West Bancorporation Inc Q2 FY2021 Earnings Call

Good day and welcome to the West Bancorporation Corporation Quarterly Earnings Call. All participants will be in a listen-only mode. Operator instructions: Please note this event is being recorded. I would now like to turn the conference over to Doug Gulling, Chief Financial Officer. Please go ahead.

Hey, thank you, Matt. Good morning, everyone. Thank you for joining us. On the call today from West Bancorporation Corporation, we have Dave Nelson, our Chief Executive Officer; Harlee Olafson, Chief Risk Officer; Jane Funk, Chief Accounting Officer; Brad Winterbottom, West Bank President; and Brad Peters, our Minnesota Group President. And we’ll begin with our fair disclosure statement. Comments made during this conference call may contain forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any forward-looking statement made by us during this call is based only on information currently available to us and speaks only as of today's date. The company undertakes no obligation to revise or update such statements to reflect current events or circumstances after this call, or to reflect the occurrence of unanticipated events. With that, Dave Nelson will start us off.

Thank you, Doug, and good morning, everyone. Thank you for joining us and for your interest in and support of our company. While everyone is back to work at West Bank, all COVID loan modifications have expired and our bank is operating under normal non-pandemic protocols. West Bank had another record quarter. Our loan growth net of PPP during the first six months, year-to-date, was 6%. And we have a good pipeline. So based on this performance, we have declared a $0.24 second quarter dividend, which will be payable August 25 to shareholders of record as of August 11, 2021. With that, I'll turn the call over to Harlee Olafson, our Chief Risk Officer.

Thank you, Dave, and good morning to everyone. I will address credit issues first. Overall credit quality at West Bank is very good. At the end of the quarter, we had only one loan past due over 30 days in the amount of $85,000. This loan is a home that will be paid off in August. Our Texas ratio dropped from 9.3% to 5.31%. Our one significant non-accrual borrower has sold one of their properties. It is expected to close on September 1, 2021, and will decrease our non-accrual by over $5 million. Other properties are also in play. One has a preliminary memorandum of understanding (MoU) that would provide for a sale of $10 million. We believe the specific provision of $3 million that we have on this one credit is more than adequate. One significant credit on our watchlist was severely impacted by the pandemic. I'm pleased to say that they are recovering nicely and are positively cash flowing. We will wait to see sustained performance before we upgrade. All COVID modifications have expired and all customers are back to full payments as of June. PPP loans continue to pay off; we're getting regular reductions on those balances on almost a daily basis now. Credit trends are good and businesses have significant liquidity. I know that Brad Winterbottom and Brad Peters will discuss markets in Minnesota and Central Iowa, but I would add that our Eastern Iowa market is doing very well and has a significant pipeline. And with that, I will turn this over to Brad Winterbottom, our President.

Good morning everyone. Dave mentioned 6% loan growth year-to-date. We had 3% in the first quarter and 3% growth in the second quarter, so we're up $125 million in loans. That growth is really spread across all of our markets. There has been good demand in all markets and our pipeline remains very strong. When I look at the pipeline, there are a lot of good names in all of our markets that we are pursuing. Deposits are also up $125 million for the first six months. We're gathering deposits; Harlee mentioned the lack of past dues. Our customers seem to be doing very well. There is demand out there. It is tough — there are very aggressive interest rates from our competitors. We're holding our own. And with that, I will pass it over to Brad Peters to talk about Minnesota.

Thanks, Brad. Good morning, everyone. I'm going to provide a brief update on our progress in Minnesota. Our team continues to make good progress in building our presence in each of our Minnesota regional centers. Our calling activities continue to focus on commercial and industrial (C&I) lending and our pipelines remain robust. Loans outstanding in our four Minnesota markets have grown to nearly $560 million and our C&I focus has driven strong core deposit growth and treasury management business. We continue to make progress on our new building in St. Cloud. We're anticipating opening that new facility late this year. The Mankato market is scheduled to close on a building site in mid-August, and we're expecting to begin construction later in the fall. That is the end of my comments. I will now turn it over to Jane Funk.

Yes. Thank you, Brad. I'm just going to give a little information on the PPP loan activity and the impact on net interest income. For the second quarter, interest income on the PPP loan portfolio was $1,387,000 year-to-date. Our total PPP income was $4,229,000. The acceleration of fees in the second quarter was around $700,000; year-to-date acceleration is about $2,700,000. Our balances on PPP loans at June 30 were $85 million. We had unamortized fees remaining on $85 million of $3 million; the vast majority of that is in the second round of PPP. And with that, I'll turn it over to Doug.

Okay, thanks, Jane. I just have a couple of comments related to provision and margin. On the provision, as you know, we took a negative $2 million provision in the second quarter. I would say that that was primarily due to the adjustment of some qualitative factors. We dropped our qualitative factor related to the overall economy by 5 basis points due to what we perceive to be improvement. It is still well above the pre-pandemic factor that we had been using. We also made a small adjustment in qualitative factors related to our commercial real estate (CRE) portfolio due to the improvement there. As far as the margin is concerned, looking ahead, we would say that we expect the margin to be under some pressure due to the fact that we have little if any repricing power on the deposit and liability side. Any loan payment, loan payoff, any investment maturity, or paydown on mortgage-backed securities generally gets renewed at a lower rate. Offsetting that, and what will be a positive, is as we continue to decrease the amount of Fed funds and put that money into the investment portfolio, that will be an offsetting positive. But overall, it will probably be a little bit of pressure on the margin. And with that, we would like to entertain any questions.

We will now begin the question-and-answer session. Operator instructions: At this time, we will pause momentarily to assemble our roster. Our first question will come from Brendan Nosal with Piper Sandler. Please go ahead.

Hey, good morning, everybody. How are you?

Good. Good morning, Brendan.

Maybe to start off here on the growth side of things — obviously another quarter of very strong results. You folks have managed to kind of push through the general lending slowdown that has plagued a lot of other small banks over the past year. It sounds like pipelines remain quite strong, and you're still getting in front of good opportunities. So I guess my question is: you've been doing kind of 6% growth year-to-date — is that something reasonable going forward, kind of 10% to 12% annualized?

Yes, I would say that's a good assumption based upon what we're looking at today.

All right. Fantastic. Maybe turning to the expense side of things: I'm just kind of curious for a little bit of color on the expense outlook and where you might see opportunities over the next year or so just to keep an eye on the overall cost base?

We wouldn't expect any wild fluctuations in our expenses. This year, FDIC insurance premiums were up some because our deposit mix and asset size changed. In the compensation area, the price of our stock at the time that RSU grants are made influences expense. But beyond that, we would expect our expenses to remain pretty well under control and continue to have a very favorable efficiency ratio.

Okay. That's helpful color.

We are — and I would add, Brendan, we've added a couple of bankers in our markets. The expectation is that they will more than pay for themselves.

Yes, of course. Okay. Excellent. You folks mentioned one of the positive offsets to potential margin pressure is your ability to invest Fed funds into higher-yielding securities. I'm just kind of wondering, how much in terms of balances do you think you'll be able to put to work and what do those rates look like today for you?

We have roughly $250 million in Fed funds. We don't have a real specific target, but I would expect that we could put another $100 million to $150 million to work over the next few months. We're doing a somewhat gradual transfer of that money. I think we moved $60 million in May and another $60 million in June. We get a little bit in July and will probably ramp that up somewhat in August and September. As far as the reinvestment rates, they aren't impressive. We're staying relatively short on those purchases. If we can get above 1%, we feel pretty good.

Okay, excellent. Just trying to think about adequate reserve levels as the overall economy improves. This quarter had a negative provision and you released some reserves, but you still have a much higher overall level than pre-COVID. I'm wondering your thoughts on the glide path for the reserve ratio, where that might settle, and whether getting there comes in the form of loan growth or outright reserve release?

We don't have a target ratio. The ratio is the result of our analysis every quarter. The factors that go into that are what you would expect: loan growth, changes in the watchlist and the direction of those changes, and then an overall evaluation of our various qualitative factors. So we don't have a target ratio; we let the ratio fall where it may after we evaluate all those pieces.

Okay, that's fair. Maybe last one: there were some nice improvements in total criticized assets this quarter, but they're still trending above where they were at this point last year. How do you view the timing and drivers of further improvement to work through that remaining credit noise?

I will respond to that. We had an increase in the watchlist and that was really due to one specific customer. That customer is showing improvement, but we would look to see sustained improvement in cash flow over a period of time before we would upgrade. Our risk of losses there is minimal, so it's not a loss-driven situation. It's really a situation of recovering from pandemic-type issues related to reduced operations and then ramping the business back up. Even though the criticized levels are higher than they have been, I'd also comment that the overall watchlist and all categories within it are less than 5% of total loans, which in historical perspective is still very low.

All right. Excellent. Thank you for taking my questions, everybody.

Thanks, Brendan.

As there are no more questions, this concludes our question-and-answer session. I would like to turn the conference back over to Doug Gulling for any closing remarks.

We would just like to thank you for joining us this morning. Again, we appreciate your interest in our company. So thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.