West Bancorporation Inc Q2 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the West Bancorporation Incorporated Earnings Call. My name is Irene and I will be coordinating this event. I would like to turn it over to our host Jane Funk, Chief Financial Officer. Jane, please go ahead.

Thank you and good morning, everybody. Thanks for joining us on the call this morning. Today on the call, we've got myself; Dave Nelson, our CEO and President of WTBA; we've got Harlee Olafson, our Chief Risk Officer; Brad Winterbottom, our West Bank President; and Brad Peters, our Minnesota Region President. I'll start out reading our fair disclosure statement. Any 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. And with that, I'll turn the call over to Dave Nelson to get us started.

Thank you, Jane, and thank you everyone for joining us. We very much appreciate your interest in our company. We had another good quarter with strong performance metrics. I just have a few general comments and then we'll turn the call over to others for more details. We have declared a $0.25 dividend to common stockholders payable August 24th to shareholders of record as of August 10th, 2022. While the increasing rate environment is putting pressure on our margin, our credit quality has continued to improve to the point where we almost have an absence of problem loans or even past due loans. In most of our communities in which we do business are all sitting on record building permits. The extent of the impact that our inflationary marketplace coupled with the corresponding increasing interest rates will have on delaying or perhaps stalling some of this activity remains unknown. However, in any event, we have a strong pipeline in pristine credit quality. With that, I'd like to turn the call over to our Chief Risk Officer, Mr. Harlee Olafson.

Well, thank you, Dave. Again, this is Harlee Olafson, and I'm going to make a few comments on our credit quality. First being that our credit quality, in our opinion, is in the best shape that it has ever been. We have no past due loans over 30 days. Our philosophy that there is not enough margin in banking to take on risky credit has served us well in the past and hopefully in the future. We don't feel we have concentrations in business that may suffer unduly in a recession; certainly, there may be some challenges, but we believe our strong customer base will manage through an economic downturn. Previously, we had one significant credit on non-accrual within our portfolio that has now been resolved. We had a $2.5 million specific loss reserve assigned to that credit and the loss after payoff was less than $500,000. This freed up a little over $2 million in reserve. Before I turn the call over to Brad Winterbottom, I will comment on our Eastern Iowa performance: loan growth in Eastern Iowa has continued to be strong at approximately 9% year-to-date. Prospects for future business there are good, but we also see that there has been a slowdown in new projects there and in our other markets. Again, I will now turn the call over to our Bank President, Brad Winterbottom.

Thanks, Harlee. For the quarter, total loan growth is approximately 3%, which was an excellent quarter. Going forward, we have headwinds in front of us. We have a couple of loans, three loans that are commercial construction projects that have matured and two have paid off as of today, with the third one expected to pay off through the remainder of this year, and those three total $100 million. We have some replacements for those, but in terms of the growth pattern, I think that will probably slow some things up. We're seeing our homebuilding business, which we have a nice portfolio of dealing with very reputable long-term homebuilding customers in Central Iowa, they are slowing given the interest rate environment, and we're seeing some deals getting passed on or in the planning stages we're working on due to the supply chain issues, uncertain construction costs, and the rising rate environment. Some of those folks have put that on hold, which makes sense to them, it makes sense to us. We have a very long list of other things that we're working on to replace some of this volume. I can tell you where that will end up, but obviously with the rising rate environment it's a lot harder to refinance something today than it was maybe six months ago. We're in a deposit-gathering mode right now. We've lost some deposits. Existing customers are using their money to do other things; one was a significant acquisition that they funded out of cash. So we're gathering deposits. We're still making calls daily on customers and prospects, and I anticipate that will not change. Mr. Peters, you are next.

Thanks, Brad. Good morning, everyone. I'm going to provide a brief update on our market expansion into Minnesota. Our team continues to make good progress in growing business in each of our Minnesota regional centers. Each of our markets are seeing solid growth; our bankers are focused on building relationships and our activities have created ongoing new business opportunities. We continue to grow our business by adding new relationships focused on C&I. This focus has driven strong core deposit growth and treasury management business. We opened our new building in St. Cloud during the month of March and the Mankato market has begun construction of a new facility with plans for completion in the middle of next year. Our Owatonna market is in the process of exploring potential new sites for building. That is the end of my comments. I will now turn it back over to Jane.

Thanks, Brad. I'll make just a couple of comments on the financial statements. On the income statement, we did record a negative provision this quarter. The total negative provision for the year is $2.5 million that's primarily driven by the impaired loan that we had that was our significant impaired loan that was settled. In June, we had a specific reserve on that particular relationship of $2.5 million. Our ultimate charge-off was $451,000. So that was the primary reason for the negative provisions in the second quarter. Our effective income tax rate was higher this quarter due to the Iowa Bank franchise tax rates; there was a change in those rates that were enacted in June and that resulted in us remeasuring our deferred tax assets as a result of those changes in tax rates, leading to an additional tax expense of $671,000 in June. So that's a one-time event, a one-time remeasurement of the deferred tax assets, and the significance of the amount is really driven by the large deferred tax asset on the investment portfolio. From a margin standpoint, our margin for the quarter was 2.93% compared to 2.99% last year, and year-to-date we are at 2.89% compared to 3.08%. The 2021 numbers have more of an impact from the PPP loans. So when we look at the decline in margin, part of that is driven by fewer PPP fees recognized in 2022, and then also just recognition of the rate environment that we're in—pressure on the deposit side for pricing, as the market rates increase and really continued pressure also on the loans side in our markets. We're still seeing a fairly high level of competition and pricing competition on loans. We did complete our sub-debt issuance in June—around June 15th. We issued $60 million of sub-debt at the holding company level, and the net proceeds of that were injected into West Bank capital. Brad had mentioned our decline in deposits, primarily driven by existing customers using some of their liquidity to complete business transactions, rather than borrowing for those transactions or using their cash, and then also some accounts that were a little bit more sensitive to market rates moved some money into treasuries that accounted for the vast majority of our shift in deposits in the second quarter. That's all the comments that I have on the financial statements, and I think we will open it up for questions at this time.

Thank you. Ladies and gentlemen, we will now begin our question-and-answer session. Our first question comes from Brendan Nosal from Piper Sandler. Brendan, you can go ahead.

Hey, good morning folks. How are you?

Good morning, Brendan.

Good morning.

Yes. First, congratulations on the credit clean-up in this quarter. Certainly nice to see. Maybe to start off on the growth side of things, based on your prepared comments, there are definitely some competing factors with strong pipelines, but higher anticipated payoffs as we move through the year of that $100 million. Can you help me just kind of tie that to get, what you're expecting for loan growth to the balance of the year?

That's really kind of hard to say, but I'll give it a shot. We have picked up a couple of other nice construction projects and large ones. So, that's going to replace the items that I talked about in terms of the pay-off that happened in the month of July, and another one that is a condo project that will get paid off as those units are sold. And those are all scheduled to be closed, the vast majority of those, by the end of this year. So, I think we have some construction projects that are right behind the ones that are paying off. So we should catch that up, but that'll probably take maybe a year to do that, but in the meantime, we're working on—literally, I got a list here of our weekly pipeline report of things that we're working on and there are probably over 40 names that we're chasing that we're having significant conversations with. So I would not anticipate double-digit loan growth by the end of the year, but that's just my opinion and I have nothing in front of me that says that we'll have that or don't have that. I don't know if that helps, sir.

Yes, it certainly does. Thank you. Seems like you're saying that you don't think you'll achieve double-digits, and that's for the full-year, correct?

That's for the full year, based on what I know today.

Perfect, perfect. That's helpful. All right, good. Maybe moving on to the funding side here, kind of, I get the deposit dynamics you guys highlighted during the prepared remarks and hear you loud and clear that you are in deposit gathering mode, but just kind of help me understand the potential for additional deposit outflows as you look at things today? Will that pressure vein or do you think that dynamic will continue as rates move higher?

I think what we saw in the second quarter was a little bit of that; that was kind of a timing thing—that's when the Fed started moving rates. So we had some people that moved kind of quickly to alternative investments. I haven't seen that in the last few months; that would have been early in the second quarter. And then certainly the significant customer that had the significant transaction and was using cash for that—good for them for having the ability to do that. It's part of our deposit management process to manage those flows. I'm not seeing, at this point in time, any other large things like that happening. But we certainly know that the Fed just moved another 75 basis points and are expected to maybe move another 100 basis points this year, and that certainly—customers are certainly monitoring that as closely as we are. So it's hard to predict what the flows are going to do, but what's happened in the last couple of months has been pretty stable.

Okay, fantastic. That's a couple of color. Let's see, maybe turning to deposit pricing, so interest-bearing deposit costs were up 18 basis points quarter-over-quarter, the kind of feels like it's the data of 25% to 30% so far averages what Fed funds did this quarter. Can you update us on your deposit beta assumptions through this cycle? And then is what you're seeing on deposit pricing from the past couple of hikes?

Well, I think on deposit pricing, what you just mentioned for betas, our betas might be a little bit higher than the industry in general. But certainly, that's an ongoing management process for us in this environment of regular volatility and communication with our customers and what they're seeing as alternatives for their funds. And so I think the betas that you just mentioned probably will continue to see those betas throughout the year.

Okay, good. Turning to the margin this quarter. I guess, once you strip out PPP, the result was quite nice actually and it looks like kind of, remixing of the earning asset base really drove a lot of expansion—more loans and less cash and securities. So I'm curious if there's any more remixing of the asset base that you intend to do at this point?

Not. No, nothing specific.

Okay, all right, good. And then maybe kind of your thoughts on the margin outlook as we move through the balance of the year in light of what the Fed has likely continue short-term rates?

Yes, the margin is really going to be a function of managing the deposit betas, the deposit volumes that we can bring in, a function of the local market competition and the competition on the loan side also, not just the deposit side. So I think we're a little bit more liability sensitive, so we're still expecting to see some pressure on margin. We issued sub-debt in the middle of June, and so that pricing really isn't reflective in our margin yet. So it will just be a factor of how we manage through loan generation and managing deposit betas.

Yes, understood. Okay. See, maybe on expenses, I guess, core expenses were about 5.5% to 6% for the quarter to $11.3 million. Is that a run rate that you feel pretty good about for the remainder of the year? Or is there the potential for some more upward pressure?

I would think the rest of the year would be pretty similar.

Okay, perfect. Maybe finally on the capital ratio. So get capital ratios, like many other banks, were impacted again by AOCI, but the reg ratio there are still quite healthy. Just any updated thoughts on kind of how you view the discrepancy with a thinner TCE ratio today but still strong reg ratios?

Yes. Our GAAP capital right now, the biggest impact on that is the investment portfolio and the fair value adjustment on the investment portfolio. So that'll vary among institutions depending on whether they've got held to maturity securities, what their level of available for sale is, so the comparability to other institutions gets a little bit clouded from stuff like that, but we continue to watch it, but we don't have any specific actions that we plan at this same time to change our strategy.

Yes. Okay, perfect. One final one from me before I step back here. Just on the tax rate, I know there was the one-time expense this quarter related to the Iowa tax law change. Outside of the one-time expense, will there be any go forward ramifications on your effective tax rate?

Not that I'm aware of at this time.

Okay, all right. Perfect. All right, well, thank you so much for taking my questions.

Thanks, Brendan.

Thank you. It appears we have no further questions at this time. I would like to return the floor to Jane Funk for any closing remarks. Jane, please proceed.

Yes, thank you. Once again, we just want to thank everybody for joining us and having an interest in our company this morning. And we'll talk to you all again next quarter. Thank you.

Ladies and gentlemen, this concludes today’s conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now.