Equity Bancshares - Q3 2024

Transcript

Operator (participant)

Hello, everyone, and welcome to Equity Bancshares' Q3 2024 earnings call. My name is Lydia, and I'll be your operator today. If you'd like to ask a question during the Q&A, you can do so by pressing star followed by one on your telephone keypad. I'll now hand you over to Brian Katz to begin. Please go ahead.

Chris Navratil (CFO)

Good morning. Thank you for joining us today for Equity Bancshares' Q3 earnings call. Before we begin, let me remind you that today's call is being recorded and is available via webcast at investor.equitybanc.com, along with our earnings release and presentation material. 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. Joining me today are Rick Sims, our Bank CEO, Chris Navratil, our CFO, and Krzysztof Slupkowski, our Chief Credit Officer. We are pleased to take you through our Q3 results, including record results in many areas. As rates have started to decline, our AOCI is recovering well from the bond restructuring done in late 2023. Our margin is holding steady, and we are optimistic about our opportunity to expand net interest income in the next several quarters, as Chris will discuss. Rick's efforts to lead a sales-driven organization are starting to pay off, as you can see in our balance sheet growth in loans and our strong pipeline. We also received a noteworthy final payment from a franchisor borrower that defaulted in 2019.

Brett Reber and Greg Kossover did excellent work to structure a workout that allowed the borrower to reorganize and ensure a significant repayment of the debt. The resolution resulted in a current period gross income of $8.5 million. This result underscores our commitment to and expertise in recovering on problem credits if they arise. During the quarter, we also continued to execute on our mission to meet the needs of our customers while building shareholder value. Period-end loan balances increased by $147 million. While non-municipal customer balances and overall deposits were materially flat, our sales and operational teams, under the leadership of Rick Sims and Julie Huber, are aligned and motivated to continue to drive the bank forward.

In addition to excellent operating results, we realized further expansion of capital while also increasing our dividend by 25% during the quarter, closing with TCE ratios of 8.21% and tangible book value per share growth of 10.4%. During the quarter, we also closed and converted our second bank merger of 2024, welcoming KansasLand Bank and its bankers to the Equity franchise. The transaction closed 71 days after announcement, with systems conversions taking place later in the Q3. As we look to the Q4 and into 2025, I am enthusiastic about our team, our markets, and the opportunities that lay ahead. Our balance sheet remains strong, and our organization is aligned in its goal to be the premier community bank in our footprint for our customers and potential partners. I'll let Chris talk you through our financial results.

Chris Navratil (CFO)

Thank you, Brad. Last night, we reported net income of $19.8 million or $1.28 per diluted share. Adjusting for merger expenses incurred related to the KansasLand transaction and gain on security sales, net income was $20.2 million or $1.31 per diluted share. Net interest income was flat quarter over quarter, while net interest margin was 3.87% versus 3.94%. We will discuss margin dynamics in more detail later in this call and remain optimistic about opportunities for margin maintenance and income expansion in future quarters. Non-interest income came in higher than our outlook for the quarter and included a continued positive trend in service charge line items. Also reflected in non-interest income was an $831,000 gain on acquisition related to the KansasLand transaction.

Non-interest expenses, adjusted for one-time M&A charges totaling $29.6 million, were driven down quarter over quarter due to the $8.5 million recovery Brad previously discussed. Excluding this benefit, the write-down of a former bank location of $742,000 and additive incentive accruals of $900,000, non-interest expense, exclusive of M&A, was flat at $36.5 million linked quarter. Our GAAP net income included a provision for credit loss of $1.2 million, primarily driven by loan growth late in the Q3. We continue to hold reserve for potential economic challenges. However, to date, we have not seen specific concerns in our operating markets. The ending coverage of ACL loans is 1.21%. 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. Total classified loans closed the quarter at $48.7 million, or 8.3% of total bank regulatory capital, improving 15 basis points linked quarter. Non-accrual loans as a percentage of total loans increased 10 basis points to 0.87%. Although the increase was primarily driven by the addition of one relationship, we are seeing an increase in negative migration of small loans. Delinquency in excess of 30 days declined from $13.7 million to 10.3 million. Net charge-offs annualized were 18 basis points for the quarter, while year-to-date charge-offs annualized were 13 basis points through September 30. Recognized charge-offs continue to reflect specific circumstances on individual credits and do not indicate broader concerns across our footprint.

While our credit outlook for the year remains positive, we recognize minor weaknesses are emerging due to the ongoing impact of inflation on our borrowers. Specifically, smaller operators and quick service restaurants are facing pricing pressures and margin constraints. While there is risk, the bank is adequately secured, exposure is granular, and meaningful losses are not expected. We continue to leverage our portfolio monitoring tools to identify potential risks and remain prudent in our credit underwriting, while maintaining healthy levels of capital and reserves to face any future economic challenges. Chris?

Chris Navratil (CFO)

Thanks, Krzysztof. Average loans increased during the quarter at an annualized rate of 1.8%. Loan originations in the quarter totaled $246 million, with a weighted average coupon of 7.75%, positioning the bank for an improved earnings in the Q4. During the Q3, the coupon yield on loans increased to 7% from 6.96%. Overall, loan yields declined four basis points to 7.11%, driven by a decline in purchase accounting accretion of five basis points and non-accrual effect of an additional five basis points. Excluding these non-coupon items, loan yields improved six basis points. Cost of interest-bearing deposits increased to 2.85%, while the contribution of average non-interest-bearing deposits to the average deposit mix held consistent at 22%.

Total cost of funds was effectively flat for the quarter at 3.11%. Net interest income totaled $46 million, down slightly linked quarter due to the previously discussed loan yield dynamics. Margin and earnings are stable, with continued potential for upside via additive production. Based on balance sheet positioning leading up to the FOMC's decision to drop interest rates in September, we were able to neutralize the impact of a 50 basis points drop on earnings and margins. We continue to carry excess cash balances, which are offset by wholesale borrowing. 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 10 basis points for the current quarter.

Our outlook slide includes a forecast for the Q4 as well as a first look at 2025. We do not include future rate changes, though our forecast continues to include the effects of lagging repricing in both our loan and deposit portfolios. Our provision is forecasted to be approximately twelve basis points to average loans. Rick?

Rick Sems (Bank CEO)

In September, we held our annual strategic retreat with members of the board and senior bank leadership. Our team left our time together energized and focused on all we expect to accomplish over the next three to five years. We are aligned and committed to executing for our customers, employees, and shareholders. We have maintained a strong balance sheet and are positioned to be a facilitator of the banking needs of our community, as well as a partner of choice for banks in our region pursuing scale or ownership liquidity. Our teams delivered on our mission during the Q3. Excluding M&A, we grew ending loan balances by $118.2 million, or 3.42%. We also added KansasLand during the quarter, contributing an additional $28.3 million. Total ending balances increased by 16.9% on an annualized basis.

As we enter the Q4 and look to 2025, pipelines remain strong, with $448 million in the 75% or greater bucket, and our 25% pipeline, which is an indicator of opportunity identification, hit an all-time high of $673 million. With a strong pipeline and motivated bankers, I am optimistic we will continue to see organic balances growth. Deposit balances, excluding public funds, which generally see a decline in Q3, were down $20 million, while the bank continued to allow for movement of high beta non-relationship balances. Under the leadership of Jonathan Roop, I look forward to the retail team driving relationship expansion over the remainder of the year and into 2025. In addition to this focus on retail, our commercial teams remain focused on being a full-service banker to our customer base, including deposit and treasury services.

Our team continues to prioritize net interest margin and managing a challenging yield curve. This strategy has resulted in passing on loan opportunities at lower yields, as well as higher cost transactional deposits. We closed the quarter with a loan-to-deposit ratio of 82.5%. During the quarter, our team closed and converted another bank acquisition. Under the leadership of Julie Huber and David Pass, our teams have successfully completed two acquisitions in 2024, each of which was announced and closed within 75 days. Our ability to facilitate these transactions is a continued source of pride for the team.... We believe there is a meaningful opportunity to both maintain and grow our deposit base in our current markets, allowing for further balance sheet and earnings growth in 2025 and beyond.

We have rolled out a comprehensive sales training program, fostered organizational buy-in, and aligned incentives with expanding our customer base and driving franchise value. Coupled with our capacity to facilitate strategic M&A, I'm excited about our position to operate over the coming quarters. As indicated in our outlook slide, we expect to drive mid- to high-single-digit organic loan growth in 2024 and 2025. We have the strategy, discipline, tools, and people in place to realize this expectation. Brad and I look forward to assisting the team in execution. Service revenue improved quarter over quarter, including increasing contributions from cards, trust, wealth management, and mortgage. Our trust and wealth management team continues to add assets under management and has a robust pipeline headed into the Q4 in 2025.

Brad Elliott (Chairman and CEO)

Our company is well capitalized, asset quality remains strong, our balance sheet structure is solid, our team is experienced, and we have a granular deposit base. We see momentum on the M&A front and expect that to continue. Equity will remain disciplined in our approach to assessing these opportunities, emphasizing value while controlling dilution and the earn back timeline. Thank you for joining the earnings call. We are happy to take your questions at this time.

Operator (participant)

Thank you. Please press Star followed by the number one if you'd like to ask a question, and ensure your devices are muted locally when it's your turn to speak. If you change your mind or your question has already been answered, you can withdraw your question by pressing Star followed by the number two. Our first question comes from Jeff Rulis with D.A. Davidson. Please go ahead, your line is open.

Jeff Rulis (Managing Director, Senior Research Analyst)

Thanks. Good morning. Commenting on the loan growth inflection sounded fairly strong towards the end of the quarter. Just wanted to get a sense for, do you think sort of Fed visibility had anything to do with that, in terms of your customer base and some of your optimism going forward? Do you think that's triggered a little bit of activity?

Rick Sems (Bank CEO)

Yeah, probably not a lot had to do with that. I mean, I think a lot of this were deals that we've been working on, relationships we've been working on. You know, things just broke at that point in time. There was a number of things that people wanted to get done at the end of the quarter, and I think that led to that. So as we look forward on it, I think it's we're actually identifying opportunities with existing clients that we really haven't lent to in the past. That's one of the avenues, and the other one, obviously, is we're just expanding that group of prospects that we're calling on. So I really don't think that's probably the main reason why we saw things break free.

Jeff Rulis (Managing Director, Senior Research Analyst)

Okay. And so that really hasn't been an overhang, maybe call it year to date, like widening the time horizon. You haven't heard, "I don't, I don't know where rates are going to go. I'm gonna, I'm gonna hold back on projects," generally speaking, you don't-

Rick Sems (Bank CEO)

We're not hearing that now. Yeah, I'm sorry.

Jeff Rulis (Managing Director, Senior Research Analyst)

Okay.

Rick Sems (Bank CEO)

Yeah, generally speaking, I think that was probably maybe last year that might have been part of that, but I think that hasn't been really what's, I think, driving at this point in time.

Jeff Rulis (Managing Director, Senior Research Analyst)

Appreciate it. Pop into expenses. I just want to, the amortization expense, that is included in your expense guide? Is that-

Rick Sems (Bank CEO)

So the CDI and tangible amortization, is that what you're referring to, Jeff?

Jeff Rulis (Managing Director, Senior Research Analyst)

Yep.

Rick Sems (Bank CEO)

Yes, that's included.

Jeff Rulis (Managing Director, Senior Research Analyst)

Okay. And that one, one for the quarter, that's pretty. I mean, KansasLand was, you know, closed first day of the quarter, so that's a pretty good run rate on that line item.

Rick Sems (Bank CEO)

Yeah, that'll be a good run rate for the next couple of quarters, and then you'll start to see a little bit of pivot out of the OK. It'll start to run down from there. But, yeah, good run rate for the next couple.

Jeff Rulis (Managing Director, Senior Research Analyst)

Okay. And as I guess if you kind of exclude the offset and gain this quarter, drop out merger costs, I look at the Q4 run rate, it looks a little maybe lower than implied. Is there anything that we would expect to kind of come out of the? Is it maybe out of comp or some modest cost saves? Where will, on the expense line, absent the one-timers, where will some of the declines come from, if possible, out of expenses to kind of get you maybe to say, what would occur to get you at the low end of that range on the expense guide?

Rick Sems (Bank CEO)

Yeah, I'd say there's a few things we're working on. From a current quarter perspective, salaries and employee benefits included almost $1 million of additive accruals this time around. So that won't, that isn't expected to repeat through the final quarter. That's just a catch up on year-to-date performance. The other line item here includes a shift in unfunded commitments. So we did have some reserving for unfunded commitments this quarter that I don't necessarily anticipate repeating, just depending on how actual production is facilitated in the Q4. There's other line items in here, data processing. We're focused on opportunities there, advertising and business development. There's some opportunities there heading into the Q4.

So there's some incremental small wins we can get, but the larger ones are the additive accruals through salaries and employee benefits and some opportunities in that other line.

Jeff Rulis (Managing Director, Senior Research Analyst)

Okay, great. And maybe one quick last one, Krzysztof, but on the kind of discussion of some inflation pressures on some borrowers, is that, you know, it doesn't sound like you're too concerned broad-based. Is that really a range-bound select group of borrowers? And do you see that somewhat transitory with that group? Just kind of a little more of how this progresses from your perspective.

Krzysztof Slupkowski (Chief Credit Officer)

Yeah, so I think what we're seeing is the credit quality normalization the rest of the country has been experiencing for a year now. But if you look at our historic levels of problem loans, we're still below recent historical average and really near our historic low levels in some categories. But you know, they moved down this quarter and only at thirty basis points of total loans, which is positive. But you know, the delinquencies have been elevated the last few quarters, comparing to the historicals. But if you look what's hitting the delinquency list, it's all small loans and very granular.

So, and then if you look at the non-accrual loans, it looks like a similar story outside of a larger credit or a mid-sized credit that hit our non-accruals in the Q3. So, it looks like smaller operators and smaller borrowers that's who's getting the most, you know, stressed, if you will, at this time. We do not see that trend kind of migrating to our larger borrowers yet. We think that the smaller borrowers, the smaller operators, they don't have the pricing power to pass on the increased costs of their products to the customers like the bigger operators do.

I guess that's what we see for now.

Brad Elliott (Chairman and CEO)

And the larger credit that went to non-accrual is SBA guarantee or SBA-related as well. And I would actually say, Jeff, one of the issues they have is the SBA gave them EIDL loan funds, and so they had excess cash and didn't manage it very well, which is what created some of the issues.

Jeff Rulis (Managing Director, Senior Research Analyst)

Okay, I appreciate it. Thank you.

Operator (participant)

Our next question comes from Terry McEvoy with Stephens. Your line is open.

Terry McEvoy (Managing Director)

Hi, thanks. Good morning. Maybe just a question for Chris. Could you just talk about how the balance sheet's positioned for, call it, two more rate cuts in the Q4 and possibly more in 2025? And then on the deposit side, how are you managing adding new relationships with just managing the margin?

Chris Navratil (CFO)

Yeah. So the first piece of that, Terry, from a sensitivity perspective, for the first 50 basis points during the quarter, as we mentioned in the prepared commentary, we've been able to ultimately neutralize that based on relative positioning, and there's continued room to do that. Looking at total cost of funding, we got to a point through this cycle where there is significant room to move down both on a contractual and a non-contractual basis. So optimistic as the Fed meters a decline, that we'll be able to neutralize the impact or nearly neutralize the impact of those kind of moderate changes, with the caveat, if they do something significant and crazy, it'll impact us, just like it'll impact the rest of the industry.

The secondary question there, in terms of how we're approaching new customer acquisition, you know, where we sit in the positioning of our balance sheet relatively is we have a significant amount of higher cost deposits with some significant lower cost deposits. I'd say higher cost deposits, but higher cost deposits and funding, so there's some line of credit advances and things in there as well, where we have some opportunity to reprice what is already higher costing at what would be a relatively high price in our marketplace, so we can be a bit opportunistic in some ways on how we pursue pricing new relationships and new opportunities, but we're going to continue with the discipline we've been operating under.

We're going to approach being the community bank that our customers want and need and do that to effectively both via pricing and service and make sure we're managing margin on the way down. So opportunistic, we are optimistic we have some opportunity there, but we're going to remain disciplined.

Terry McEvoy (Managing Director)

Thanks for that. And then, as a follow-up, maybe a question or two on the new calling efforts. Any specific markets where you feel you're really gaining traction? And then when you look out over the next several quarters, where do you see the most upside? Is it loans, which I think we're starting to already see, or is it deposits in certain fee categories?

Chris Navratil (CFO)

Yeah. So on the real positive side, I mean, we've seen Tulsa and Wichita, and I'd actually say Western Missouri, which is showing some real signs of being real strong for the Q4 as well. So those markets are doing really well. Kansas City, you know, continues to be a consistent player for us in there. I think I also see out west in some of our western markets in Kansas as opportunities for us as well.

So I think that part's been all strong. And really, there are great companies in all of our markets that we're just working to get out to. So I'm optimistic that all of them can provide something to that. And I do see the loan side right now. That said, you know, so I think that's what we've focused initially on. But we're really now bringing in the fact that when we get deposits or we get loans, we get deposits with it as well. So I think we're going to see that as that's kind of the next phase of our sales process, of really getting the team to work more on that deposit front and more on the fee income side.

So I think that'll delay a little bit more on that. But as you probably know, we're going to see the deposits you know rebounding back just from the public fund side of it in the Q4. But from a growth perspective, new things like that, I think we'll start seeing that more into mid-2025 in that area.

Terry McEvoy (Managing Director)

Thanks for taking my questions.

Operator (participant)

Thank you. Next in queue, we have Andrew Liesch with Piper Sandler. Please go ahead.

Andrew Liesch (Senior Equity Research Analyst)

Hey, guys. Good morning. Just kind of a follow-up question here. The last topic, you ran through historically some thoughts on if you increased the loan-to-deposit ratio from 80% to 90%, what that would mean to earnings and profitability. Now, obviously, there's some seasonal aspect here in deposits and redoubled efforts to expand the deposit base. But, do you think that this might be the start of a trend of slowly increasing that loan-to-deposit ratio?

Brad Elliott (Chairman and CEO)

Yeah. Yeah, that's what we're working on. And I think on the deposit side, I think it's, you know, the industry's never really focused on deposits until the last four or five quarters. If you had looked at our deposit cycles, the municipal deposits always flow out in the Q3. It's kind of their low balances, and their high balances is always December. So that's when the tax revenues come in for those municipalities. And if you remember, we bank all the municipalities in all these small towns, so the cities and the counties and the school districts. And so, you know, it's really a big flow in that happens in those markets, and it's kind of a something that we do.

The good thing about it, as Chris said, we actually have pricing power on those because they're usually tied to indexes. So a lot of times they are higher cost of funds for our balance sheet, and they automatically reprice if rates change. So it's not hard for us to reprice those higher-cost deposits down during a cycle. And I do think, Andrew-

Andrew Liesch (Senior Equity Research Analyst)

Got it.

Brad Elliott (Chairman and CEO)

as Rick has been working with the team, we're going to continue to see solid loan growth, and not crazy numbers, just something that's, you know, in that 6% to 10% range, as our teams have really bought into the whole process and the cycle and are really using the strategies that they're supposed to be doing, and we have done in the past, so I think we're going to see solid loan growth, as we go forward as a company.

Rick Sems (Bank CEO)

On the loan-to-deposit, I mean, we're always looking for those non-interest-bearing. And that, to Chris's point earlier, then gives us that ability to be disciplined to if we want to let go, it just gives us flexibility. So we'll be able to manage that, I think, pretty well as we head into 2025.

Andrew Liesch (Senior Equity Research Analyst)

Got it. Thank you. You know, you've answered all my other questions. I'll step back.

Operator (participant)

Our next question comes from Damon DelMonte with KBW. Please go ahead.

Damon DelMonte (Managing Director of Equity Research)

Hey, good morning, guys. Hope everybody's doing well. Just a couple questions around the margin. Chris, could you just remind us what you guys have in the way of fixed-rate loans that will be repricing either here in the Q4 or probably more so in 2025?

Chris Navratil (CFO)

Yeah. So our portfolio today is comprised of about 40% of fixed rate, fixed-rate loans. We have a few hundred million, so $300 million to 400 million of that will reprice over the next five quarters. And then there is some of it that is longer dated. There's residential real estate in there, and there's some 3 to 5 year CRE stuff in there, too. So we're going to continue to see some repricing over the next five quarters, and the composition kind of continues to remain the same, about 40% of the portfolio being fixed rate.

Damon DelMonte (Managing Director of Equity Research)

Do you happen to have, like, what the average yield is on what's repricing, what it's repricing from to where it would go?

Chris Navratil (CFO)

I don't have that over the next five quarters. I can get it for you, Damon. I will say we have a meaningful aspect of the portfolio that is still or sub 5%. So, there's meaningful opportunity to reprice out.

Damon DelMonte (Managing Director of Equity Research)

Got it. That's helpful. And then how about on the CD side? Do you have any sizable blocks that it will be repricing coming up?

Chris Navratil (CFO)

No, that's really a continuous trend, about the same levels every quarter repricing, and those have been a little bit sporadic, so you saw it during the quarter, we saw some expansion in that cost. I think we'll see the opposite trend as rates have come down, but that trend is really a relatively consistent one, month over month over month.

Damon DelMonte (Managing Director of Equity Research)

Got it. Okay, and then just, well, just one last modeling question here. You mentioned that the fair value accretion this quarter was lower. Do you know how much it was? I think last quarter it was around six basis points of an impact to the margin. Do you know what it was this quarter?

Chris Navratil (CFO)

Last quarter, purchase accounting was. We saw nine basis points of benefit on purchase accounting in June, and we saw four basis points in September. And I expect the go-forward run rate to fall between those two numbers. I'll lean towards the lower end-

Damon DelMonte (Managing Director of Equity Research)

That's great.

Chris Navratil (CFO)

just because there's some more volatility to it now, but I think it'll fall between four and nine.

Damon DelMonte (Managing Director of Equity Research)

Okay, great. And then, the tax rate was also lower this quarter. Anything unusual with that? And I know the guidance kind of goes back to what we were looking for this quarter, but anything unique this quarter?

Chris Navratil (CFO)

Yeah. So we were able to take advantage of a tax planning strategy that allowed for the release of some deferred taxes and net operating losses at our holding company. So we're realizing the benefit of that during the quarter, which is offsetting the impact of last quarter's BOLI transaction. So the two net out, where the full year tax rate's about 21%, but they're definitely opposing trends quarter over quarter.

Damon DelMonte (Managing Director of Equity Research)

Got it. Okay, that's helpful. And then I guess lastly, you know, Brad, you mentioned that you guys are still, you know, active with prospects for M&A. You know, any change to the geographic strategy there and any change in the type of bank you'd be looking to acquire?

Brad Elliott (Chairman and CEO)

No, our strategy is still the same. I would say that, you know, the M&A pipeline is strong. The number of conversations that we have going on have honestly picked up in the last few weeks. Some of them are clean deals, some of them are stressed deals, and, you know, you could actually see that there's a couple of FDIC deals. That doesn't mean we're going to play in them, but or get them, but, there's a couple of those hanging out there that have to come eventually. But the, you know, the number of conversations is pretty strong right now.

Damon DelMonte (Managing Director of Equity Research)

Got it. Okay, great.

Brad Elliott (Chairman and CEO)

And we're not going to change our geography, and we're not going to change what we've been doing.

Damon DelMonte (Managing Director of Equity Research)

Okay, great. Appreciate that color. That's all that I had. Thank you very much.

Operator (participant)

Thank you. We have no further questions, so this concludes our Q&A session as well as the conference call. Thank you for joining us. You may now disconnect your line.