first quarter, as we disclosed in the filing, we had purchased back about 22,000 shares. Obviously, there were no blocks during that time, so we weren't able to purchase blocks, and we have to adhere to the rules. Our allotted amount on a daily basis is only 4,200 shares, and it obviously is driven by the market, whether it's going up or down, and whether we can buy those even in a single day.

Operator, Operator

Last question that's on here. When are insiders allowed to buy shares given the blackout periods? And do you expect any buying in the coming months?

Jeff Dick, Chairman and CEO

The insiders have to adhere to all the blackout periods. Our blackout will end the morning of Wednesday the 24th, I believe. We'll have up until two weeks before the next blackout period starts, which is typically two weeks before the end of the quarter. That's it for now. As always, if you have any questions or want to speak to us online, we're always happy to engage with you. Ben, I think you're getting off light today. I brought Ben Baboval because he's our Chief Risk Officer, steeped in compliance. Sometimes when we have these conversations, especially on Avenue, people want to know how we do things differently. So maybe you can explain when those consent orders come in and what we look at?

Ben Baboval, Chief Risk Officer

Yes, sure. Typically, when we see those consent orders come in, we will look through that consent order, examining all the different reasons why those things were issued, and compare their actions to ours to determine how we solve for it or how we have solved for it. That goes back to interagency guidance and a variety of statements we see from regulators.

Jeff Dick, Chairman and CEO

Yes, with that in mind, we look at those and compare them with our processes to see if we need to make tweaks to comply with what regulators are looking at. We feel like we've done a good job adhering to all the laws, rules, regulations, and best practices, but like anything, there's constant change. Ben and his team assist in that process. Going forward, it will be a good success story. I think many fintechs will be looking at us not only because we have the right systems but also because we can provide a more reliable solution with lower costs to them. As I mentioned earlier, there are fewer middlemen to feed in this process. To ensure a smooth transition, we focus on connecting their application with our ledger through APIs, compliance training, and templating all required policies. We evaluate their business plan, financial situation, and vendor management simultaneously. We're adaptable and work as quickly as fintechs can move. Once this space is functioning efficiently, I anticipate many success stories. We realized it took longer than expected, but we've controlled costs efficiently. So again, thank you, Andrew, for reading the questions for us. We appreciate your investment. I can't believe what the stock has done today. I know our margin is compressed, but we're still in the 3s at the end of the day. If you look at a lot of our peer banks, they're trying to get back to the 3s. I don't underestimate that. Lastly, we have 2.1% of our total loans classified. During my years as a regulator, I never saw a bank with less than 15%, 20%, or 35% average. We have a pristine portfolio. The one significant loan that's non-accrual and substandard has a wonderful possible outcome. Everything is heading in the right direction, and we work hard to make those things happen for you, our investors, benefiting all of us. Thank you for your time, and I look forward to talking with you again in the future. Please always reach out if you have any questions. Have a great day.