Equity Bancshares Inc (EQBK) 2022 Q2 法說會逐字稿

Thank you for standing by, and good day. Welcome to the second quarter 2022 Equity Bancshares, Inc. Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chris Navratil. Please go ahead.

Good morning, and thank you for joining Equity Bancshares conference call, which will include a discussion and presentation of our second 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 1, 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.

Thank you, Chris. Good morning, and welcome to our second quarter earnings call and thank you for your interest in Equity Bancshares. I'm pleased to report the bank had a very successful second quarter, continuing to build our momentum from our strong start to the year. We successfully completed the sale of 3 branches in the second quarter, which included $53 million of deposits and $26 million of loans and resulted in a gain of $540,000 in noninterest income. Our EPS was $0.94 versus consensus of $0.75. Net interest income and net interest margin both increased moderately quarter-over-quarter, but expanded significantly on an adjusted basis. which Eric will walk you through.

We continue to see the benefit of the hard work performed by our special assets and credit teams with nonaccrual loans down quarter-over-quarter. The improvement of existing and introduction of new products and services continue to positively impact our earnings composition. We were active during the quarter with our buyback. We'll continue to keep our eye on tangible equity as it relates to our buyback activities.

I'll let Eric take you through the numbers, and then we'll walk you through some of our areas of focus for 2022.

Thank you, Brad, and good morning. Last night, we reported net income of $15.3 million or $0.94 per diluted share. Noninterest income increased late quarter to $9.6 million and noninterest expenses less merger costs increased $2.2 million linked quarter to $31.3 million. We calculate core EPS to be $0.91 per diluted share. To reconcile GAAP earnings to core earnings this quarter removed merger expenses of $88,000 and a gain on branch sale of $540,000. I'd note in the second quarter, we recognized $402,000 of PPP fee and interest income compared to a peak of $8.2 million recognized in the third quarter of 2021.

We haven't been excluding PPP from our core numbers given its contribution to our financial results for the last 8 quarters. But its contribution is now de minimis and we are pleased about the improved quality of our second quarter earnings. Our GAAP net income includes a provision for loan loss of $824,000, the uncertainty of the economic environment and continued impact on the economy from previous stimulus measures are reflected in our qualitative and economic components of this calculation.

The June 30 coverage of ACL to non-PPP loans is 150 basis points, up from 148 basis points the previous quarter. I'll stop here for a moment and let Greg talk you through asset quality for the quarter. Greg?

Thanks, Eric. We had another excellent quarter in credit and special assets with no measurable migration into our classified assets and continued improvement in legacy balances of the same many of those assets, approximately 70% acquired in mergers and the trends in nonaccruals and net charge-offs are very positive as well.

From the analysts on the call today, I believe most have met John Creech, our new Chief Credit Officer. John has now been with Equity Bank for 2 full quarters, and he and his team in credit have continued to do great work, and we are excited about the future and credit under John's leadership. John, will you take us through your thoughts on our credit culture and credit production as well as share details on credit and special assets?

Thanks, Greg. I too am excited about the future of Equity Bank and how my team can contribute to our success. I will begin with some highlights on special assets. Under June Pressnell's leadership and a lot of hard work by the lenders and our credit specialists, our classified assets have declined to their lowest level in many years. As Greg mentioned, inflows are minimal and improvements are plenty, specifically in several assets acquired in mergers, whose operating performance has increased measurably. Our classified asset ratio continued its downward trend to 13.1% at June 30 versus 17.1% linked quarter.

In addition, our portion of the aviation-related credit discussed in previous quarters is currently on our books for less than $1 million with a disposition expected to close in the third quarter. Nonaccrual loans declined 9% in the quarter as well and are just 59 basis points of total loans, our lowest level as a public company. Our credit culture is what I expected. Strong underwriting across a wide range of asset classes, and it takes advantage of the diversity in our footprint. We have ample opportunities to bank credits in Western Missouri which is a different market than Kansas City and the same is true for Western Kansas and Wichita in Northern Oklahoma and Tulsa and Northern Arkansas. We can maintain a safe and conservative credit posture and still meet our production goals because our markets are each different.

The bank has done a really good job from the beginning of understanding diversification and managing concentrations of credit. All regions adhere to the same underwriting standards but have flexibility to work with customers to responsibly grow their banks which allows us to bank a variety of industries and segments well. In the quarter, our department ran a stress test on 1/3 of our portfolio with no projected exposure given the current rate environment. We will continue to do this in future quarters and adjust concentrations in underwriting on a dynamic basis.

I'd like to add that our sales culture under Craig Anderson continues to generate a healthy pipeline which stands at about $550 million today. Each of our loan officers in all our regions utilized an intentional sales process. We cultivate relationships through identification of products that meet the needs of our customers. As we look to build relationships in future quarters, our platform will be our advantage.

Thanks, Brad. I do think it's worth commenting about our general reserves. This is the second consecutive quarter of general reserve build due to the economic environment. including market rate increases leading to extension within the portfolio. These reserve builds were offset in the broader ACO by specific credit adjustments as facts and circumstances surrounding previously acquired assets continued to improve. Uncertainty surrounding the impacts of inflation, supply chain disruption and input cost escalation that our customers are starting to experience persist. 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?

Thanks, Eric. Organic originated loans totaled $288 million in the second quarter of the total originations, 90% were in commercial, CRE and agricultural loans. When excluding the change in our PPP loan balances and the branch sale, loan growth in the quarter was $20 million. We note commercial loans declined during the quarter, we had 2 of our top customers pay down their lines driven by business cyclicality in their specific businesses. Agricultural loans also continued to decline driven by excellent cash flow and balance sheet positions of our agricultural customers.

Line utilization in our Agricultural segment is 38% compared to 43% at 6/30/2021. Our year-to-date loan growth, excluding the branch sale and PPP, totals 8.5%, in line with the forecast. Our noninterest income excluding the gain related to the branch sale, saw improvement from the first quarter. Commercial credit card and debit card interchange both saw large increases quarter-over-quarter with debit card income up 7% and credit card income up 20%.

We continue to emphasize putting commercial cards in the hands of our clients and driving debit card utilization through marketing campaigns. Mortgage banking revenue continued to face industry headwinds and was down $130,000 for the quarter. The build-out of our HSA platform is complete. We have growing pipelines that our health care services team has developed that will allow us to service their employees' HSAs and other tax-advantaged flexible spending accounts. This business will contribute new low-cost deposits and fee income through interchange and brokerage. Eric?

Net interest income totaled $39.6 million in the second quarter increasing from $39.3 million in the linked quarter, representing a $600,000 increase. During the second quarter, the coupon yield in the loan portfolio increased approximately 16 basis points to 4.42%. We had a $631,000 derivative benefit to interest income in the quarter. When excluding the derivative benefit, the onetime benefit of the shift on previously nonaccrual loans in the first quarter and PPP impacts in both comparable periods, NIM in the second quarter increased 11 basis points to 3.31%.

Origination fees recognized from forgiven PPP loans continued to decrease. NIM was benefited by PPP loan fees in the second quarter by 2 basis points as compared to 5 basis points in the previous quarter. We recognized $374,000 of fee income and $28,000 of interest income related to PPP loans in the second quarter, down $425,000 from the previous quarter. At quarter end, we had $125,000 of net unrecognized fee income associated with PPP loans, which totaled $7.4 million. Noninterest expense was up $2.2 million linked quarter led primarily through a quarter-over-quarter increase in reserves for unfunded commitments.

March 31 results included a release of $1 million during the quarter versus a reserve of $300,000 a in the quarter ending June 30. Deposits, excluding the branch sale declined $36 million. We saw a $48 million reduction in a single deposit relationship as a school district in our Kansas City region deployed project funds.

Our outlook slide continues to show a moderate view on NIM expansion through the remainder of 2022, primarily due to the uncertainty with cost of funds. The forecast does not contain any future rate hikes. The competitive landscape in our community markets remains rational despite the Fed fund's 50 basis point increase in May and 75 basis point increase in June. However, with the current market expectations of a 75 to 100 basis point increase next week and potentially an additional 100 basis point increase through the remainder of the year, the environment in which we operate is dynamic.

On the asset side, we're seeing improvement in origination and renewal yields. C&I origination yields increased 91 basis points in the second quarter, representing 24% of the quarter's origination volume. And CRE origination yields increased 59 basis points, representing 37% 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. As I have said previously, we're working to move earning assets away from the investment to the loan portfolio which is assisting the higher asset yields. Brad?

I'd like to point out our progress on our strategic goals for 2022. We are focused on the continued improvement of operating performance. We're excited about the build-out of our HSA business, which provides cross-selling opportunities to our commercial and municipal 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 contributing to fee income. We're looking at several new services and products for our customers that will support our goal of increasing fee income as a part of our revenue mix. We continue to have conversations with potential partners. We believe prudence around deal underwriting is key in the face of the current economic uncertainty. Balance sheet, capital and credit strength will benefit us as opportunities arise through the cycle. We will maintain our focus on organic growth efforts. And as always, we'll 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 Instructions) Our first question is from Terry McEvoy with Stephens.

Maybe just start, given the big picture concerns about the future direction of the economy. Can you just talk about any industries you're watching closely? And a little bit more sensitive to? And would you expect in the second half of this year based on your outlook today incremental reserve building?

So the things we're watching most closely, Terry, are one- to four-family construction. We don't have a ton of that, but we're watching it very closely. It's something that we continue to evaluate. Multifamily, we continue to evaluate and watch it as well. We don't see any stress yet in those areas, but we are monitoring that more closely than we have in the past and making sure that we have all the processes in place to jump on that if there's any need to do that. Is there anything else, John, that you're looking at?

No, there's not. We sort of think that this is an environment where the smaller customers are generally wind up being challenged more than the bigger customers, and we don't have a lot of that in our portfolio.

And then as a follow-up, maybe a question for Eric. Within your outlook for the third quarter and, I guess, the rest of the year, can you just talk about your view on deposit costs, deposit betas? And maybe if there's any noticeable differences between your community and metro markets as it relates to deposit costs.

Yes. I mean looking back on the second quarter, I think we did a really good job in controlling costs, and I think that a couple of drivers of that will continue to help us here in the third quarter and the fourth quarter. A lot of our deposit generation is in our community markets and the community markets have not as of yet shown any irrational pricing from our competitors. And frankly, we haven't been having a lot of conversations with our customers about rate. We're more focused on the product and the service that we can offer them. So I think given that, that will be helpful for us here in the back half of the year even with the Fed moving rates. Certainly, I do expect that there will probably be pressure on the cost of the funding. But I think having our teams focused on the product and the service that we can offer and not bleeding with rates will help us in controlling that.

Our next question is from Jeff Rulis with D.A. Davidson.

First question maybe for Craig. Just wanted to get a sense for how that -- I think you mentioned the pipeline at $550 million. How does that compare with how you entered the second quarter. That's kind of the first part. And then second, just I think you've noted that some residential kind of headwinds in that portfolio, maybe some ag tailwinds to go? And as you look at the outlook for the second half of loan growth is pretty guarded, I think you guys have been pretty consistent with the macro environment, some concerns there, but just think about your elements of growth that -- what could play out in the second half that maybe exceeds your expectations?

You bet, Jeff, our pipeline at $550 million is very consistent to what we've seen over the last couple of quarters. It might be off by $25 million or $50 million, but the teams are very focused on making calls in all of our different markets. In the second quarter, we really focused on some of the smaller C&I opportunities in the $1 million to $5 million space and had made significant progress with winning some of those customer relationships, and we'll continue to do that in the third and fourth quarter.

Right now, the pipeline looks strong going into third quarter. We feel like we have very strong momentum. But with rates rising probably again next week, softness may happen at some point. If we have some of our customers and prospects and their CEOs decide that they will put off expansion projects or new acquisitions or whatever the case may be off for a while due to the fact that interest rates have risen 200 basis points in a very short period of time. But today, we feel very good about where we are heading into the third quarter.

Okay. I wanted to jump to the fee income kind of outlook and you got a core just over $9 million if you back out the gain. I think expectations to kind of maybe decrease or drift a little lower than that in the next quarter. I think component of that, I would assume mortgage stays fairly soft. But is there something else in fees. I mean, you've had some good growth in service and debit areas. Is there another component that would lead to that kind of declined to the low $8 million on a quarterly basis?

No, probably a little bit of conservatism there. Mortgage banking has obviously been sliding a little bit given what we're seeing in the economy. And other -- on the other line there, what the $2.5 million in there includes loan repurchase obligation. It's actually footnoted on Slide 19 of the earnings deck. That was related to our Almena acquisition in late 2020.

So there is some benefit there for the reversal of that repurchase obligation. So that won't repeat. But fundamentally, we're seeing good growth in service charges and fees, debit card income. Commercial credit cards has been an area of focus on our teams and selling those cards to our commercial customers, and that's in the service charges and fees line, and that's been showing -- we're showing about 20% increase there. So it's not spiked out, but its contribution is becoming more meaningful. So we have developed and been throughout the year -- this year with marketing programs to drive our customers to use their debit cards more frequently and further everyday spending categories, which has been helping interchange income and those marketing programs are continuing to be our scheduled throughout the year. So we actually -- from a core fee income perspective, we're quite optimistic that we'll continue to show progress there. It's just some of these one-off items that are driving that forecast to be pretty flat from where we're at today.

Got it. Okay. Appreciate that. And Eric, while I've got you, maybe 1 last one. Just -- the tax rate was pretty low and it looks like the expectations to stay near this level. What -- if anything to kind of touch on that expecting that rate?

We had entered into a -- and this wasn't budgeted, but we had entered into a new tax credit here in the second quarter, a portion of that benefit was recognized here in the second quarter and because effective tax rates are annualized. So it shows a little bit of an outsized benefit in the second quarter. But going forward, we'll get the benefit of that tax credit investment that we've made as well as another one that we -- another solar tax credit that we completed late last year as well as other planning efforts around the REIT. So we're expecting that the ETR to be between 14% and 16% for the remainder of the year.

(Operator Instructions) Our next question is from Andrew Liesch with Piper Sandler.

Just 1 follow-up question on the margin here. So I heard that your guidance does not assume any more rate hikes. It does look like the asset betas are performing well and if you're being rational on deposit costs are going to eventually rise. So maybe we don't see the similar magnitude of margin expansion in the next couple of quarters that we saw here on a core basis. But I guess at what level do you think the margin will stabilize just given that we do expect to see another 75 to 100 bps next week and maybe another 100 bps of rate hikes by year-end?

If I could answer that question with a great accuracy, I would probably need another job. I think a lot of the -- you kind of pretty much answered the question for me. I think that will continue to be able to show benefits in higher yields on the asset origination side. And I do think that we're experiencing a little bit of a lag effect on the deposit repricing. So as we march forward with another 75 basis points, if you look at the behavior of spread in margin in the second quarter, is that going to be repeatable in the third quarter? I'm not quite sure because we're going to be experiencing some of that lag effect from earlier repricing in the year.

But where does it stabilize, I don't have a great crystal ball to help answer that question for you, Andrew. But we're focused on preserving margin. And the way we do that is by, again, getting the coupon that we can get on the assets origination, moving earning assets away from the investment portfolio into loans, selling deposit products to our customers, not operating accounts and checking accounts because that helps drive our -- preserve our cost of funds as well as drive fee income.

Got it. All right. That's helpful. And I guess, maybe this is more of a question for Greg and Brad then just on the margin. It seems like the deposit base is much better positioned for rate hikes than the last tightening cycle, I just want to make sure that you guys agree with that comment.

I think this predates me, but obviously, we talk a lot about it. I think the last rate cycle, if you looked at the behavior of the cost of funds, there was an acquisition involved there.

Yes. What I would tell you is we did the acquisition of Tulsa, which was short deposits. And -- so we were in the need for liquidity at this rate cycle, we are not in the need for liquidity. We haven't put ourselves in that same position. As a matter of fact, we've worked really hard to make sure we're not ever in that position again. And so -- and we also have some tools this time around Brilliant Bank that should help offset that. So I don't think it's going to be at all the same as what the last rate cycle looks like for us.

Our next question is from Brett Rabatin with Hovde Group.

Actually, it's Taylor on for Brett. Thanks for the color on the line utilization regarding ag. I might have missed this, but do we see maybe that retracing back to where it was a year ago? And maybe some other commentary about maybe the other commercial segments and their utilization trajectory?

Yes. I would say on the ag side, I would not expect a significant lift in Q3 or Q4 based on kind of what our customers are telling us. We've got very strong balance sheet. So with that customer base, we're just not hearing any sense that they're going to be utilizing their lines more actively in Q3 or Q4. I would say, on the C&I side, usage on lines is still probably not where it was pre-COVID just because of all the PPP money, Main Street lending, et cetera. So I wouldn't expect significant rise in our C&I line of credit either in Q3 or Q4.

Great. And then one question on M&A. I know you've talked about you guys are seasoned acquirers, but have talked about the AOCI overhang. And I didn't know how much of that is baked into expectations, which would maybe level set what the earn-back could be? Just kind of curious for some more commentary on that.

Yes, I don't think it's level set the expectations because if you take a bank that's heavy in bonds, they've lost 20%, 25% of their tangible equity. And so when you're doing the modeling, it really stretches out the earn back for the same price. And so I don't think the owners or directors of those other institutions yet have come to realize that there are 2 ways to resolve that. One is either pay less for your institution today or wait 3 years until that AOCI comes back in into their balance sheet. So I don't think those expectations have levels set yet.

Our next question is from Damon DelMonte with KBW.

So first question, I just wanted to touch on capital management. You guys have been pretty active in the first half of the year with buybacks. And kind of just given the impacts from AOCI and the active miss with the buyback, kind of what your thoughts are here in the back half of the year?

We're -- I mean, we still have an active buyback and we'll continue to have an active program available to us. We are exhibiting a little more caution relative to probably what we're doing earlier this year in terms of pace of how we're utilizing the authorization from the Board. We're focused on keeping an eye on that tangible equity ratio. But that is -- we're not suspending the buyback or anything along those lines. But we are focused on keeping our eye on that ratio.

And how much do you have left in the current authorization?

I believe there's around 130,000 shares left and 1 million shares that was authorized by the board in October last year.

Got it. Okay. And then, Eric, did you say before that the margin this quarter included a derivative benefit of like $630,000. Was that related to this quarter or previous quarter?

We entered into a flipped effect for 2 years on a portion of our -- I think the notional was around $150 million, $175 million. And the reason we did that is if you look at the 2-year REIT, it just shot up so quickly, we saw some value and actually taking some floating rate and fix it for 2 years and pull some economics forward. So that's what that derivative benefit pertains to.

Got it. Okay. And then I guess just lastly, in regard -- kind of circling back to the commentary on the provision and being conservative with your outlook for potential for some sort of recession. Do you have any type of like targeted reserve level in mind? Are you looking to kind of keep it at this 150 level, having come down from the ramp up during COVID to now to this like 150 level? Do you think you'd try to hold it there? Do you think you need to bring it higher? Just trying to get a little perspective on how we think about reserve build going forward over the next couple of quarters.

Yes. Well, how about this. So from a budgeting perspective, I still feel comfortable with how we look at it, which is 20 basis points on an annualized basis on average loans. That's how we look at it from a budget perspective. We don't have a target in mind when we look at the adequacy of the ACL, we focus in on historical losses, which have been improving -- and then we look at the economic environment through our regression modeling, which obviously has some lags in it. So we're seeing some benefit there because COVID is now kind of even in our regression modeling is in the history, and then we have the qualitative part of the analysis, and that's where some of our conservatism as to the economy and uncertainty with that is where we drive some of the provisioning for the ACL. So right now, it results in about 150-basis-point coverage. I don't see that changing dramatically based on the information that we have, but that's but that's not how we look at it when we meet during the quarter.

And ladies and gentlemen, seeing no further questions. This will conclude our Equity Bancshares' Presentation and Conference Call. Thank you for joining, and have a great day.