Equity Bancshares - Q4 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Q4 2023 Equity Bancshares, Inc., Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising that your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Brian Katzfey, Director of Investor Relations. You may begin.

Brian Katzfey (Director of Investor Relations)

Good morning. Thank you for joining us today for Equity Bancshares' fourth 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 Chairman and CEO, Brad Elliott.

Brad Elliott (Chairman and CEO)

Good morning, and thank you for joining Equity Bancshares earnings call. We're excited today to take you through our fourth quarter results, including beating consensus earnings, a repositioning of our bond portfolio, and our announced merger with Rockhold Bancorp, the parent company of Bank of Kirksville. Joining me today are Rick Sems, our Bank President, Chris Navratil, our CFO, and Krzysztof Slupkowski, our Chief Credit Officer. Let's look back at the fourth quarter. In early quarter, our balance sheet strength, including high levels of capital, robust loan loss reserves, and available liquidity, positioned the bank to take advantage of the current environment to build for the future. We announced a merger with the Bank of Kirksville, which combines like-minded organizations while expanding our footprint in Missouri. We are excited to report that we received approval from the Federal Reserve Bank this week and anticipate of closing in February.

Different than with past transactions, we will not convert the core systems until May of this year due to scheduling conflicts with the different core and electronic providers. Also, during the quarter, we repositioned $450 million in our investment portfolio, significantly improving our earnings while not impacting tangible equity. In fact, tangible book value expanded during the quarter and year over year, as you will see in our slide deck. These transactions reflect our team's focus on value creation. Our employee base is engaged and motivated to drive exceptional outcomes, which provide value to our customers, employees, and shareholders. I'm incredibly proud of all we accomplished this quarter and throughout 2023. It was a year of challenges and change, and as we reflect at December 31, Equity is better positioned for the future than ever before.

I have never been more excited about what Equity is positioned to accomplish than I am starting 2024. We have an excellent management team, strong balance sheet, and a guiding expectation to be the bank of choice for our communities. I'll let Chris talk you through our financial results.

Chris Navratil (CFO)

Thank you, Brad. Last night, we reported a net loss of $28.3 million or $1.84 per diluted share. Adjusting for the loss realized within the repositioning of our investment portfolio, as well as one-time merger expenses, current operating income was $11.9 million, or $0.77 per share, compared to $0.80 per share in the third quarter. Net interest income was down $1.5 million linked quarter, while net interest margin declined from 3.51% to 3.49%. We will discuss margin dynamics in more detail later in this call. Non-interest income, adjusted for the loss on repositioning of investments in Q4, was down $1.5 million linked quarter.

The decline is primarily attributable to derivative fair value change and a special asset benefit related to Almena State Bank of $500,000 during Q3 that did not recur. Non-interest expenses, adjusted for one-time M&A charges totaling $34.7 million, were modestly higher quarter-over-quarter, primarily due to incentive accruals and increased advertising costs. Our GAAP net income included a provision for credit loss of $711,000. To understand the attribution of the inputs, you can reference our earnings deck, which shows the calculation. We continue to hold reserve for potential economic challenges. However, to date, we have not seen any specific concerns in our operating markets. The December 31 coverage of ACL to loans is 1.31%. 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 remained at historically low levels in the fourth quarter, with total classified loans closing the quarter at $40.5 million or 7.1% of total bank regulatory capital. Non-accrual loans, as a percentage of total loans, remained below 75 basis points. Net charges for the year were 13 basis points of average loans. Recognized charges have been reflective of specific circumstances on individual credits and not related to the broader concern in the markets in which we operate. We have now completed a whole cycle of annual reviews and renewals, incorporating the latest operating results of our borrowers. These have affirmed the resilience of our portfolio in the current interest rate and economic environment. We have not seen any deterioration at this point in our commercial real estate book. We continue to monitor our portfolio for early signs of deterioration.

Our risk rating migration during this cycle has resulted in historically low problem credit ratios, a testament to our disciplined underwriting practices at origination, the strength of our local economies, and proven workout strategies. While our credit outlook for 2024 is positive, we maintain a favorable position in terms of capital, reserves, and credit strength to confront any potential future economic challenges.

Chris Navratil (CFO)

Thanks, Krzysztof. As previously mentioned, we sold a large portion of our bond portfolio during the quarter, pulling forward cash flow of approximately $450 million. As of the end of the period, all sales have settled, and funds have been redeployed in securities purchases, funding of loans, are being held in cash or are used as an alternative to more expensive funding sources for the balance sheet. The benefits of the transaction are expected to be fully realized in the first quarter of 2024. Loans increased during the quarter at an annualized rate of 6.1%. Loan originations in the fourth quarter totaled $143 million, with a weighted average coupon of 8.61%, compared to $149 million and a weighted average coupon of 8.46% in the third quarter.

We continue to successfully originate loans in the current interest rate environment, contributing to expanding coupon yield on interest-earning assets. During the fourth quarter, the coupon yield on loans increased to 6.71% from 6.62%. Total loan yield declined as purchase accounting, loan fees, and non-accrual accounting contributed 2 basis points in quarter four versus 15 basis points in quarter three. Were these levels to be consistent period over period, NIM would have improved 8 basis points. Cost of interest-bearing deposits increased 19 basis points to 2.58% in the quarter, a decline from the 26 basis points expansion in the third quarter, while the contribution of average and non-interest-bearing deposits to the average deposit mix declined to 22.8% from 23.0%.

Net interest income totaled $39.5 million in the fourth quarter, down $1.5 million from the third quarter, driven by declining average earning assets as the excess cash liquidity the bank has been maintaining was used to fund the decline in average deposit balances. We continue to have $140 million outstanding at the Federal Reserve's Bank Term Funding Program. We are currently earning a positive spread on that borrowing, though it does have the effect of reducing margin. We calculate that the excess liquidity has the effect of reducing margin by 7 basis points for the current quarter. Salaries and benefits increased to $741,000 in the quarter due to a decline in share-based compensation forfeiture, as well as year-end incentive accruals. Marketing expenses remain elevated from advertising to continue to attract deposits.

Our outlook slide includes a forecast for the first quarter as well as the 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 of average loans. Important to note, the forecast does not include the impact of the Bank of Kirksville merger. Previous disclosure at announcement date indicated income accretion of $0.36 for 2024. Rick?

Rick Sems (President of Equity Bank)

I'm pleased with what we accomplished in 2023 and all that we are positioned to accomplish moving forward as we continue to emphasize value creation in our markets. Partnering with the Bank of Kirksville and their committed team of banking professionals provide added scale and market expansion, which will contribute to our growth goals in 2024. During the quarter, our non-brokered deposit base increased by $13.3 million, attributed to seasonal inflows in our municipality operating accounts. We continue to see pressure on pricing and have maintained our disciplined approach as we consider the impact of Bank of Kirksville closing in the first quarter. As we enter 2024, we'll be going to market with a new suite of checking accounts designed internally by Jonathan Roop and Julie Huber, which we believe will enhance our value proposition for customers.

In addition to our new accounts, we have partnered with Marstone, Inc., to provide digital wealth services to our customer base, further enhancing our value proposition with our consumers. We believe we have the team and the suite of products to remain the banker of choice in the markets we serve. On the asset side of the balance sheet, our loan production continued at a consistent pace as we originated the same dollar level of loans in Q4 as in Q3, but at improved yields and ROEs to the bank. As we look to 2024, pipelines are strong, and we expect pull-through to increase as rate pressures moderate. As of the end of quarter, our 75% probability pipeline stood at $450 million, while our 50% probability was $260 million, bringing our greater than 50% pipeline to over $700 million.

As indicated in our outlook slide, we expect to drive mid to high 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.

Chris Navratil (CFO)

Service revenue was down quarter-over-quarter, though we continue to see increasing contributions from previous investment in cards, treasury, and wealth management and insurance. Our teams are focused on enhancing customer value in 2024 and beyond, which we expect to drive expansion of the business lines moving forward. Finally, I'm pleased to announce the promotion of Justin Harris to Regional CEO, Community South. He will now be leading both our Ozark and Southeast Kansas markets. Justin has been leading the Ozark markets for a couple of years and is ready for an expanded role. I look forward to partnering with Justin as we look to continue to be, to build Equity Bank in these markets.

Brad Elliott (Chairman and CEO)

Our company is well capitalized. Our asset quality metrics are the best they've ever been. Our balance sheet structure is solid, and we have a granular deposit base, which is positioned to improve with the addition of the Bank of Kirksville. Our strategic directives for 2024 have been set, and the team has hit the ground running. Rick, in collaboration with Mark Parman, Brad Daniel, and Justin Harris, have their teams poised to hit our goals for 2024. We look forward to onboarding our new Kirksville team members and continuing to redeploy assets into customer relationships that build franchise value. We continue to see momentum on the M&A front and expect that to continue throughout the year. Equity will remain disciplined in our approach to assessing these opportunities, emphasizing value while controlling dilution and the earn back timeline.

As you can see from our presentation, I believe we have the right team, the right balance sheet, the right geography, and a proven track record to execute on strategy that we started some 20 years ago. We have the ability to grow organically and through M&A. What an exciting time for our team members. Thank you for your interest in, in Equity Bancshares, and we'll open it up for questions.

Operator (participant)

And thank you. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one. Again, please stand by, we'll be compiling the Q&A roster. And one moment for our first question. And our first question comes from Terry McEvoy, from Stephens Inc. Your line is now open.

Terry McEvoy (Managing Director and Research Analyst)

Hi, good morning. Thanks for taking the questions. Chris, if I heard you correctly, the margin outlook assumes no changes in interest rates. I guess my question is, if the forward curve is accurate and we get a rate cut, let's call it the middle part of this year, how do you think the balance positioned for rate cuts?

Chris Navratil (CFO)

Yeah, it's a great question, Terry. We look at the balance sheet as near, as near to neutral as it can be at the moment. Our real challenge in terms of attempting to forecast that out, and I think the industry's challenge, is how does competition react on deposit rates as the market begins to come down for short-term rates? So we have the capacity, we have the positioning on our balance sheet to be able to cut quickly, but in a situation where competition is being irrational, it can become challenging. So it's hard to pinpoint exactly how we're gonna react in a downward rate environment. But when you look at it on a contractual readjustment basis, we have the capacity to maintain a neutral balance sheet today.

Terry McEvoy (Managing Director and Research Analyst)

Just sticking with the margin, and I apologize if I missed it. What was the accretion in the fourth quarter? I have 11 basis points in Q3, but I couldn't find Q4.

Chris Navratil (CFO)

The purchase accounting accretion?

Terry McEvoy (Managing Director and Research Analyst)

Correct. Yes. Sorry about that.

Chris Navratil (CFO)

Yeah. Purchase accounting was one basis point in quarter four.

Terry McEvoy (Managing Director and Research Analyst)

Perfect. And then maybe lastly, could you just update us on the size of the aviation loan portfolio and share any comments you might have on how the challenges at Boeing may impact some of your Wichita-based suppliers that you have relationships with?

Krzysztof Slupkowski (Chief Credit Officer)

Hey, hey, this is Krzysztof. Thanks for the question. It's a very fair question, given the recent developments. I can tell you that our direct exposure in the, to Spirit and Boeing is minimal. We have made a conscious decision about two and three years ago to reduce our exposure in the aerospace, even given everything that's transpired with the MAX 8 and just COVID. As of today, we only have about $50 million in direct exposure to aerospace, of which only $6 million is, has some exposure to Spirit and Boeing, and is, this is local credit. The borrowers that are making up this $6 million, they have diversified revenue streams, so only a portion of their, revenue comes from Spirit.

To add more flavor to it, half of this exposure has government guarantees. So we feel pretty good about the risk exposure we have to this sector at this time.

Brad Elliott (Chairman and CEO)

That would have been different, Terry. A few years ago, we probably would have had $75 million of exposure a few years ago.

Terry McEvoy (Managing Director and Research Analyst)

Thanks again for taking my questions.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from Jeff Rulis from D.A. Davidson. Your line is now open.

Jeff Rulis (Managing Director and Senior Research Analyst)

Thanks. Good morning. Just a couple questions on the outlook slide. Wanted to get the rate, or sorry, the margin, down pat. So if I hear you right, kind of 3.49 reported, I think you mentioned kind of regular way would have been maybe 3.57. Is that right? As you talk about the impact of some one-timers in there.

Chris Navratil (CFO)

If it was normalized compared to the last quarter, Jeff, it would have been 357. I think I'd look at last quarter as a little bit high, so somewhere between, so call it 354 on a normalized basis is what I'd look at.

Jeff Rulis (Managing Director and Senior Research Analyst)

354. Okay. And the expectation to hop into the 370-380 range in the first quarter, what is the underpinnings of that increase?

Chris Navratil (CFO)

Yeah, so that's all tied into the bond repositioning efforts in the fourth quarter. So we saw a small period of benefit on the bond repositioning in December, and we'll realize a full period of benefit from that into the first quarter, which is what's driving up that NIM.

Jeff Rulis (Managing Director and Senior Research Analyst)

Is that all repositioning, or is there some core traction gaining on the margin at that point?

Chris Navratil (CFO)

So it's majority of the repositioning. There is some traction being gained generally in terms of growth of our loan portfolio. You saw it throughout Q4. We referenced it in the call, you know, 6% loan quarter growth. We're bullish on our capacity to continue to grow the loan portfolio, so there's some additive benefit to putting on those higher-yielding assets. And then the majority of that uptick is driven by the repositioning of the bonds.

Jeff Rulis (Managing Director and Senior Research Analyst)

Got it. And then to kind of extend upon got your comments on the sort of neutral balance sheet will depend on deposits as deposits maybe cuts get layered in, but pretty flat for the year. Does what would Kirksville in a vacuum sort of impact, if at all, on that margin?

Chris Navratil (CFO)

Kirksville is $0.36 accretive to overall earnings. I'll get you the margin impact as we talk, Jeff. I got to get it pulled up.

Jeff Rulis (Managing Director and Senior Research Analyst)

Just a kind of a similar question on the average earning asset growth. Looks like legacy pretty flat. Is it safe to say that earning asset, we could just tack on Kirksville and kind of that's the expectation for the full year?

Chris Navratil (CFO)

Yep. I think that's the right way to think about it. The average earning assets being flat is essentially some repositioning of ... so using cash that we currently have on our books to fund the loans, so not adding incrementally more average earning assets as we build the loan portfolio. And then you would tack Kirksville on top of it, Jeff. Yep.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay. Maybe I'll just one quick one on credit. I just wanted to talk about that increase in nonaccruals. I think it was a singular credit, but if you could walk us through the addition there.

Krzysztof Slupkowski (Chief Credit Officer)

Yeah. So, most of that increase that you see is related to one larger credit. There was another smaller credit that makes up the difference, but it's a primary residence, large, large credit, large loan on the primary residence that we have a first mortgage that we feel very good about from a loan-to-value standpoint. So, we're hoping to get out of it soon.

Jeff Rulis (Managing Director and Senior Research Analyst)

Is that a borrower that has other lending relationships with the bank, or is this a singular residence?

Krzysztof Slupkowski (Chief Credit Officer)

This is the only, this is the only loan we have.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay. Okay. And maybe, Brad, just real quick on the, you know, as you maybe close Kirksville next month, kind of leaning into that, if maybe additional M&A deals don't transpire, kind of checking in on your appetite of the buyback if we go some time without any transactions that look attractive.

Brad Elliott (Chairman and CEO)

Yeah. What I would tell you, Jeff, is even with the M&A front, we're back to looking at the buyback each day. So, we've got enough capital to close the transaction. We did hold the capital back in the last quarter to make sure that we could have excess capital to fund the transaction. So we've accomplished that. So we're now looking at buyback this quarter. As if an M&A deal came to fruition, you know, we'd have a quarter or two before, you know, it would close, and so we're building cash pretty fast and earnings are strong. So, we're back looking at buyback on a daily basis.

Jeff Rulis (Managing Director and Senior Research Analyst)

Okay, thank you.

Operator (participant)

Thank you. If you would like to ask another question, that is star one one. Again, if you would like to ask another question, that is star one one. One moment for our next question. Our next question comes from Andrew Liesch from Piper Sandler. Your line is now open.

Andrew Liesch (Managing Director)

Hey, good morning, guys.

Chris Navratil (CFO)

Good morning.

Andrew Liesch (Managing Director)

Sticking with the outlook slide here on average deposits, looks pretty flat throughout the year. I heard you mention you got the new checking account suite coming up, but you have some brokerage there. I guess, what are the ins and outs on deposit growth? And obviously, the loan growth is pretty optimistic. So, do we assume that you're going to use cash flows from the securities book to fund that without much deposit growth?

Rick Sems (President of Equity Bank)

Yeah. So first off, just, I'm looking at it flat. I mean, we've got, as we talked about, we had some inflows as we normally do on the seasonality of the public funds business. So that moved it up. So we're going to, you know, kind of backfill that throughout the year. That's why you don't see a large growth in that. In addition to that, with as we add in the Bank of Kirksville, we've just taken a more conservative approach as far as making sure that we continue to be very disciplined on what our cost of funds are. And so I think that's why we're viewing this as a little bit less growth.

We're also going to try to look and see to make sure we try to push our mix, and which is what the new products are geared towards. So, you know, continuing to maybe give up on a little bit of that time deposit to replace it, hopefully with more non-interest bearing and transactional accounts. But I don't know, because you wanted the other question. Jim—I'm sorry, Andrew, you had another question on there?

Andrew Liesch (Managing Director)

Yeah. Funding the loan growth then, is it really just going to be remixing if you have the, like, what are the cash flows off the securities book?

Chris Navratil (CFO)

Yeah. So we do have some continuing cash flows coming off of our securities book. We're continuing to look at from a capital perspective, having excess capital and potentially pursuing more opportunities and continuing to sell as the market creates opportunity for us to be opportunistic in repositioning the bond portfolio directly, as we did in the fourth quarter. And as you look at the end of the fourth quarter, Andrew, we were sitting on a meaningful level of cash. At that point, we've continued to have meaningful cash levels kind of throughout the year. So part of that repositioning or loan funding is coming right out of that cash. And then when we get to Bank of Kirksville, with that transaction, we're bringing on more cash and some relatively short-term investments.

So there's cash flow coming off of that one quickly, too. So without meaningful deposit balance growth, we have, we believe, the capacity to continue to fund the loans at the level that we're depicting here.

Andrew Liesch (Managing Director)

Got it. All right, now you've covered all my other questions. I'll step back. Thanks.

Chris Navratil (CFO)

Thanks, Andrew.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from Damon DelMonte, from KBW. Your line is now open.

Damon DelMonte (Managing Director)

Hey, good morning, guys. Hope everybody's doing well today. Just a couple quick ones here. One, on the deposit remixing that's been occurring. You know, I think non-interest-bearing deposits are now down to around 22% of total deposits. Do you feel you've kind of reached a floor there, and it should start to hold from there? Or do you feel like there's still some rotation or migration out of that category?

Rick Sems (President of Equity Bank)

Well, I wish I could give you an exact answer on that. I mean, I think we're seeing, we're not seeing accounts decreasing. So what we're really seeing is we're seeing balances decrease within those accounts. So, you know, we do think that those accounts are getting fairly low in the consumer area, but since we're so granular, you know, it's something that we're obviously continuing to keep an eye on, but it requires us to start growing accounts. And so that's kind of what we're looking at. So I don't think I-- I think it does feel like that number is slowing.

You know, and so also, if that's the case, I mean, I think we might still have a quarter of a little bit more of, you know, kind of where it continues to shrink on an average basis. But we're getting to that final point here, so.

Brad Elliott (Chairman and CEO)

And what I would tell you is, yeah, it moved down a tick, but it moved down a tick only because we're in roundings, right? So it didn't move down from 23 to 22. It moved down from just below 23 to somewhere into the 22s. So it's not like it fell a whole percentage point, even quarter to quarter.

Damon DelMonte (Managing Director)

Right. Right. Got it. Okay, and then on the guidance slide, I think for non-interest income, you're guiding to $8 million-$9 million for next quarter. And I think this quarter was kind of in the low $7 million range. Can you just kind of help us figure, like, walk us through from where you were here in the fourth quarter and how you get to an $8 million-$9 million level?

Chris Navratil (CFO)

Yeah, so we were somewhat light this quarter compared to what we'd look at as a run rate. Some of that's driven by derivative fair valuation. So when you look quarter-over-quarter, we benefited from derivative fair value change. In Q3, we were hurt by it in Q4. We won't expect the same level of kind of comparative shift. And then as we look into next year, we're continuing to see opportunities from some of our legacy acquired assets that are bringing in opportunity to realize some benefit from working out some special assets. Similar to what we've had in previous quarters with the upticks in kind of repurchase obligations and other things we've talked about..

We're seeing some of that come back through again, and we expect to benefit from in the first quarter and have some additional benefit throughout the year, which is what's being reflected in that figure.

Damon DelMonte (Managing Director)

Got it. Okay. That's helpful. Thank you. And then lastly, just on the loan growth. You know, the high single-digit outlook, could you just kind of give us a little bit more color as to what areas of the portfolio you feel most comfortable about? Is it on the C&I side, where businesses are, you know, investing in capital expenditure projects, or is it more on the development side with CRE folks?

Rick Sems (President of Equity Bank)

So we're definitely seeing C&I, positive movement on C&I, and then owner-occupied CRE as well. Both of those look pretty strong. We've had a really good start to the year, that, that give us confidence in, in being able to hit those numbers. And additionally, I think we'll, we'll see, you know, sort of small... We, we have a really small portfolio when you look at things like our, private banking and, and, you know, our exposure to HELOCs and things like that. I think you'll see small, just incremental, growth in that as well. So it's, you know, development, we'll, we'll definitely have, looking forward, we'll definitely have some of our construction deals, we'll be funding up this year, that are - that, that we're looking at, so we'll, we have that confidence in there.

So, we're not-- we're being really thoughtful on the new deals that we do in that space, but, we're seeing a lot of stuff coming back to us. So things that we held firm on from both a credit perspective and a pricing perspective, we're getting to see another look at those deals as maybe other banks are either falling by the wayside or, you know, there's some concern by the borrower on if that bank can get the deal done. So, it's not-- I wouldn't just say it's just one area, and it's not all of them, but it's really kind of those that owner-occupied CRE and C&I, for sure, with added a little bit on the consumer side.

Damon DelMonte (Managing Director)

Got it. Okay, that's helpful. That's all that I had. Thank you.

Rick Sems (President of Equity Bank)

Hey, Jeff, just to circle back really quickly on the one open question on accretion to NIM from BOK. The way we had it modeled is 7.5-10 basis points of NIM accretion for this year.

Operator (participant)

Okay, thank you. I am showing no further questions. This concludes today's conference call. Thank you for participating. You may all disconnect.