Equity Bancshares - Q2 2024

Transcript

Operator (participant)

Hello, everyone, and welcome to the Equity Bancshares second quarter 2024 earnings call. My name is Ezra, and I will be coordinating your call today. If you would like to ask a question, please press star followed by one on your telephone keypad. And if you change your mind, it would be star followed by two. I will now hand over to your host, Brian Katzfey, Director of Corporate Development and Investor Relations, to begin. Brian, please go ahead.

Brian Katzfey (Director of Corporate Development and Head of Investor Relations)

Good morning. Thank you for joining us today for Equity Bancshares' second quarter earnings call. Before we begin, let me remind you that today's call is being recorded and is available via webcast at investor.equitybank.com, along with our earnings release and presentation materials. Today's presentation contains forward-looking statements which are subject to certain risks, uncertainties, and other factors that could cause actual results to differ materially from those discussed. 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 the call over to our Chairman and CEO, Brad Elliott.

Brad Elliott (Chairman and CEO)

Good morning, and thank you for joining Equity Bancshares earnings call. We are pleased to take you through our second quarter results, including a set of new record-high watermarks, integration of the Bank of Kirksville merger, and the announcement of our acquisition of KansasLand Bancshares. Joining me today are Rick Sems, our bank CEO, Chris Navratil, our CFO, and Krzysztof Slupkowski, our Chief Credit Officer. It was another exciting quarter of improving operating performance for our company. Excluding the impact of BOLI, repositioning costs, and merger expenses, we outperformed market expectations. With the momentum of rebalancing our portfolio last year and the Bank of Kirksville transaction in the first quarter, we realized expansion in both net interest income and net interest margin. We closed the quarter with a loan deposit ratio below 80%.

Strong capital ratios and significant liquidity to continue to drive earnings growth in 2024, both organically and via strategic M&A. During the quarter, we completed the integration of systems from the legacy Bank of Kirksville locations and announced and received regulatory approval of our acquisition of KansasLand Bancshares. The KansasLand transaction officially closed on July 1st, 2024, 71 days after announcement. We continue to emphasize shareholder return through our quarterly dividend, as well as active participation in our share repurchase program. During the quarter, we repurchased 152,982 shares under our current authorization of up to 1 million shares. At the close of the quarter, we have capacity to purchase an additional 637,427 shares under the authorization.

During the quarter, we announced the promotions of Rick Sems to bank CEO and Julie Huber to COO. These promotions strengthen the management team while reinforcing our operating structure. We are confident they will continue to excel in the expanded roles. As we emphasized at our investor meeting in June, we are bullish about where our company is positioned. We have an excellent leadership team, motivated producers, and an abundance of deployable capital to drive positive stakeholder returns. I look forward to continuing our positive momentum. I'll let Chris talk you through our financial results.

Chris Navratil (CFO)

Thank you, Brad. Last night, we reported net income of $11.7 million or $0.76 per diluted share. Adjusting for merger expenses incurred related to Bank of Kirksville and KansasLand transactions and the cost of surrendering a portion of our BOLI portfolio, net income was $15.2 million or $0.99 per diluted share. During the quarter, our realized effective tax rate was 28.1%, driven up by one-time BOLI surrender charges of $1.8 million. As Brad alluded to, we repositioned approximately $60 million in BOLI into higher-yielding contracts during the quarter. Realized losses are modeled to be recovered inside of two years through the non-interest income and tax lines. Without the repositioning, the tax rate for the quarter would have been 17.5%.

Net interest income was up $2.3 million linked quarter, while net interest margin improved from 376 to 394. We will discuss margin dynamics in more detail later in this call. Non-interest income was in line with our outlook for the quarter and included a 6.3% linked quarter increase in service charge line items. Non-interest expenses, adjusted for one-time M&A charges totaling $37.0 million, were up linked quarter, primarily attributable to Bank of Kirksville additions, including CDI amortization, technology, and facility expenses. The purchase accounting for Bank of Kirksville was finalized during the quarter, resulting in an insignificant increase to the previously recognized gain on acquisition. As Brad noted, Equity announced our acquisition of KansasLand during the quarter and subsequently closed it on July 1st. KansasLand has $50 million in assets operating out of two branches.

We modeled $0.03 accretion for 2024 at announcement, which remains the expectation. Our GAAP net income included a provision for credit loss of $265,000. We continue to hold reserve for potential economic challenges. However, to date, we have not seen specific concerns in our operating markets. The June 30 coverage of ACL on loans is 1.26%. I'll stop here for a moment and let Krzysztof talk through our asset quality for the quarter.

Krzysztof Slupkowski (Chief Credit Officer)

Thanks, Chris. Asset quality metrics continue to screen at historically low levels, with total classified loans closing the quarter at $49.6 million, or 8.8% of total bank regulatory capital. Non-accrual loans as a percentage of total loans remained below 75 basis points. Net charge-offs annualized were 14 basis points for the quarter. Recognized charge-offs have been reflected of specific circumstances related to individual credits rather than broader market concerns. The acquisition of KansasLand Bank, mentioned earlier, will have a negligible impact on bank's problem asset position. We continue to utilize our portfolio monitoring tools to detect early signs of credit deterioration. At this point, we have not seen any systemic deterioration in any of our portfolios. Our continued stress testing confirms the resiliency of our CRE book. Our exposure to office space is very low and continues to perform well.

Despite these positive indicators, we remain cautious in our underwriting and continue to monitor for any emerging risks while maintaining healthy levels of capital and reserves to face any future economic headwinds. Chris?

Chris Navratil (CFO)

Thanks, Krzysztof. Average loans increased modestly during the quarter. Loan originations in the second quarter totaled $99 million, with a weighted average coupon of 8.76%, compared to $116 million, with a weighted average coupon of 8.61% in the first quarter. During the quarter, the coupon yield on loans increased to 6.96% from 6.84%. Overall, loan yields improved 30 basis points to 7.15%, driven by accretion from Kirksville, expiration of a pay-fixed interest rate swap, and higher coupon originations. During the quarter, our bond portfolio yield improved to 3.99% from 3.89%, reflecting the impact of repricing Kirksville's bond portfolio at acquisition date.

Cost of interest-bearing deposits were materially flat at 2.78%, while the contribution of average non-interest-bearing deposits to the average deposit mix increased to 22.7% from 21.7%. Net interest income totaled $46.4 million during the quarter, up $2.3 million from the prior quarter, as our earnings streams benefited from previous period's strategic decisioning and continued to outpace rising funding costs. We continue to carry excess cash balances, which are offset by wholesale borrowings. We are currently earning a positive spread on these positions, though it does have the effect of reducing margin. We calculate that the excess liquidity has the effect of reducing margin by 9 basis points for the current quarter. Non-interest expense during the quarter was $37 million, excluding $2.3 million in realized merger charges.

The integration of core banking systems following the Bank of Kirksville transaction took place in May. Kirksville operating costs, including CDI amortization, were the primary driver of expense expansion. Our outlook slide includes a forecast for the third quarter as well as full year 2024. We do not include future rate changes, though our forecast still includes the effects of lagging repricing in both our loan and deposit portfolios. Our provision is forecasted to be approximately 12 basis points to average loans. Rick?

Rick Sems (Bank CEO)

Equity has grown during the first six months of 2024, and we are positioned to continue to do so. During the quarter, our team was able to successfully integrate the Bank of Kirksville merger while also assessing, negotiating, and announcing our acquisition of KansasLand. Credit goes to Julie Huber and her operations teams for getting it done. Outside of M&A, our production teams remain focused on driving organic growth on both sides of the balance sheet. Following the company's annual meeting in late April, we rolled out a producer incentive program that is designed to award our team with ownership for hitting higher growth goals. The program kicked off in the quarter, and we anticipate it to yield benefit over the remainder of the year. We have, we have also rolled out a comprehensive training program to help improve our commercial banking capabilities.

In Q2, all of our commercial bankers have successfully completed round one of their training. In addition, the team has identified 1,200 prospect companies which were called upon in Q2. We expect this expanded calling effort to lead to pipeline expansion in Q3 and Q4. During the quarter, we were able to grow average loan balances 2.3%. We expect pipelines to continue to grow, and our sales teams are motivated to meet the needs of our customers and communities, which will drive organic growth. During the quarter, customer deposit balances were generally flat, with immaterial levels of expected runoff from the Bank of Kirksville customer base. Our team continues to focus on net interest margin and managing a challenging yield curve. This focus has resulted in us passing on loan opportunities at lower yields, as well as higher cost transactional deposits.

As discussed in our investor materials from June, we believe there is meaningful opportunity to both maintain and grow our deposit base in our current markets. Total deposits closed the quarter at $4.34 billion.

Loans as a percentage of deposits closed at 79.6%, positioning our bank to be a capable lender for new and current customers in our footprint. As indicated in our outlook slide, we expect to drive mid-single-digit organic loan growth in 2024. We have the strategy, discipline, tools, and people in place to realize this expectation. I look forward to assisting the team in execution. Service revenues improved quarter-over-quarter, including increasing contributions from cards, treasury and wealth management, service charges, and mortgage. Under the leadership of Andrew Musgrave, Trust and Wealth Management saw its best revenue quarter in over three years as the team has been able to drive both AUM and pipeline growth.

Our company is well capitalized. Our asset quality metrics continue to run at historic lows. Our balance sheet structure is solid, our team is experienced, and we have a granular deposit base. We look forward to continuing to redeploy assets into customer relationships that build franchise value. We see a lot of momentum on the M&A front and expect that to continue. Equity will remain disciplined in our approach in assessing these opportunities, emphasizing value while controlling dilution and the earn back timeline. Thank you for joining the call, and we're happy to take your questions at this time.

Operator (participant)

Thank you very much. To ask a question, please press star, followed by one on your telephone keypad now. When prepping to ask your question, please ensure your device is unmuted locally, and if you change your mind, please press star followed by two. Our first question is from Jeff Rulis from DA Davidson & Co. Jeff, your line is now open. Please go ahead.

Jeff Rulis (Managing Director and Senior Research Analyst)

Thanks. Good morning. I just a question on the margin front. Just, it looks, you know, I think, kind of flat to down, for the second half and wanted to... I think there was a mention of the lagging effect of repricing deposits. Is that the genesis for the kind of the conservativeness on margin? I just wanted to double-check that.

Chris Navratil (CFO)

I think it's, it's two things, Jeff. One of it is just always that continuing potential pressure on deposits that we're recognizing in that number. But it's also the purchase accounting adjustment as it relates to Bank of Kirksville. That, that particular transaction, we realized a level of purchase accounting accretion of about 10 basis points to loans, 7 basis points to margin during the quarter. If that normalizes down to five or six, that drives down margin a little bit. So it, it's a little bit of both those things. It's leading to a little bit of conservatism in that number.

Jeff Rulis (Managing Director and Senior Research Analyst)

Yes. Okay, and just wanted to make sure you do not have rate cut expectations in that margin guide. And if not, what would that net effect be from your perspective?

Chris Navratil (CFO)

That's correct. We don't have any in the model itself or in those four in that outlook. It, you know, as our balance sheet sits today, we're in a modestly asset-sensitive position. So for small rate cuts, we expect a small adjustment down in terms of margin. But at the same time, we think we have ample opportunity on the liability side to be moving rates down to maintain or nearly maintain where we are from a margin perspective. So we think for small movements as we go forward, we won't see meaningful degradation in margin. If we start to see larger cuts, that's where there could be some challenge, but we're not forecasting or looking at that at the moment.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay. And then hopping over to the loan growth outlook. I think you covered it well. I mean, the numbers and the outlook look fairly muted for the second half, despite some of that positivity and those incentive plans. But I think you kind of mentioned some cautiousness on underwriting and loan yield discipline. Poking through that second half, I think you talked about pipelines building, but yet kind of a flattish outlook. Any more color on the loan growth front in the second half? And maybe trying to get to those incentives that you launched, is that more of a kind of a 2025 impact? Just trying to get the timing of when you see that kick in.

Chris Navratil (CFO)

Yeah, I'll just say one thing, Jeff, in terms of the outlook: is that average balance depiction is part of what's driving that. So the slower first half, we do think there's some meaningful opportunity going in the second half and expect year-over-year loan growth of kind of mid-single digits, 5%-ish. So that's a little bit of that dynamic, but I'll let Rick further address expectations.

Rick Sems (Bank CEO)

Yeah, I mean, our expectations are we are going to see some growth there in the second half. You know, we've kind of gotten to a point where we think... And what we're seeing is some of the borrowers are just a little slow to break loose and go ahead and commit to do any deal. But we expect that to kind of click in in the second half. So we see loan growth, you know, into the late, you know, late in this quarter, but probably into the fourth quarter, and then really trying to drive it into 2025 with what we're focused on with the incentives and the calling effort that's going on right now.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay. And just a last one on the—just want to confirm the. And they're probably immaterial, but the loan—well, the loan balances from KansasLand, that is in the guidance and maybe confirming that. Also, just what were the 6/30 loan and deposit balances at that KansasLand?

Krzysztof Slupkowski (Chief Credit Officer)

20 or 30?

Brad Elliott (Chairman and CEO)

Yeah. Yeah, $35 million-ish on the loan side, and $40-some million-ish on the deposit side.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay. All right. Thank you.

Operator (participant)

Thank you. We've got another question from Andrew Liesch, from Piper Sandler. Andrew, your line is now open. Please go ahead.

Andrew Liesch (Senior Equity Research Analyst)

Hi. Thanks, good morning, guys. Just a question on the swap that expired. Just curious what basis points benefit to the margin did that generate?

Chris Navratil (CFO)

Yeah. Thanks, Andrew. The benefit for the quarter on that derivative transaction was 8 basis points. I mean, potentially slightly greater as you look forward, so 9 basis points on a go-forward basis, that expired in the middle of April.

Andrew Liesch (Senior Equity Research Analyst)

Got it. All right, that's helpful. And then the, the excess liquidity that you mentioned, nine basis points last quarter, does the guide include that, that excess liquidity on there, on the, on the balance sheet?

Chris Navratil (CFO)

Yeah, the guide includes the cash, and it includes the margin impact.

Andrew Liesch (Senior Equity Research Analyst)

Got it. All right. Okay, that's helpful. And then, Brad, just on the M&A front, just curious if you could provide some more commentary on what's gone on, maybe over the last six weeks or so. Like, how have your conversations been tracking with prospective targets?

Brad Elliott (Chairman and CEO)

Yeah, we've got, there's actually several new conversations kicking up, Andrew, and so there's lots of conversations going on. As you know, that never means that anything is, is in concrete going to happen. But, you know, we kick a lot of tires, have a lot of conversations, model a lot of deals, and then see if we're, you know, the partner they want to pick. And so, it's, you know, I'm encouraged by the standpoint of I think there's a lot of opportunities that, that we're able to talk with right now. I think people have realistic expectations. I think conversations are going well. And so, you know, things, stock price moving up, probably helps some of those transactions.

Some of those transactions are all cash, so it doesn't influence them at all. But I think there's lots of positive momentum in the second half of the year for conversations.

Andrew Liesch (Senior Equity Research Analyst)

Great. All right, you've already covered my other questions. I'll step back.

Operator (participant)

Thank you very much. We've got another question from Terry McEvoy, from Stephens. Terry, your line is now open. Please go ahead.

Terry McEvoy (Managing Director)

Great. Thanks. Good morning, everyone. Chris, maybe a couple of questions for you. When we were together last month, you raised the outlook for the net interest margin, and I think you commented that there was some accretion behind the increase. Could you just maybe quantify the accretion last quarter, and how are you thinking about the second half of this year from an accretion perspective?

Chris Navratil (CFO)

Yeah. So through the second quarter, Terry, the accretion recognized through margin was 7 basis points. As I look forward, I think—so it'll range between, I expect for this year, five and eight. So the higher end is the kind of more meaningful accretion from BOK, plus some additional KansasLand. The lower end would just be slower accretion on the BOK side, as well as KansasLand. So it's going to be between 5 and 8 basis points, I think, the rest of the way.

Terry McEvoy (Managing Director)

Thanks. And then just one other small one. What are your thoughts on the tax rate in the fourth quarter in 2025?

Chris Navratil (CFO)

Yeah. So for the rest of this year, the way the BOLI transaction works is basically factored into the effective tax rate for the year. So without any additional tax planning, we would see the tax rate yield realized year to date, which is about 24%-24.5%. That would be consistent the rest of the year. As you look at the outlook, we've put 20%-22% in there, for quarter end of the year. And the reason for that is we do have some tax planning strategies we're working on that we think, can lower that rate. So if we realize those benefits, we'll see that tax rate somewhere closer to 20%. If we don't, it'll be where it is today on a year-to-date basis, which is about 24.5%.

Terry McEvoy (Managing Director)

Thanks, Chris. And then, Brad, going back to the M&A discussion, what's the profile of a potential M&A partner today? What are the reasons for having a conversation with Equity? And are there any similar characteristics among some of those potential partners?

Brad Elliott (Chairman and CEO)

You know, there are similar characteristics. Some reasons are there, you know, the age of ownership is in their 70s, management's in their 70s. Some of the reasons are, they're fighting the headwinds of margin compression, and it's continuing to get worse. They don't look like it's going to get better. And others are some regulatory pressure, from different things in not high-risk areas, but just things that their board is tired of dealing with. And so there's kind of a whole bag of stuff. Each one's kind of different. There's not a theme across the board. The only one theme is several of them, you know, are fighting the headwinds of margin compression.

You know, even if the Fed starts cutting rates, it's not going to improve their margin enough to make a difference. Deposits have repriced on them faster than the assets are, and the assets are still two or three years out.

Terry McEvoy (Managing Director)

Perfect. Thanks for taking my questions. Appreciate it.

Operator (participant)

Thank you. And we've got the next question from Damon DelMonte. Damon, your line is now open. Please go ahead.

Damon DelMonte (Managing Director)

Hi. Thanks. Good morning, everyone. So quick question on the outlook for provision. You know, credit trends have been pretty stable, as Krzysztof provided a good overview. Do we kind of think of the reserve as just being flattish and provision just being driven by loan growth, if net charge-offs are, you know, relatively modest?

Brad Elliott (Chairman and CEO)

Yeah, Damon, I think that's a good way to put it. You know, always pending other things, right? So if, if we had some charge-offs work through, if we had some deterioration in credit quality, that's obviously going to drive provisioning and reserve levels. But if, if things continue on their current trajectory, that statement is correct. We would see really any meaningful provisioning coming through loan production and growth.

Damon DelMonte (Managing Director)

Got it. Okay. And then with regards to the buyback, you know, again, active this quarter, we've seen a rally in the shares and, you know, the sector as a whole. Kind of just curious on your updated thoughts on current prices and if it's still attractive for you guys to remain active.

Brad Elliott (Chairman and CEO)

I think we have to be strategic in thinking about, you know, that, and we always are. We have a certain buyback and earn back that we do, and so we'll continue to look at that, Damon, to see if it still fits us. You know, we're getting to a level where it probably doesn't, which is a positive thing from the standpoint of the stock. You know, the price is performing. But we'll still evaluate on a daily basis, you know, within the parameters that the board sets on whether we should be buying shares back or not.

Damon DelMonte (Managing Director)

Got it. Okay. Everything else I had was asked and answered, so thank you very much.

Operator (participant)

Thank you. The next question is from Brett Rabatin, from Hovde Group, LLC. Brett, your line is now open. Please go ahead.

Brett Rabatin (Managing Director and Head of Equity Research)

Hey, hey, guys. Good morning. I joined a little bit late, but I just wanted to get a little flavor for what you're seeing on the competitive side on deposits. And, you know, if you're adding new money, have the expectations come down, you know, at all in some of your markets? And just, you know, maybe a flavor for what you're having to pay if you want to add new money to the balance sheet.

Rick Sems (Bank CEO)

Yeah. So this is Rick. You know, we're seeing the pressure abate a bit. I mean, every once in a while, you know, you get requests and things like that for an exception that come through. But we're clearly seeing the velocity of that decrease. And so that's good, because in a lot of the markets that we're in, you know, there aren't as many competitors, so we're able to, you know, kind of keep those rates down. It still happens. And the issue is really more, I think, on the individual circumstances of those banks. That's more of what we're seeing.

So banks, you know, struggling with their loan-to-deposit ratio, all of a sudden, somebody comes out of the blue because of, you know, issues that they have there. And then we're, you know, facing a rate that might be in the fives, for, you know, for some money market or, you know, year-out rate. And we're really not playing in that market, at this point in time. So we, as far as on the outlook of it goes, I think we'll continue to see, you know, sporadic or, one-off, competitors doing things like that. So we just take them one at a time.

Brett Rabatin (Managing Director and Head of Equity Research)

Okay. That's helpful. And then just thinking about, you know, M&A is obviously a strong topic with you guys. With your stock a little bit higher, you know, I know cash is something that you typically use in deals, but, you know, would we not expect you to maybe use more stock in the transaction from here? And how are you guys thinking about tangible book dilution, payback, et cetera, at this point?

Brad Elliott (Chairman and CEO)

Yeah. So our metrics haven't changed since we started the company. They're not going to change today. So, you know, we're still going to be under a three-year earn back. Stock does come more into play, although we've had a lot of conversations with people about taking shares all along the way. And, you know, some of it has to do with the smaller companies generally want cash just because they're less sophisticated, and they've had 90% of their assets tied up in the bank. And so one of the reasons they're selling is to get liquidity later on in life. So that's why the cash usually comes into play. But, you know, there are conversations currently happening with stock, and I think it will increase with the stock market recovery.

Brett Rabatin (Managing Director and Head of Equity Research)

Okay. Great. Thanks for taking my questions.

Operator (participant)

Thank you very much. We currently have no further questions. Thank you, everyone, for joining. That concludes today's call. You may now disconnect your lines.