Bank7 - Q2 2023

Transcript

Operator (participant)

Good morning, everyone. Welcome to Bank7 Corp's Second Quarter Earnings Call. Before we get started, I'd like to highlight the legal information and disclaimer on page 25 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 just based on the 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. Please note that this conference call contains references to non-GAAP financial measures. You can 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; and Kelly Harris, Chief Financial Officer. With that, I would like to turn the floor over to Tom Travis.

Tom Travis (President and CEO)

Thank you. Good morning, and welcome, everyone. We were pleased with our quarter and pleased with our year-to-date. If you boil it all down to why we were able to again, have record profits and earnings per share, it's really a story of sticking to your fundamentals, our fundamentals, and relationship banking. You know, we're proud of the banking team that we have, the bankers, the executive management, all the way down to the front line. You know, continue to stay focused on our fundamentals, and we are also mindful of what's going on in the market, and we're carrying excess liquidity just in case.

We're happy with the position of that balance sheet that, you know, continues to have no debt, extra liquidity, and, you know, plenty of money for turbulence should it come into the markets again. With that being said, it's not sexy and fancy, but fundamentals just don't go out of style, as they say, and we're real pleased about it. I think if you look back at the prior two quarters, earnings call, commentary, maybe three quarters, the year has kind of shaped up the way we thought it would. You know, with the Fed continuing to increase rates, clearly, the funding costs have gone up, but we've managed our margin within our historical ranges and very happy about that.

With all that being said, we're happy to take any and all calls that or questions you may have. Thank you.

Operator (participant)

Ladies, and gentlemen, at this time, we'll begin the question-and-answer session. To ask a question, you may press star and then one using your touch-tone telephones. To withdraw your questions, you may press star and two. If you are using a speakerphone, I do ask that you please pick up the handset prior to pressing the numbers to ensure the best sound quality. Once again, in order to join the question queue, you may press star and one. Our first question today comes from Tom Wendler from Stephens Inc. Please go ahead with your question.

Tom Wendler (Research Analyst)

Hey, good morning, everyone.

Tom Travis (President and CEO)

Good morning.

Tom Wendler (Research Analyst)

Just want to start off with expenses. We saw another decrease this quarter. Can you maybe give us some color on your expectations for expense growth moving forward?

Kelly Harris (CFO)

Yeah, we did have a slight decrease in Q2 versus Q1, and from a run rate perspective, I like the second quarter better going forward. Maybe a little bit higher at $7.5 million.

Tom Wendler (Research Analyst)

Perfect. Thank you. Just kind of moving on to credit. We saw a step-up in your allowance this quarter, even with decreasing non-performing loans and loan balances remaining relatively flat. Can you maybe give us some color around the reserve build?

Jason Estes (Chief Credit Officer)

Yeah, I think that it's just kind of our DNA whenever you have what we believe to be some economic headwinds out there or potential headwinds to continue to build. You know, the portfolio has held up very well. Past dues are down. You know, you'll see positive trends, credit trends throughout the book, I think when you're comparing to the last couple of quarters. With that being the case, you know, we're not oblivious to the impact of higher interest rates and what that's going to look like in the economy as the year goes on, and you're starting to see some of those effects, I think, in the economic data.

Regardless of what the Fed does, you know, in the next couple of meetings, we just think it was prudent to get ahead of that.

Tom Wendler (Research Analyst)

Okay. No, that was really good color. One last one from me. Loan balances remained flat this quarter. Can you maybe give us some color on your expectations for loan growth and if there's any sort of segments you're looking to grow more than others?

Jason Estes (Chief Credit Officer)

From a segment standpoint, you know, we're pretty consistent, I think. You, you see us, you know, hospitality, energy, C&I, and then the same stuff we've been doing, I think, expect the same in the future. As far as growth, I think if you go back to the last couple of calls and the commentary, it's been, "Hey, look, this won't be a year like last year, where the growth was probably a little bit more than we had anticipated." You know, think single digits this year, and I still feel confident in that. I think this will be the third call in a row or maybe even the fourth, where we've talked about what does this year look like?

Tom Wendler (Research Analyst)

Mm-hmm.

Jason Estes (Chief Credit Officer)

I think we're unchanged, even though, you know, March was a little bit turbulent and caused some uncertainty. It, it's still looking like that's a, that's a good number for the overall year.

Tom Travis (President and CEO)

Jason, am I correct that construction is actually down?

Jason Estes (Chief Credit Officer)

It is. It is.

Tom Travis (President and CEO)

Yeah. That's one segment that we would point out that I don't know the numbers, but our construction lending has definitely slowed as we expected it would.

Tom Wendler (Research Analyst)

All right. That was great color. Thank you, guys. Great quarter.

Jason Estes (Chief Credit Officer)

Thank you.

Operator (participant)

Our next question comes from Nathan Race, from Piper Sandler. Please go ahead with your question.

Nathan Race (Managing Director and Senior Research Analyst)

Yep. Hi, guys. Good morning. Thanks for taking the question.

Tom Travis (President and CEO)

Good morning.

Nathan Race (Managing Director and Senior Research Analyst)

Just a question on just kind of the margin outlook, ex fees and accretion. You know, it looks like it came down about six basis points versus the first quarter. It looks like the increase in deposit costs was actually less than what we saw during the first quarter. Just curious to kind of get your expectations in terms of perhaps the magnitude of future pressure that we can expect during 3Q and 4Q of this year.

Kelly Harris (CFO)

Nate, this is Kelly. I think from an ex-fee perspective, 4.55% is a good number, and I'll just highlight the fact that we are carrying additional liquidity, and so you could see a shift, you know, potentially, if we do fund up loans. When we do fund up loans, some of that cash bleeds down, and, you know, that could prop up NIM a little bit as well. The Fed is meeting next week, and so that'll have an impact on NIM going forward as well. I think from a core NIM perspective, 4.55% is a good number.

Tom Travis (President and CEO)

That's kind of real time, isn't it, Kelly?

Kelly Harris (CFO)

It is.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, got you. Perhaps maybe a larger, kind of a broader question on the NIM going forward. You know, in a theoretical kind of higher for longer interest rate environment, where are you guys going to see your margin kind of settling out ex fees, over that kind of longer term period?

Tom Travis (President and CEO)

We're delighted and proud of the efforts of the team with regard to negotiating and walking away from transactions that don't meet our hurdle. We've consistently said that we're going to operate within our historical ranges. You know, I believe if you look back in history, I'm not sure we've ever dipped below about 4.25% or 4.3%. There's nothing that we see today that would lead us to believe that we're going to operate outside of those ranges. I'm not saying that we're going to go from 4.55% real time today to 4.30%, but if it happens, it happens. I think a lot of it depends on the Fed and what they do. I think everyone's expecting a rate increase next week.

You know, if they, if they do take a pause and they don't do any more, then I think you're going to more easily keep your NIM from dropping to the absolute low in the historical range. So, you know, we'll just see. As we point out in our deck, I think it's 51% of our loans are daily floaters, and we have right now about $80 million or so that are at the ceilings. Clearly, when the Fed increases next week, you're going to have a few more loans at the ceiling. I think for us, we're going to be within those historical norms. You know, I would point out also, at some point, Nate, you know, we're carrying a pretty heavy treasury note position.

We're 7 months away from the actual maturity on that instrument, and if we chose to do so today, you know, we could liquidate that and pick up, you know, pick up, I don't know what the effect would be to NIM and basis points, but it would certainly pick up earnings. There are some things that we have that are going to eventually offset that, you know, that NIM pressure.

Nathan Race (Managing Director and Senior Research Analyst)

Mm-hmm. If I remember correctly, that large maturity in the securities book, that occurs in the first quarter of next year?

Tom Travis (President and CEO)

February. I think it's the end of February.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, great. Perhaps just changing gears, you know, thinking about the energy portfolio in particular, it didn't appear that you guys had much growth. In fact, it looks like it also shrank a little bit versus the first quarter. Just curious kind of what opportunities you're seeing in that space, and perhaps just if you could kind of touch on what you're seeing from a credit quality perspective across your energy portfolio as well?

Jason Estes (Chief Credit Officer)

Yeah. Outside, there's one large credit, I think that's, you know, out there in the public realm, that we really can't talk about because there's ongoing litigation. Outside of that one credit, the energy book is performing very well. I will say that the deal flow there has slowed quite a bit, you know, from the pace of last year. We did contract about $10 million during the quarter. Wouldn't be surprised if there's a little more contraction as the year goes on in that book. Overall, credit quality there is very strong with primarily companies we've banked for a long time.

Nathan Race (Managing Director and Senior Research Analyst)

Gotcha. Jason, just any update on those kind of two large nonaccrual loans that I believe constitute the large majority of the existing NPA balances coming out of the second quarter?

Jason Estes (Chief Credit Officer)

Yes. Yeah. One of them had a consistent, nice, continued improvement, and it has now for 12 months, maybe a little more than 12 months. We used to refer to it as the green shoots. I don't even know if you can call it that at this point. It's just a nice recovery story there. We're optimistic that one may come out of that bucket in the near future. The other credit, again, that involves litigation, well secured. Don't expect any loss, but, you know, we have to work through the court system to get that money back.

Nathan Race (Managing Director and Senior Research Analyst)

Okay, great. I appreciate the added details on the office commercial real estate exposure on the slide deck. Any additional color you can provide on that portfolio in terms of kind of the maturities that are expected, you know, over the next year or so, and just generally how you're feeling overall about the office CRE portfolio, just given that's, you know, an area of focus these days for investors?

Jason Estes (Chief Credit Officer)

It is. We're so unique, I think, compared to maybe other banks our size and especially the bigger banks, because a lot of, you know, the majority of our office, this is gonna be an owner-occupied deal, and it's typically. Don't think downtown at all, think suburban. You know, we used to call them like a house office almost. You know, these are smaller loans. They're amortizing rapidly, we just don't expect stress in that portfolio of ours. We really don't see a single loan in there that we have any expected issues on.

Tom Travis (President and CEO)

You know, Nate, I would add to Jason's comments that, you know, we all know that the news is dominated and emanates from New York and Washington and some on the West Coast as well. You know, that's where you have this spectacular news stories about. I mean, you read about the horror in San Francisco downtown and some of these other cities, and also on the East Coast. You know, I'm not making fun of anybody or anything, but I just. It's just a perfect illustration of somebody decides it's a big deal, and it is a big deal in those geographies and in those urban markets, but it doesn't have anything to do with how we loan money and what goes on in the Texas and Oklahoma markets.

Regardless, it's nice to hear your reinforcement in your comments about we anticipated concern. It seems like in the world that we live in, you're guilty. You know, if you have one office loan, it's like, Oh, my God! We anticipated the questions, and that's why we went into additional disclosures. It's nice to hear you know, point that out. It's just a different world than where the news comes from.

Nathan Race (Managing Director and Senior Research Analyst)

Got it. That's very helpful. If I could just ask one last one for Tom, perhaps on just kind of capital management priorities. Obviously, you guys are continuing to build TCE. Your regulatory capital ratio is also increased in the quarter. You guys have what I think is a premium currency on a tangible book basis relative to peers. I think a couple of quarters ago, we were talking about a potential acquisition opportunity. We'd just love to kind of hear your thoughts on kind of how you're prioritizing excess capital deployment. Within that context, I can understand, just given the macro uncertainty that exists out there, that maybe there's a more of an impetus to perhaps just kind of hold capital these days. Would just love to get any thoughts along those lines, Tom.

Tom Travis (President and CEO)

Well, I guess we could be kind of a smart aleck and answer and say, "Gosh, we're sorry that we're making so much money, that capital is piling up so quickly." You know, with all seriousness, that's the fact, and we clearly are very interested in acquisitions. We've always been consistent. We look at the right side of the balance sheet. We're constantly talking and pursuing opportunities that make sense. In the meantime, it's just gonna continue to pile up. There's really not much we can do about it, with the exception of, you know, I guess we could do a special dividend or we could do something. You know, these are slippery slopes that we're living in right now, so we're plenty comfortable with letting the capital build up for a little while.

You know, we have flexibility. I think our dividend payout ratio, I think, Nate, you helped us with some of that, and so did KBW, and I think we're at somewhere in the 18%-19%, Kelly, in payout ratio, and I think the industry is 35%?

Kelly Harris (CFO)

Correct. I think we're a little bit below that with the-

Tom Travis (President and CEO)

Right. I guess what I'm trying to say, Nate, is that this earnings machine is a beast, and we have optionality if we chose to reduce capital by other ways, you know. For now, we're gonna steady as she goes. Maybe we'll find something to buy.

Nathan Race (Managing Director and Senior Research Analyst)

Yep. Yep. No, understood. It's definitely a good problem to have. Are you seeing any more opportunities on the acquisition side of things these days? You know, obviously, you know, a lot of your smaller competitors, I imagine, to some degree, are experiencing margin pressures, well and above you guys. I'm just curious if that's maybe leading to an increased number of discussions these days.

Tom Travis (President and CEO)

Well, you would think it would, but I think this phenomenon that we have where you have these-- I think some people call them zombie banks, but these-- there's so many people that went out and, unfortunately for them, made the decisions to extend way out in their durations, and now they're just stuck. They're stuck and not able to sell their institutions because of that big MTM issue, AOCI, and I don't see that changing unless, if the higher the rates go, the worse it is for them and the more stuck they are. That's taken a lot of opportunities off the table. It's just gonna be that way for a while.

Nathan Race (Managing Director and Senior Research Analyst)

Got it. Understood. Makes sense. I appreciate you guys taking all the questions and all the color. Great quarter.

Tom Travis (President and CEO)

Thank you.

Operator (participant)

Once again, if you would like to ask a question, please press star and one. Our next question comes from Brady Gailey from KBW. Please go ahead with your question.

Brady Gailey (Managing Director)

Hey, thank you. Good morning, guys.

Tom Travis (President and CEO)

Morning, Brady.

Brady Gailey (Managing Director)

I just wanted to circle back to the energy credit that was recently in the media. I think this was an energy company that you guys were a lender to, that went bankrupt. I was just wondering if you could talk about the size of that credit, and it doesn't appear that that credit moved into NPAs. Do we think that'll be more of a third quarter NPA increase?

Kelly Harris (CFO)

Yes, the loan is approximately $33 million on our books. It's a club deal, multiple banks involved, 4 total. Yeah, the loan's current. You know, there's litigation going on here, I don't want to get too far into it other than to say, we're a senior secured lender. We believe in the asset value, we believe in the cash flow the assets produce, we do not expect at this time that there would be a loss on that credit. The good news on the credit is, you know, with it being in this bankruptcy process, this isn't gonna linger. You know, I could see it being an issue into the fourth quarter, I don't think it's gonna be an issue past the fourth quarter.

We're gonna have resolution pretty quickly here.

Brady Gailey (Managing Director)

Okay. I think that energy company, was into natural gas. I know the price of natural gas has been pretty depressed here. Are you all seeing any other weaknesses in any of your other, natural gas borrowers?

Tom Travis (President and CEO)

This is Tom. Brady, listen, The answer is no, we're not. This was the management of the company, dropping the ball, okay? You know, we see management teams in this industry operate as much like banking. We see management teams operate through down cycles and up cycles, and the people that stick to the fundamentals, that watch their liquidity, they don't get caught in traps. This is a lot less to do with the price of the commodity than it is the management and the oversight of the company, and we'll just leave it at that.

Brady Gailey (Managing Director)

Okay. My final question, you talked about having capital piling up here, you know, your excess capital is growing. We talked about M&A, I mean, if you look at your stock, the stock trades at 1.45 at tangible book value. Which if you look at that relative to the ROE that you guys are performing at, like, that's a very compelling valuation. Do share buybacks ever make sense as a, as a way to give capital back to shareholders?

Tom Travis (President and CEO)

Well, you know, I think the answer to that is that we've always felt like that the market hasn't properly valued the company based on quarter-after-quarter and year-after-year of exemplary performance. That's just a fact. You know, unless that dynamic changes, it's hard to see, you know, it's hard to see that it's gonna change materially. With that being said, I think it wanders into, are you a short-term investor or are you a long-term investor? If you really like a compounder, there's not a better stock. We love what we're doing, and we really don't feel the pressure to do any share buybacks, because even with the capital piling up, what's our ROE? 22%, 3%?

Kelly Harris (CFO)

26%.

Tom Travis (President and CEO)

Right, 26%. Well, that was for the quarter, and so I don't know what it's gonna be for the year, but I guess I would say to you, Brady, that, yeah, I understand the argument, but until we dip down into a much lower return on equity, we're proving to the market that we can grow the company and we can carry substantial capital and yet still outperform on the returns. We really don't have that, I guess you'd call it, immediate pressure, or even near-term pressure to repurchase shares. That's kind of the way we view it.

Operator (participant)

Ladies, and gentlemen, at this time, and showing no additional questions, I'd like to turn the floor back over to Tom Travis for closing remarks.

Tom Travis (President and CEO)

Thanks again for your interest and participation. We like where we're at. The company's dynamic. We've got a wonderful team of bankers and management. We're really blessed to be in the part of the country that we're in. We'll keep doing what we've been doing. Thank you.

Operator (participant)

Ladies, and gentlemen, with that, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.