Bank7 - Q4 2023

Transcript

Operator (participant)

Welcome to Bank7 Corp.'s fourth quarter and full year earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. Before we get started, I'd like to highlight the legal information and disclaimer on page 24 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. 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, Vice Chairman and CEO; J.T. Phillips, Chief Operating Officer, Jason Estes, Chief Credit Officer, Kelly Harris, Chief Financial Officer. And with that, I'll turn the call over to Tom Travis. Please go ahead.

Tom Travis (Vice Chairman and CEO)

Thank you. Good morning, everyone. It's a beautiful day here in OklahomaCity. To those of you that are around the country, we've had a cold spell of weather that it's nice to be over with. As you can see, we had signaled in our last earnings call back in late October that we had subsequent events post the third quarter closing that were going to affect significantly the fourth quarter numbers, and as you can see, that in fact did happen. I suppose that it reminds me of a comment I've heard before, and I think everyone on the call has heard before, and that is, except for the one event, how was the play, Mrs. Lincoln?

Not to be morbid, but that's pretty much how we view our company today, because when you look at the totality of the fundamentals of the company for the year, but for that one event, it was a phenomenal year. And when you, when you evaluate, you know, what we say is a phenomenal year, even with the large charge related to the one credit, we're still at almost 19.5% return on tangible common equity. Actually, that's average tangible common equity. And we did some analytics about three weeks ago, and we used the first three months or first nine months of the year, and about 90% of the banks in the country did not make 19.5% return on average tangible common equity.

So, as you can see, and as we mentioned in the last earnings call, in a perverse way, the strength of the company is highlighted by the fact that we took this significantly one-off out-of-character, negative event and just kept right on moving forward. And so that's the way we view it, and we take comfort in that. And if you look at the other components of the company and not just the earnings and the return on equity, you can see that the company's done an excellent job of managing its net interest margin. The historical averages of the net interest margin are pretty much where we are today, and we did that through a pretty difficult rate environment, but not for that one credit.

The credit metrics are really strong and even better than they had been for, you know, the prior year or two. And so we feel really good about the book. The interest of the operating expenses for the company are very much intact as far as maintaining our Efficiency Ratio. The one comment I would make is that the company, as a part of that one credit, we acquired a couple of handfuls of oil and gas wells. We did not acquire a company, we acquired specific Working Interest in oil and gas wells, and as a result of that, you'll see a slightly inflated non-interest income number. You'll also see a slightly inflated non-interest expense number.

And so if you remove those two items out of the income statement, you will have—you would have seen that the efficiency ratio would still be in that 33%-34% range instead of a 39% range. And so when we look at the fundamentals of the company, we feel really good about it. I would say that with regard to the one particular one-off credit, we are in the seventh or eighth inning of the bankruptcy process and litigation. We have real strong clarity and good optics into where we think it's going to end up. We feel good about the amount of money that's been either expensed or set aside relative to some certainty. Clearly, we don't feel good about having to do it. However, we are confident that we've accounted for what we need to account for.

And with regard to that credit, with regard to the bankruptcy, with regard to the litigation, we're a very transparent company. We always answer every question we can. However, we cannot really speak much to it, and we need to be respectful of the fact that details and specifics are in the public realm here today, and so we're not really going to comment much beyond what's been said today, other than we feel like we've accounted for it properly. And so with all that being said, we feel really good about our company, and we're excited to move forward into this new year. And with that, we'll open it up for questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press Star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press Star, then 2. At this time, we will pause momentarily to assemble the roster. Our first question will come from Brady Gailey of KBW. Please go ahead.

Brady Gailey (Managing Director)

Hey, thank you. Good morning, guys.

Tom Travis (Vice Chairman and CEO)

Good morning.

Kelly Harris (CFO)

Good morning.

Brady Gailey (Managing Director)

So I understand the impact of, you know, owning these energy assets, and it's pushing up the income, it's pushing up expenses. How long do you anticipate owning these assets? Is this gonna be a short-term thing, or is this something that you anticipate owning for a while?

Tom Travis (Vice Chairman and CEO)

This is Tom, and I've got. I'll give you the approximate numbers. I have the exact numbers in my lap, but just to make it easy for you. So we booked approximately $16.9 million of an asset value on the balance sheet, and the effective date and cash flow of the wells started September the first of last year. And so when you look at the starting point on the balance sheet of $16.9 million, for the first four months, we will have collected $4.5 million. So the new asset or the actual cash flow that results from that is about $12.4 million. So we will have collected for the first four months, and most of which we have collected, 27% of that asset value.

So then, when you think about cash flow for 2024, the cumulative cash flow at the end of this year is projected to be 60%. So in math, that means we will have collected $10.2 million of the $16.9 million. And then, if you want to roll that forward through 2025, we will have collected $13.2 million of the $16.9 million, which is about 78% of the cash flow. And for anyone on the call that's not familiar, the cash flows from producing oil and gas wells is not a linear decline curve. It's skewed more heavily towards the more recent months. And so as you collect the cash flow, the asset value will come down much more quickly in the early months and then smooth out.

So the bottom line is, is that, again, we will have collected a little over 25% of the cash flows of that beginning asset value by now, and then by the end of the year, 60%. And so we expect it's already not a material amount relative to the company, but we will expect by the end of the year it to be pretty immaterial.

Brady Gailey (Managing Director)

Okay. All right, so that, that's the plan, and, and there's not a thought of just simply selling these assets more near term?

Tom Travis (Vice Chairman and CEO)

It's possible. I will tell you that, we have hedged about, what is it, 62%?

Matt Olney (Managing Director)

Of the oil.

Tom Travis (Vice Chairman and CEO)

Jason?

Matt Olney (Managing Director)

The oil revenue, yes.

Tom Travis (Vice Chairman and CEO)

So this is predominantly oil and not natural gas, and so we have hedged to make sure that we can receive the most of the cash flows, if not all of it. And so, it is possible if you saw an increase in the commodity prices and the market would value the assets higher, it's possible we could sell.

Brady Gailey (Managing Director)

Okay. All right. And then maybe looking at the core fundamentals of the bank, which were pretty impressive in the quarter, how are you guys thinking about loan growth from here? And what's the outlook for the core net interest margin?

Jason Estes (President and Chief Credit Officer)

Hey, Brady, it's Jason. I think, again, kind of like last year at this time, we were sitting here coming off of a really rapid growth in 2022, and we signaled, "Hey, this is gonna be a different year. We think it'll be more like a mid-moderate single digit." I think we ended up at 7%. I think something in that range is probably reasonable to expect for this year. I think we've got a fair amount of known payoffs coming in the first half of the year, expected, known, quantified payoffs. The deal pipeline's still nice. We booked about $90 million of new fundings in the fourth quarter, which was a nice, solid quarter.

So, you know, it looks like first quarter pipeline is decent, but with those known payoffs, you know, I think we'll be pretty muted in the first half of the year and pick it up in the second half.

Tom Travis (Vice Chairman and CEO)

I would also note that we would have to signal that the large energy credit paydown and payoff has been delayed somewhat because of the bankruptcy. So you could likely see a little bit higher payoff amount in the first quarter, due to that, than you would normally see.

Brady Gailey (Managing Director)

All right. That, that's helpful. And then the core margin, it's been pretty consistent around 4.50%, for the back half of 2023. Is that how we should think about it going forward, or do you think that there could be some slippage there?

Kelly Harris (CFO)

Hey, Brady, this is Kelly. If you look at December NIM, core NIM, we were at 4.45%, average 4.50% for the quarter. We do have a large tranche of U.S. Treasuries that matures at the end of February, that will move to a higher-yielding asset, you know, 5.33%, assuming the Feds. And so you will see there's some positive events that will occur during the quarter that should lift NIM. That said, no color on what the Feds are going to do in March, as well as then fighting paydowns.

Tom Travis (Vice Chairman and CEO)

That's a good recap, Kelly. I would use the word delighted but not surprised. We are delighted with our company's ability to have managed the NIM through the interest rate cycle. We're not surprised about it. We purposely worked very hard to match the balance sheet so that we're not caught with interest rate swings and wild fluctuations. And so, as we are prone to say on a regular basis, we're pleased with our ability to illustrate a NIM that's very steady, irrespective of the changes in the interest rate markets, and we don't see that changing.

Brady Gailey (Managing Director)

All right. And then just finally for me, Kelly, what, what's the size of those Treasuries that are rolling off, and what's the rate there?

Kelly Harris (CFO)

$100 million at 1.5%.

Brady Gailey (Managing Director)

Okay, great. Thanks, guys.

Operator (participant)

The next question comes from Nathan Race of Piper Sandler. Please go ahead.

Nathan Race (Managing Director)

Hi, guys. Good morning.

Tom Travis (Vice Chairman and CEO)

Good morning.

Kelly Harris (CFO)

Good morning.

Nathan Race (Managing Director)

Just want to clarify on the last point around the securities that are maturing in the first quarter. Is the plan just to leave those in cash, or do you guys plan on redeploying that into securities in the first half of the year, or just leaving it for some dry powder to redeploy into loans, as Jason described earlier?

Tom Travis (Vice Chairman and CEO)

We're not gonna speculate. It's obviously tempting to believe that we're at the end of a rate cycle and, you know. However, as we all know, I think the wise thing for anyone to do is to not speculate and think you know. And so we're going to take advantage of the yield curve inversion, and I think today, the 10-year is somewhere around, what is it? 4.1%, and the Fed's still over 5%. So I think our belief is that we'll put it at the Fed and kind of stay away from any kind of fixing in and trying to anticipate rates dropping. I think you also, you know, remember that, you know, liquidity is a real important function of the bank and part of the Rubik's Cube.

And so, you know, $100 million sounds like a lot of money, but it's really not relative to the movements on the balance sheet, relative to loans and liquidity. So keeping it short and in cash will benefit us on the yield curve side, and it also maintains that strength and flexibility for liquidity and cash.

Nathan Race (Managing Director)

Okay, got it. That's helpful. Just curious how you guys are thinking about deposit betas and pricing on the way down. You know, if we get a few Fed rate cuts at some point this year, you know, how do you see that impacting the margin and just kind of overall the trajectory in NII over the course of 2024?

Tom Travis (Vice Chairman and CEO)

I don't, I mean, Kelly or Jason, you want to talk about, we budgeted pretty, pretty similar from where we are.

Kelly Harris (CFO)

Yeah. I think if you look at our historical NIM, you know, through various rate cycles, we've been able to manage it up and manage it down, and I don't foresee this being any different. And so if, if the Feds cut, then we'll be able to push down the deposit rates in tandem with, with the asset side.

Tom Travis (Vice Chairman and CEO)

Anything you want to add to that, Jason?

Jason Estes (President and Chief Credit Officer)

No, other than, you know, we spend a lot of time on these calls talking about, you know, NIM and growth rates, and they're very important things. And I think if you look at our history, we've proven that we're not willing to sacrifice margins for, you know, the sake of growth. And so I think you're going to see our discipline, just like it was there last year, it's going to continue to be the same, right? We're going to work as hard as we can to maintain, you know, top-tier profitability while we grow this company.

Nathan Race (Managing Director)

Got it. Very helpful. Makes sense. And just one last one for me on kind of, excess capital priorities into this year. You know, you guys are operating with pretty healthy capital levels across the board. So just curious, you know, what you see in terms of, acquisition opportunities and just kind of your optimism level on that front.

Tom Travis (Vice Chairman and CEO)

I would say that we are laser-focused on acquisition opportunities, and it takes laser focus because there's still a healthy amount of what we call the zombie banks, that I think you guys do, too. And we continue to have conversations. We are making calls on people that are not for sale. We're planting seeds. We are constantly evaluating everything we can, and it's probably going to be a tougher environment for the next 2 or 3 or 4 months or just as tough of environment, I should say. And then, if rates do start coming down, some of the, quote, "zombie banks," may have an ability to sell, and so you might see a little flurry there in the back half of the year if the rates come down.

So our goal is to position ourselves and to try to be there when we can, so that we can buy, and we definitely have a mindset to do that.

Nathan Race (Managing Director)

Got it. That's great. And if I could squeeze actually one last one in. Just curious, Jason, maybe in terms of, you know, overall migration trends and criticized and classified in the quarter outside of the one energy loan that we've touched on?

Jason Estes (President and Chief Credit Officer)

Yes. So the quarter. Yes, Tom mentioned in his opening comments, you know, the credit quality of the book, the metrics have actually improved outside of this one credit, not that they were bad other than this deal. But, you know, I think if you recall, a couple of years ago, we had another charge-off. That loan paid in full during the quarter, the remainder of it, and so the balance we had left is all paid off and it's gone. And then, you know, we've had another NPA we've been carrying. It's about 34% of the NPA balance at the end of the year, and we're optimistic that, you know, that thing could be off of that list here in the, maybe even in the first quarter. And so, you know, we're not seeing stress throughout the portfolio.

That, that being said, you know, we've got a medical relationship that has migrated down, and it's about $10 million altogether, but it's more going positive than there has been negative for the last couple of quarters, outside of the one credit.

Nathan Race (Managing Director)

Got you. And just within that context, do you kind of envision the reserve kind of remaining where it was coming out at the end of the year relative to loans, or do you guys kinda see it as kind of an overinflated level, just given some of the credit events that occurred late last year?

Jason Estes (President and Chief Credit Officer)

I would say it's probably overinflated of our historical range and where we strive to keep it, but I think it's warranted based on what's transpired, you know, in the last couple of quarters.

Nathan Race (Managing Director)

Okay, great. I appreciate all the color. Thank you.

Operator (participant)

The next question comes from Matt Olney of Stephens. Please go ahead.

Matt Olney (Managing Director)

Hey, thanks, guys. Good morning.

Tom Travis (Vice Chairman and CEO)

Morning.

Matt Olney (Managing Director)

Do you guys have the dollar amount of the charge-off for the fourth quarter? I didn't see that one.

Kelly Harris (CFO)

Hey, Matt, this is Kelly. Yeah, the total NCO for the quarter was $16.5 million.

Matt Olney (Managing Director)

Okay, perfect. Thank you, Kelly. And then on the deposit side, really strong non-interest-bearing deposits in the fourth quarter. Any color on the growth there? And then you hit on the betas earlier, but just the appetite to grow deposit balances for the year.

Tom Travis (Vice Chairman and CEO)

Well, the non-interest-bearing will come down a little bit in the early part of the year. We had a few large, significant non-interest-bearing deposits that occurred later in the last year, and we expect some of that to run off. And so we don't believe that the non-interest-bearing deposits are gonna show much absolute growth from the prior year because of that, inflated number that came in late in last year. So now, relative to, you know, if you take those few deposits out, we would expect to do what we've always done, and that is a nice, steady growth in our deposit book and our relationship deposits.

Our bankers are doing a really nice job of making loans when we have new deposit relationships, and so we don't expect there to be much difference, if at all, in the way we operate going forward.

Kelly Harris (CFO)

I think it's probably fair, too, to say we're still seeing some migration where people are moving what were non-interest-bearing accounts over into some interest-bearing products. And, you know, that's been ongoing ever since the rate, this last rate cycle, moving up started.

Matt Olney (Managing Director)

Yep. Okay, that makes sense. And then just as far as the rate sensitivity, you gave us some good details there on slide 4. It looks like about 78% of your earning assets reprice in that first year. Just within the loans, and that's it. It seems like most of those that reprice the first year are going to be floaters that reprice in the first few weeks after a Fed cut. Is that right? Or any color on kind of what percent of those loans are floaters?

Tom Travis (Vice Chairman and CEO)

Yeah, I think if you look at the first footnote on that same page, Matt, of that $1,043 million in loans in that less than a year, $901 million are daily floaters, and of that, you've got $86 million at the ceiling. So roughly, what, 90% of that total?

You said it. There's $1 billion in loans that are floaters?

Kelly Harris (CFO)

$900 million.

Tom Travis (Vice Chairman and CEO)

Yeah. And look, I think we always have to remember, not saying that people don't, but, you know, we are very active in managing our floors. And so that's part and parcel to the stability of the NIM and the historical illustration that we show you and our ability to maintain that NIM. So, you know, yes, they'll float down, but at some point, we start hitting floors, and that's a big component of our, of our bank.

Matt Olney (Managing Director)

Yep. Okay. Good points. And then on expenses and fees, any color on the way you're thinking about that in 2024, if we just remove the oil and gas assets that you mentioned before?

Tom Travis (Vice Chairman and CEO)

You know, we're proud of that. If you look at the expense load for the bank and you take out the oil and gas impact, and am I right, Kelly? It was 33% efficiency ratio.

Kelly Harris (CFO)

Mm-hmm.

Tom Travis (Vice Chairman and CEO)

And if you look at the expenses, too, you know, to the size of the bank, and we feel really good about our ability to manage our expenses, and I think that's been proven over the years, and nothing is going to change. We're spending a little bit of money to upgrade and relocate a few fixed assets, but that really won't show up until very late in the year and probably really not until next year, because it just takes a while to construct a few branches. So, but even with that, we don't expect the expense load of the bank to change in a meaningful way.

Matt Olney (Managing Director)

Okay. All right, guys. Thanks for your help.

Kelly Harris (CFO)

Thank you.

Operator (participant)

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

Tom Travis (Vice Chairman and CEO)

Thank you again. We're pleased with our position of our company and our results, and we're especially pleased to move past that one-off event, and it's in the rearview mirror, and we've shown the ability to manage through that and still produce good results. We're really excited about this year and excited to just get right back on track to those really, truly strong, strong numbers. We appreciate everyone's participation and involvement.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation, and-