Bank7 - Q1 2023

Transcript

Operator (participant)

Welcome to Bank7 Corp's first quarter earnings call. Before we get started, I'd like to highlight the legal information and disclaimer on page 23 of the investor presentation. For those who do not have access to the presentation, management is going to discuss certain topics that contain forward-looking information, which is based on management's beliefs as well as assumptions made by and information currently available to management. Although management believes that the expectations reflected in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove to be correct. Such statements are subject to certain risks, uncertainties, and assumptions, including, among other things, the direct and indirect effect of economic conditions on interest rates, credit quality, loan demand, liquidity, and monetary and supervisory policies of banking regulators.

Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may vary materially from those expected. Also, please note that this conference call contains references to non-GAAP financial measures. To find reconciliations of these non-GAAP financial measures to GAAP financial measures in an 8-K that was filed this morning by the company. Representing the company on today's call, we have Brad Haines, Chairman, Tom Travis, President and CEO, J.T. Phillips, Chief Operating Officer, Jason Estes, Chief Credit Officer, Kelly Harris, Chief Financial Officer. Please note this conference is being recorded. With that, I'll turn the call over to Tom Travis.

Tom Travis (President and CEO)

Thank you for joining us, everyone. We're pleased that we again delivered strong results. We have to acknowledge and thank our team members for their outstanding contributions. Let's move on to our results. We started the year with an all-time high loan book, and the majority of those loans had daily floating rates, and that really set the stage for our strong quarter. As we progressed through the quarter, we were able to overcome significant loan paydown and payoff activity. Therefore, on a net basis, the loan team was successful and achieved a small amount of growth in the portfolio, which was also helpful. At the same time, and consistent with expectations we mentioned during our January call, deposit costs accelerated and continued to rise during the quarter, which put downward pressure on our margin.

Regardless, we still achieved strong net revenue, and we're pleased with our margin and expect it to remain within our historical range. It's probably good to move into a discussion regarding our liquidity, which clearly is a major focal point in today's environment. You can see we have provided enhanced disclosures, and we are comfortable with our overall liquidity profile. Our cash position is historically more than industry averages and continues to be that way today. In addition, our reliance on public funds is far below industry averages. We also have a large amount of availability on our lines of credit, which we did not draw as we did not experience panic from our customer base. In fact, we show a small increase in deposits for the quarter, including a small increase in our core transaction accounts, which continues to be the case as of yesterday.

We do not anticipate incurring stress in this area. We also provided more disclosure regarding our asset-sensitive balance sheet, as you can see, our asset liability matching has us in a good position. Our historical use of floating-rate loans with interest rate floors and shorter maturities will continue to benefit our company. Our balance sheet is properly matched and strong as we don't have much of an AOCI adjustment. We continue to operate debt-free. Regarding our small AOCI adjustment, it will rapidly decline as more than half of the investment portfolio consists of U.S. Treasury notes that mature in only 10 months. Overall credit quality is steady and continues to exhibit strong characteristics. We upgraded a few adversely rated credits and also had one payoff. We added a few downgrades, nothing out of the ordinary.

We also converted our allowance methodology to the CECL model, and our allowance is strong and where it needs to be. Moving into capital. With regard to capital, we plan to continue building it, and the combination of our strong earnings and low dividend payout ratio will cause it to increase quickly, especially considering a slower growth environment. Clearly, this environment of macroeconomic stress guides us to maintain capital at slightly higher levels. Our high level of earnings is a real source of strength for our company. We like to illustrate that strength in the deck with the inclusion of our stress test scenario, as it reflects how our strong earnings provides a substantial buffer based on industry and bank examiner DFAST parameters. In conclusion, we had a very strong quarter.

We are pleased to provide exceptional returns to our shareholders and also report that we are well-positioned to navigate through the choppy waters that are in place today. We intend to continue to build capital and keep our focus on liquidity and growing our deposits. We continue to benefit from being located in this dynamic part of the country. Therefore, in spite of the current macroeconomic headwinds, we remain cautiously optimistic about the near future and are excited about our company. With that being said, we're standing by for any questions. Thank you.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. The first question comes from Nathan Race of Piper Sandler. Please go ahead.

Nathan Race (Managing Director and Senior Research Analyst)

Yep. Hi, everyone. Good morning. Hope everyone's doing well.

Tom Travis (President and CEO)

Good morning.

Nathan Race (Managing Director and Senior Research Analyst)

Maybe just start on kind of the outlook for loan deposit growth. You know, you had some growth in deposits in the quarter. Looks like it was mostly in CDs. Just curious to kind of get your updated thoughts on just, you know, how we should think about deposit growth over the balance of 2023 and how you're thinking about loan growth within the context of pipelines coming out of as they stand here in April.

Tom Travis (President and CEO)

This is Tom. I'll take the deposit side and then ask Jason on the loan side. With regard to deposits, I would say that, you know, with all due respect and understanding that we're in a tough economic environment, there's a lot of noise centered around a few spectacular outliers. We believe the fundamentals, the combination of fundamentals, our business model, and our geographic location, will continue to do what we've always done, and that is grow our bank with transaction accounts, with money market accounts, and in conjunction with the expansion of our customer base. I wouldn't expect any meaningful up or down movements. It's just steady as she goes and business as usual for us. I think Jason can speak to the loan book best.

Jason Estes (Chief Credit Officer)

Good morning, Nate. I think on the loan side, you know, we're still seeing what I would call a healthy deal flow, what resembles what I would describe as normal loan demand. I think that's really driven by our geography. You know, if you look at Texas and Oklahoma, you know, the economies here are very strong and there's still growth. I still kind of refer back to, I think on our January call, we talked about loan demand this year and growth rates probably in single digits instead of, you know, last year it was very, very robust. I still think that's pretty accurate. You know, I will say it's a little more cloudy on the second half of the year. Not sure if they're done raising rates.

With each move up, there seems to be a, you know, a little bit of slowdown in demand, but we'll see where it ends up. I still feel like there will be a, you know, slight or moderate amount of growth for the year.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, that's helpful. I think in the past, Jason, we were talking maybe mid to high single digit loan growth. Putting those pieces together with your comments, is that kind of still a reasonable expectation going forward, albeit with some lumpiness quarter-over-quarter?

Jason Estes (Chief Credit Officer)

Yes, sir.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, great. Maybe a question for Kelly just around the margin outlook going forward. Obviously, you know, it's a challenging deposit pricing environment as we sit here today, and that may only continue to ratchet up going forward. I guess just kind of thinking about the margin trajectory from here, the decline that we saw on the margin, at least on a reported basis of, you know, down 11 basis points in the first quarter, is that kind of a reasonable expectation to extrapolate out going forward? Do you think the margin pressures intensify from here?

Kelly Harris (CFO)

Nate, I think you'll continue to see liability costs reprice at a quicker clip than the assets. That said, we did decrease about 12 basis points core NIM for the first quarter, and I would anticipate, you know, a slower degradation in Q2 and then potentially Q3. You will see, you know, continued decline. As Tom pointed out on page 10, we feel very comfortable operating in our no-net interest margin range historically.

Nathan Race (Managing Director and Senior Research Analyst)

I imagine, Kelly, you know, part of the offset to some of the deposit pricing pressures, just maybe, redeploying some of the cash flow coming off the securities book into loans. Can you just remind us how much cash flow you have coming off the securities portfolio each quarter?

Jason Estes (Chief Credit Officer)

Yeah. The big tranche is going to occur in February, which is $100 million. I believe within the next, you know, excluding that, you're looking at about $1 million a month. Total.

Nathan Race (Managing Director and Senior Research Analyst)

I'm sorry.

Jason Estes (Chief Credit Officer)

portfolio is around $185 million.

Tom Travis (President and CEO)

It's really not, this is Tom Travis, Nathan Race. It's really not going to make a material impact on the margin for the next eight or nine months. It's just gonna be one big slug. Unless, of course, we were to sell that U.S. Treasury position earlier than next February, which is possible. Other than that big redemption or maturity on that one or two few securities, the benefit of reinvestment between now and then is just really negligible.

Jason Estes (Chief Credit Officer)

The liability costs will be more driven off of bringing in new money and then the time deposits repricing higher.

Nathan Race (Managing Director and Senior Research Analyst)

Okay.

Tom Travis (President and CEO)

You know, I'm gonna point out another thing. It's obvious, but sometimes we don't always think of it, that is that we believe it's prudent to hold more capital today. We believe it's prudent to hold more liquidity. Those are detrimental to the net interest margin. If we chose to run the Bank7 a little hotter, if we chose to eliminate some of those higher price liabilities, then clearly the NIM would benefit. We don't believe that's the prudent thing to do right now. It's time to be cautious.

The benefit to the company is that we operate in a really healthy NIM environment, we have the flexibility to do that versus maybe some others that don't have that strength in their NIM and they're constrained or they have to really suffer, you know, a NIM degradation of more meaningful. I think that's an important point to make.

Nathan Race (Managing Director and Senior Research Analyst)

Yep, for sure. Understood. maybe a couple more just maybe on the expense outlook. You know, obviously a nice step down. You know, it seemed like the four key levels were elevated just given the strong performance last year. Any thoughts on just kind of where the run rate goes from here? Do you guys think you can manage it at around $7.5 million per quarter? Any thoughts on just kind of the go-forward run rate for expenses?

Jason Estes (Chief Credit Officer)

Yeah. You saw a decline in the non-interest expense, you know, post Q4, I believe it was 6%. I think that Q1 is a pretty good guide going forward, although you will see some expense creep as the year progresses.

Nathan Race (Managing Director and Senior Research Analyst)

Yeah. Makes sense. Maybe just one last one on credit. You know, I appreciate the additional disclosures around the office CRE portfolio. It seems like it, you know, that asset class in particular is gonna be a non-issue for you guys, just given a lot of the specifics that you guys described in the slide deck. Are there any other, you know, portfolios where you're keeping a closer eye on these days? Are you seeing any negative migration in terms of credit size classified? It looks like NPA levels were essentially stable in the quarter.

Jason Estes (Chief Credit Officer)

Yeah. We haven't seen a material shift in really any of those industries. I will say that the hospitality segment, you know, that's one that we clearly are fond of, and we keep a very close eye on that. Most of that lending activity is in Texas, particularly Dallas-Fort Worth metro area. You know, we got the data for the full year last year. I don't have the first quarter yet, but it just continues to show strength and set all-time records for revenue and the occupancy and ADR. They've recovered, you know, from those COVID downturn times where it was really, you know, for a short-term period there, really bleak and they've just rebounded, you know. It's just, you couldn't ask for better performance really out of a, out of a segment.

Tom Travis (President and CEO)

I would add to Jason's comments and remind everyone that the interest rate environment, you know, we're very asset sensitive. The great majority of those hospitality loans are floaters. I don't know if it's 90%, but it's 80 or whatever it is. It's, it's the majority of the portfolio, whether it's 60 or whatever, 80%. I don't. It doesn't matter. The point is, the substantial increase in the interest rate has not created concern in our portfolio. I think it speaks to the underwriting and the discipline that we have, that we've been able to underwrite upfront properly, have proper margins in our debt coverage ratios and so that's a very important point to point out.

Nathan Race (Managing Director and Senior Research Analyst)

Yep. Understood. That's great color. That's all I have. I will step back, and I appreciate all the color. Thanks, guys. Nice quarter.

Operator (participant)

The next question comes from Brady Gailey of KBW. Please go ahead.

Brady Gailey (Managing Director of Equity Research)

Hey, thanks. Good morning, guys.

Tom Travis (President and CEO)

Morning.

Jason Estes (Chief Credit Officer)

Morning.

Brady Gailey (Managing Director of Equity Research)

I just wanted to get an update on, I know your NPAs are, just, you know, one or two kinda larger credits mostly, and I think one of them is an energy loan. Any update on the resolution of the energy NPA?

Jason Estes (Chief Credit Officer)

Yeah, that company, I think we've reported, I don't remember how many quarters ago, but there was a new management team put in place, a little over a year ago or right at a year ago. They continue to improve the operation. It's not improved to the point where we can remove it from this list, but there's still, I think we described it as green shoots, and they're getting taller and they're getting more vibrant, but still not to the point where we can upgrade.

Brady Gailey (Managing Director of Equity Research)

Okay. Remind us, what is the size of that credit?

Jason Estes (Chief Credit Officer)

it's approximately $7 million.

Brady Gailey (Managing Director of Equity Research)

79. Okay. I think total NPAs are around $18 million. Are there any other larger loans that?

Jason Estes (Chief Credit Officer)

Yeah. There, there is. There's the one deal that's in litigation. I don't wanna get into any details on that one, but it's approximately $10 million. Between those two credits, you're really talking about almost the entire NPA bucket. I will say that, you know, in that litigation, same comment we've made previously, you know, we're well secured. The collateral is highly liquid, and it's under the control of a receiver, a court-appointed receiver. It's just a matter of working through the court system.

Brady Gailey (Managing Director of Equity Research)

Okay. Then any outlook, I know you guys occasionally will consider bank M&A, although the backdrop makes bank M&A kind of tough nowadays, any update on, you know, any conversations you're having on the bank M&A front?

Tom Travis (President and CEO)

We're talking to a group right now. I mean, we've had one meeting, and there seems to be a potential. Way too early to say anything beyond that. you know, we continue to be very active in probing and searching and... that's about it.

Brady Gailey (Managing Director of Equity Research)

All right, great. Thanks for the color, guys.

Operator (participant)

As a reminder, if you have a question, please press star one. The next question comes from Matt Olney of Stephens. Please go ahead.

Matt Olney (Managing Director)

Hey, thanks. Good morning. Most of my questions have been addressed. Also wanna ask about just any color on incremental pricing on both deposits and loans, what you're seeing on both sides there. Thanks.

Tom Travis (President and CEO)

I would say that, you know, on the loan side, the negotiations are probably less fierce as borrowers get kind of used to, this new rate environment. I think last year, it was more cumbersome going through those conversations after they'd just been used to these lower rates. On the deposit side, you're seeing a little bit of a shift in the mix. You know, there was a comment made by one of the analysts about, you know, the CD growth, and I think you're seeing people migrate from where they didn't care if it was in a checking account earning nothing or a savings account earning next to nothing or a CD earning just slightly better than that. Now they're saying, "Oh, wait a minute.

You know, this is actually attractive to put money in a bank and lock it up for 12 or 24 months. It's worth their while. I would say you'll see more of that mix shifting throughout the year. As far as the conversations with the depositors go, there's somewhat relief from them that they finally get to earn some interest on their deposits. You know, I think that maintaining that NIM in our historical ranges is very possible. I don't think it's easy, but I do think we'll succeed.

Matt Olney (Managing Director)

Any color on the other side, on the loan yield side, incremental, yields on that side?

Tom Travis (President and CEO)

Yeah. I mean, if you want some examples, I would say, you know, right now, average originations are somewhere in the low eights probably. Who knows what happens the rest of the year, but that's kind of the current market.

Matt Olney (Managing Director)

Yep. Okay, that's helpful. I think Tom mentioned, you know, carrying higher levels of liquidity at this point given the uncertainty in the environment. Definitely appreciate that. I think most, if not all, your peers are saying something similar. At least with Bank7, we can see that in some of the end of the quarter data, March thirty-first. I know it's tough to answer, curious on thoughts on just, you know, the duration of carrying excess liquidity and how much longer you expect to carry the higher levels. Thanks.

Tom Travis (President and CEO)

I think there's a couple of things at play here. I think, you know, I've seen already, proposed commentary and proposed new metrics that are gonna be coming out of the Fed relative to liquidity. I would say that we're expecting, you know, if you look at your CAMEL rating, the L, their liquidity, we're expecting I don't know if they'll change the Call Report, you know, data. I don't know if they'll come up with a new metric, but we expect that at some point. We certainly don't With all due respect to regulators, you know, we don't need regulators to tell us how to run the bank.

We have prudently managed our liquidity based on our own experience and knowledge, and we believe we understand what it takes to properly match a balance sheet and fund a bank. With that being said, you know, we expect some of that. That's number one. Number two, I think the, you know, the speed at which the public rushed into, I would call these very, very few, I guess I would refer to them as outlier banks, that either have failed or in the case of like First Republic, have had a massive deposit exodus. You know, you have to be mindful of that. I think whether it's, you know, being cautious with regard to the public or whether it's a nod towards understanding what might be coming down the road.

You know, I will tell you that, what page is that on? I read, I think it was late last week or earlier this week, there was a commentary that somebody had talked to the, I think it was the FDIC and OCC. If you go to page four in our deck, the piece that I read was identical to what we put in our deck here, and what we illustrated was our uninsured deposits, and then we subtracted out, you know, insider deposits, collateralized deposits. I don't think the insider deposit was mentioned in with the Fed, but I think the point is that we anticipate some of this. I think caution is the word of the day.

Again, I think if you're operating a bank that has to struggle or pull levers or do things to in order to really achieve that high performance net earnings, you have less flexibility. For us, as you know, it kind of goes back to that comment on the net interest margin. You know, we'll suffer a smaller margin by being more liquid. We have the profits and the cash flow that if we have to hold more cash, okay, we'll hold more cash, and we're still going to be benefiting from that high performance. You know, that's a long way to say that who knows? We're going to be prepared and ready for it.

Matt Olney (Managing Director)

Okay. Great commentary, Tom. I appreciate that. Just one more from me on the credit front. Tom, you mentioned, you know, several upgrades this quarter. There was a payoff and maybe a downgrade or two. As you step back and look at some of the migrations, you know, both directions, any themes that you see, whether it's by loan type or geography or anything that would be helpful for us? Thanks.

Tom Travis (President and CEO)

You know, I don't see any. I think it's our radar dish is constantly it's on alert, and, you know, we have a few that have popped up just like you always do, and you have some that we've managed out. I don't see anything that's... When I say that, I'm specifically focused on losing money on loans. You're always going to have people that get into stress and work their way out of it. As far as losses to the company, I certainly don't see it.

Matt Olney (Managing Director)

Yep. Okay. Okay, guys. Thanks for your help. Appreciate it.

Operator (participant)

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Travis for closing remarks.

Tom Travis (President and CEO)

Thanks again for everyone joining. We're really proud of the company, and I think the litmus test for the banking industry was the month of March, at least the most recent litmus test. Who knows what happens today and the rest of the next few weeks. We didn't have panic, and I think that's a testament to the institution. I think it's a testament to the customer base and the fact that, you know, that we try to be steady as she goes, yet provide that good, strong performance. We're pleased, we're excited about the future and appreciate everyone's involvement and consideration. Thank you.

Operator (participant)

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