Crossfirst Bankshares Inc

NASDAQ:CFB

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good day and welcome to the CrossFirst Bankshares, Inc., Second Quarter 2024 Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mike Daley, Chief Accounting Officer and Head of Investor Relations. Please go ahead.

[Michael Daley, executive]

Good morning and welcome to CrossFirst Bankshares second quarter earnings conference call. Before we begin, please be aware this call will include forward-looking statements, including statements about our business plans, growth opportunities, expense control initiatives, cash requirements and sources of liquidity, capital allocation strategies and plans, and our future financial performance. These comments are based on our current expectations and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Our forward-looking statements are as of the date of this call, and we do not assume any obligation to update or revise them, except as required by law. Statements made on this call should be considered together with the risk factors identified in today's earnings release and our other filings with the SEC.

We may also refer to adjusted or non-GAAP financial measures. A reconciliation of non-GAAP financial measures to GAAP financial measures can be found in our earnings release. These non-GAAP financial measures are not meant to be a substitute for or superior to financial measures prepared in accordance with GAAP.

Our presentation will include prepared remarks from Mike Maddox, President and CEO of CrossFirst Bankshares; Randy Rapp, President of CrossFirst Bank; and Ben Clouse, CFO of CrossFirst Bankshares. At the conclusion of our prepared remarks, our operator, Betsy, will facilitate a Q&A session.

At this time, I would like to turn the call over to Mike, who will begin on slide 8 of the presentation, available on our website and filed with our earnings release. Mike?

[Michael Maddox, executive]

Good morning and thank you for joining us to discuss CrossFirst's second quarter financial results. I'd like to start by thanking our Colorado Springs market President, Cory Leppert, and our Colorado Springs team for hosting us today for the call.

Our company had a great quarter, delivering solid earnings growth, maintaining strong credit quality, and strategically returning capital to shareholders. We increased earnings in the quarter to $18.6 million, or $0.37 per diluted share. The earnings growth is a result of our focused strategy to scale our markets and verticals, resulting in expansion of net interest income and fee income. In turn, we continue to drive operating leverage across our expense base.

Not only did we increase earnings, but credit quality improved in the quarter, and we continue to feel good about our reserve levels against lower classified assets and manageable nonperforming balances. I also want to highlight the longer-term progress we've made, as evidenced by solid growth in year-to-date operating revenue and over 6% growth in adjusted net income compared to a year ago, despite the increased cost of deposits.

We are pleased to see steady performance in our fee lines with service charge and credit card revenues growing and combined 17% year over year through the first 6 months. We continue to focus on initiatives to drive profitable growth and leverage the investments we have made in new markets, technology, and talent.

Total assets grew to $7.6 billion, an increase of 2% from the previous quarter, led by loan growth from our dynamic Texas, Colorado, and Arizona markets. We continue to see selective new business opportunities. We have strategically moderated loan growth and remain focused on quality relationships while strictly adhering to our credit underwriting and pricing guidelines. We are fortunate to be located in great markets with strong economies, which we believe will allow us to continue to produce steady growth with high-quality customers. Building density and scaling our markets continues to be a priority.

As I mentioned, we continue to be pleased with our credit quality metrics. Past dues, nonaccruals, nonperforming assets, and classified assets are all improved in the quarter. We acknowledge that market conditions continue to apply pressure to borrowers across the country. We are actively monitoring credit risks through regular portfolio reviews, quarterly deep dives across all lines of business, and regular reviews by independent third parties to validate our assessment of risk in the portfolio, which Randy will cover in more detail in a moment.

Deposit growth continues to be an area of focus, and we continue to make progress on a number of our deposit initiatives. The second quarter is always challenging for deposit growth as our customers make tax payments in April. Despite that headwind, we drove net growth in client deposits led by Texas and our energy group. We also made progress this quarter on our focus to improve our efficiency ratio. I'm pleased to report that we completed a successful negotiation of our core services contract, which we expect will result in meaningful savings. Ben will cover the details during his remarks.

Our strong earnings growth allowed us to both build capital in the quarter while also returning capital to our shareholders through our share buyback program. For much of the quarter, our stock price was trading at a price that we believe does not fairly reflect the true value of our company. We took advantage of that opportunity and bought back stock at an average price that was well below book value, which is highly accretive value to our shareholders. We plan to continue to leverage our earnings power to build capital while also remaining opportunistic with the buyback.

Finally, I'd like to thank our employees for their continued hard work, their expertise, and their strong commitment to our clients, shareholders, and communities. We have a team of highly experienced bankers who remain focused on optimization and efficiency as we continue to scale our operations while enhancing franchise value.

And now I'd like to turn the call over to our President of CrossFirst Bank, Randy Rapp.

[W. Rapp, executive]

Thanks, Mike, and good morning, everyone. In Q2 we continue to report solid loan and deposit growth, increased fee income and improved credit metrics. Total loan growth for the quarter was $95 million, resulting in a growth rate of 6% on an annualized basis. Primary contributors to growth in the quarter were C&I, energy, and commercial real estate.

In Q2, we hired an experienced C&I team in the Dallas market that was able to move a significant number of long-term relationships late in the quarter. The growth in CRE was primarily fundings on existing construction facilities in the multifamily and industrial space. We continue to focus on increasing loan yields and the average loan yield on new production in the quarter was a strong 8.93%. At quarter end, average C&I line utilization was 52%, which is above the historical usage percentage rate of 50%.

As expected, portfolio churn increased slightly during the quarter and is now at a historical average level. We continue to expect this churn to increase over the next several quarters, primarily in the commercial real estate portfolio. Our loan portfolio continues to remain balanced with 44% in commercial real estate and 44% in C&I and owner-occupied real estate. Energy outstandings were $234 million, or 4% of total portfolio.

On Slide 9 you can see there remains good diversity within each of those portfolios with the highest CRE property type, industrial, accounting for 22% of total CRE exposure and the largest industry segment in C&I being restaurants at 12% of C&I exposure and 4% of total loans.

Our exposure in the restaurant space is primarily to proven quick-service operators with multiple locations and there remains good brand granularity in this portfolio. In the CRE portfolio, total office exposure is now $286 million, which is down slightly from the end of Q1 and is 4.5% of total loans. The average office loan size decreased slightly to $6.3 million and the largest is $25 million. The average loan-to-value is 63%, and the majority of the portfolio is suburban Class A and B office. Approximately 63% of the portfolio is set to mature in the next 2 years. However, 83% of these maturities are loans with floating rates, which have been repricing up throughout this rate cycle.

We continue to have one $13.8 million office transaction graded Special Mention, which has the support of a strong guarantor, and the remainder of the portfolio has a Pass grade. The majority of the office exposure is in our footprint centered in North Texas, Kansas City, and Colorado. During Q2, total CRE commitments remained relatively flat at $3.3 billion and unfunded CRE exposure increased from $595 million at the end of Q1 to $651 million at the end of Q2. Total CRE outstandings remained relatively flat at $2.69 billion. As previously mentioned, we anticipate increased churn in the CRE portfolio, which will lower total CRE exposure and our focus on reducing our total CRE exposure back below 300% of capital in the next several quarters.

Moving to credit highlights on slide 10. For Q2, we reported a decrease in our nonperforming assets to total assets ratio from 27 basis points at the end of Q1 to 22 basis points at the end of Q2. The decrease was primarily due to a reduction in past due 90 transactions, client payments, and some partial charge-offs. The remaining nonperforming loans are primarily C&I transactions with the largest exposure remaining under $5 million.

The ORE balances ended the quarter at $4.8 million and includes residential lots and residences in the Austin market. Classified to capital plus combined reserves decreased to 13.3% at the end of Q2 from 15.8% at the end of Q1. At the end of Q1, classified totals were comprised 72% in the C&I space, 12% commercial real estate, and 14% owner-occupied real estate. Classified loans in the energy portfolio are negligible. As anticipated, at the end of Q2, we reported a decrease in past due transactions back to historical levels. The largest transaction in the 30 to 89 past due total is a $7 million credit that is scheduled to pay off in late July.

For the quarter, we reported net charge-offs of $1 million, resulting in a charge-off rate of 7 basis points on an annualized basis and 9 basis points on a trailing 12-month basis. Charge-offs for the quarter were primarily attributable to 1 C&I credit. At quarter end, we reported an allowance for credit loss to total loan loss ratio of 1.2% and a combined allowance for credit loss and reserve for unfunded commitments ratio of 1.28%, both of which are consistent with the prior quarter. Provision expense totaled $2.4 million, resulting in a provision to charge-off ratio of 232%. With a total ACL of $76.2 million, our current ACL to nonperforming loan ratio is 640%. We are pleased with the improvements in our credit metrics during the quarter and remain highly focused on maintaining good credit quality moving forward.

As a reminder, our ongoing credit monitoring activities include third-party reviews that cover 65% of our portfolio on an annual basis. Those reviews continue to validate our credit monitoring practices and approach to risk rates.

Turning to Slide 11. For Q2, deposits increased 2% to $6.7 billion, up $147 million from the previous quarter. Noninterest bearing deposits increased slightly during the quarter to $958 million and represent 14% of total deposits. In the quarter, time deposits grew 5.6% to $1.9 billion and money market deposits grew 4.5% to $3.1 billion. Tax payments in April have historically provided pressure on deposits in Q2 and the deposit market remains highly competitive.

In Q2, we increased fee income with service charge fees increasing 11% over Q1 to $2.3 million while credit card income increased 5% over Q1 to $1.6 million. We have previously made significant investments in these programs, which are now gaining traction in the market. We are pleased with our overall deposit, loan, and fee income growth in the second quarter. Strong portfolio management remains a key focus for the remainder of the year, given the economic uncertainty, and we are proud of the decrease in nonperforming assets, classified assets, charge-offs, and past dues reported for the quarter.

I will now turn the call over to Ben to cover the financial results in more detail. Ben?

[Benjamin Clouse, executive]

Thanks, Randy, and good morning, everyone. As Mike said, net income this quarter was $18.6 million, or $0.37 per diluted share on a GAAP basis. This was an increase of about 2% from last quarter or $0.01 of EPS. Operating revenue consisting of net interest income and noninterest income also expanded 2% this quarter. Provision expense was modestly higher as the prior quarter included a higher mix of commitment funding that was already reserved.

Noninterest expense was up slightly, less than 1%, and included an incremental cost for restructuring our core system contract. This restructuring is expected to generate significant savings going forward with an expected earn back of 4 months and expected annual run rate savings of approximately $2 million per year on our current volumes. Adjusting for the core contract restructuring would add another $0.01 to EPS.

The quarterly return on average assets was 1.0% and return on average common equity was 10.6%. We realized continued balance sheet growth in the quarter, as Randy outlined, and we are really pleased to see profitability improvement in the quarter's results. Interest income expanded this quarter, driven by both higher yields and higher average balances.

Slide 12 outlines the underlying changes in net interest margin this quarter. Yield on loans increased 7 basis points, resulting in an earning asset yield of 6.78% this quarter. Average yield on new loans for the quarter was 8.93%. Better yields on our investment securities portfolio also contributed. Average earning assets increased $161 million compared to the prior quarter, primarily due to loan growth, which was somewhat backloaded toward the end of the quarter.

Our total cost of deposits was 3.92% for the quarter, increasing 5 basis points. Our total non-maturity deposit beta against the entire rate cycle through the second quarter remained at 57%, in line with our expectations. And the pace of increase in the cost of deposits continued to moderate, falling from a 13 basis point increase last quarter. Our deposit base remained consistent with the prior quarter in terms of diversification and composition, and client deposits grew by quarter end. Our loan-to-deposit ratio was down slightly to 94%.

We utilized borrowing within the quarter due to some seasonal client cash outflows, which resolved by the end of the quarter, leaving the ending balance flat to last quarter. And wholesale funding moved up slightly by 1% to 16% of assets. Fully tax equivalent net interest margin was consistent with the prior quarter at 3.20%, in line with our expected range. We expect some improvement to our NIM with any rate cuts this year.

For the quarter, yield on assets kept pace with the increase in cost of funds. Our NIM has remained stable in the low 3.20s since the second quarter of 2023. We've worked diligently to position our balance sheet to perform in the current higher-for-longer rate environment while preparing for potential rate cuts. Our earning assets continue to be primarily variable as 66% reprice or mature in the next 12 months. As Randy outlined, our loan growth was on the lower end of our expected range this quarter, and we are moderating our estimated loan growth in 2024 to a range of 6% to 8% for the year.

On the liability side, we have good variability as well. 27% of our client deposits are indexed and will automatically move down with any Fed rate movements. In addition, we have short-duration broker deposits of 16%. Our CD portfolio duration has continued to shorten as we incentivize clients to move into 6- and 9-month products, and we have $850 million of client CDs that mature in the next 12 months. As we renew CDs, the expected pressure to margin continues to narrow with declining spreads to new renewal rates.

The rate environment outlook continues to be very dynamic, and we continue to assume 2 rate cuts this year, with a potential September cut being the only significant impact for 2024. Based on that assumption and including somewhat lower loan growth, our expected margin is still in a range of 3.20% to 3.25% for the year. The absence of a rate cut would leave our margin at the lower end of that range. Noninterest income was $5.7 million for the quarter, expanding 2% from last quarter. Growing noninterest income is a key strategic priority for us, and as previously mentioned, the biggest driver of this expansion was service charges and credit card revenues. These will be continued focus areas of growth in 2024.

Moving to Slide 13. Noninterest expense increased slightly this quarter compared to the prior quarter, driven by the core contract restructuring, as I mentioned. Expenses would have declined otherwise and been in line with our guidance. Compensation declined due to lower taxes and benefits, partially due to seasonality. Our headcount was unchanged from the prior quarter and remains at the same level as a year ago, as we continue to scale with some remixing of talent toward production roles.

We expect noninterest expense to be around $37 million per quarter for the rest of 2024, including the core contract renegotiation savings. We remain highly focused on our efforts to drive additional efficiencies and gain operating leverage in 2024, as evidenced by operating revenue growth outpacing expense growth this quarter. Our tax rate this quarter was consistent with last quarter at 21%, and we expect the tax rate to remain in a range of 20% to 22% this year.

On Slide 14, our liquidity remains strong, consistent with the prior quarter at 34% of assets. We have liquidity of approximately $2.6 billion from on- and off-balance sheet sources. On Slide 15, we continue to advance our goal of building capital this quarter as we saw continued asset growth and strong earnings. We continue to focus on building capital balance and shareholder return. As Mike mentioned, we took advantage of some price pressure on our stock and increased our level of buybacks. We repurchased 237,000 shares at a weighted average cost of $12.78 compared to tangible book value per share of $14.02 at quarter end. We believe we can continue to achieve our goal of building capital while dedicating a portion of our earnings to shareholder return.

In summary, we are very happy with the first half of 2024 with strong earnings, continued organic growth, and advancement of our strategy. Operator, we are now ready to begin the question-and-answer portion of the call.

[Operator]

[Operator Instructions] The first question today comes from Michael Rose with Raymond James.

[Michael Rose, analyst]

Maybe we could just start on deposits. The growth was really strong. I know you cited energy in Texas, I believe, but I know also that you recently signed up with Nimbus. And just wanted to see how we should think about the pace and complexion of deposit growth. Do you think that the NIB mix is essentially at a stabilized level? How would you comment on cost, and how should we think about continued deposit growth as we move not only through the next 2 quarters but also into next year?

[Michael Maddox, executive]

Thanks, Michael. I think we do feel like our mix is stabilized. We obviously continue to focus on improving that mix by growing our noninterest bearing. We had nice growth across our footprint. I did highlight a couple of our groups that outperformed a little bit, but we're in dynamic markets, and so we continue to see great opportunity to grow deposits in our markets and our footprint.

Nimbus is still in process. We have not launched that yet, and we expect that will launch in the fourth quarter. So, the growth in the second quarter was just core deposit growth from our markets.

[Michael Rose, analyst]

So should we assume that there's the potential for deposit growth to actually outpace loan growth, and then hopefully if there's a little bit more clarity on the economy as we move into next year that loan growth could accelerate? Is that the way we should think about it?

[Michael Maddox, executive]

Yes, I think that's a fair way to think about it, and we're trying to be thoughtful on loan growth. We want to stick to our pricing model and to our credit standards. And as Randy said, we're focused on reducing our CRE concentration down under that 300% mark, and so we're trying to be thoughtful as we look at that area as well. And we expect loan churn to pick up a little bit, which ought to allow us to also increase our new loan volume.

[W. Rapp, executive]

Michael, this is Randy. I might add, as we've highlighted, we made some tweaks to our incentive model to highlight deposit growth, and I think we're starting to see that gain traction as well in our markets, and so we have all our relationship managers out asking, no matter what line of business they're in, they're asking for deposits. And as we think about new loans, we're making sure that comes with a full relationship and deposits as well.

[Michael Rose, analyst]

Okay. And then maybe just finally for me, just to tie all this together. So, it sounds like the potential for stronger deposit growth, you're being very thoughtful on loan growth. Maybe you look to add a little bit incrementally to the securities book. But it would seem to me that the actual ability to grow NIM, assuming we only get 2 cuts this year whatever it's going to be, is somewhat limited just given those dynamics. Is that fair as we think about it into next year, or am I missing something?

[Michael Maddox, executive]

No, Michael, I still think we have the opportunity to grow NIM and net interest income. A lot of our loan growth in the second quarter was late in the quarter. Otherwise, our net interest income would have been stronger. We think we'll have a little headwind in the third quarter with that, or a tailwind I mean. And I think you're going to continue to see solid growth the rest of the year, and hopefully with a rate cut in September, if not sooner, we ought to get some expansion of our NIM.

[Benjamin Clouse, executive]

Michael, it's Ben. I would add, while we're a little bit more balanced on sensitivity than we were a quarter ago, we will benefit from a rate cut, and we're positioned for that. Mike and Randy talked about noninterest bearing, but those have moved a little bit, but I think it's important to note they've grown with the growth of our balance sheet and really haven't moved off of that 14%, 15% level in a while.

[Operator]

The next question comes from Woody Lay with KBW.

[Wood Lay, analyst]

Yes, so it's a really strong quarter for credit. I was hoping that you could just give us some color on what drove the classified improvement in the quarter.

[W. Rapp, executive]

Woody, this is Randy. Yes, it was really across the whole portfolio. There was no -- we saw decreases in CRE, in C&I, and really it was just portfolio performance. We had some transactions refinanced. We had some that were restructured with additional equity, which allowed us to upgrade it, and so it was really no one thing that drove that decrease during the quarter.

[Wood Lay, analyst]

Makes sense. And then as it relates to the reserve, just on a percentage basis, it was flat. Given some of the credit metric improvement that we saw, did you tweak some of the qualitative factors in the quarter to keep that percentage flat?

[Benjamin Clouse, executive]

We look at those qualitative factors obviously every quarter. We've not made any significant moves in those. We're cautiously optimistic about the economic outlook, which I don't think is probably different than anyone else would think about it. Our goal really is to continue to maintain a reserve at that level, at that 1.20 level, which we think is appropriate, and the underlying change is primarily driven by loan growth and charge-offs, obviously, is how the math works.

[Operator]

The next question comes from Andrew Liesch with Piper Sandler.

[Andrew Liesch, analyst]

The commercial real estate as a percentage of capital, you mentioned a couple times now, your goal is to get it below 300%. Do you have where that was at the end of the quarter?

[W. Rapp, executive]

Yes, it's about 3.20%. And Andrew, historically we've been in the 2.70% range. We made a strategic decision to increase that given market conditions and opportunities we were seeing. And so that peaked at about 3.30%, and then now we're starting to work that back down below 3.00%, but we finished at about 3.20%.

[Michael Maddox, executive]

Well, the percentage has also changed with the 2 acquisitions we made in Colorado and Arizona that were a little heavier real estate, and so we're just trying to methodically work that back down.

[Andrew Liesch, analyst]

Makes sense there. And then on the expense front here, you get the savings from the contract renegotiation. It sounds like a lot of that's going to be reinvested back into the franchise. Just curious where some of this spending might be. Does this include the new team that you hired?

[Benjamin Clouse, executive]

Good morning, Andrew. It's Ben. That is probably the biggest portion. As I said, we've continued to remix our headcount a little bit while really holding it flat to continue to tilt it more toward production roles as we're finding efficiencies or leverage in our expense base, which, as Mike said, is our long-term goal. the other lesser factors would be we, of course, continue to experience a significant amount of inflation in our cost base as our balance sheet continues to grow, in particular in the second half of the year, our regulatory assessment is growing, and then last piece would be we have a little bit of a tilt on our marketing business development spends toward the second half of the year, but the primary driver is the investment production talent.

[W. Rapp, executive]

Andrew, to add to that, we're seeing some disruption in our markets, which is really presenting some nice talent opportunities for us. And so we're trying to be very selective in how we add that talent, but the market disruption is generating a high degree of interest in CrossFirst.

[Michael Maddox, executive]

Yes. And we were able to add 5 more production people in the quarter that really weren't budgeted. But just through normal attrition and the employee base, we were able to keep our total headcount flat. So, as Randy said, we are seeing some opportunities, and we want to make sure we are in a position to take advantage of that.

[Operator]

[Operator Instructions] The next question comes from Matt Olney with Stephens.

[Matt Olney, analyst]

I want to ask more about capital and capital deployment, and I think in the second quarter you deployed some capital via the buyback and looks like that trade's working out well so far. And I think late last year you deployed some capital via the little restructuring. I guess over the last few weeks, we've seen these bank valuations move higher. We've seen rates move lower. I'm curious around the updated thoughts around capital from here and potential for deployment given these more recent moves over the last few weeks.

[Benjamin Clouse, executive]

Matt, it's Ben. As you said we deliberately hit the buyback harder in particular earlier on in second quarter. That, of course, is the beauty of a buyback, it's flexibility. And the math is nowhere near as desirable today, which we're happy about, as we've seen a lot of price improvement through the quarter and through July.

As Mike said, we continue to have a long-term goal to build our ratios from where they are. They all moved up a little bit quarter over quarter and nicely year over year. You are correct. We utilized around $1 million of capital in fourth quarter to do a bond trade, although we did that in a way that was actually positive to our risk-weighted capital ratio because of how we redeployed the funds, as well as realizing some NIM improvement. So, our goal remains to continue, as Mike said, to be opportunistic about that capital deployment and continue to build those ratios.

[Michael Maddox, executive]

Yes. And Matt, look, we're really pleased with the movement in our stock price, and today it probably makes a little more sense to deploy that capital in the high-quality growth in our markets. And so, as Ben said, we want to continue to build capital, but worried markets are going to provide us plenty of opportunity to put on high-quality growth as well.

[Matt Olney, analyst]

Yes, okay. Appreciate that. And then, I think, Ben, you mentioned that the balance sheet migrated a little bit more towards being rate-neutral, more so than what we saw the previous quarter. Any more color on what drove this move, and any commentary about expectations and movements from here?

[Benjamin Clouse, executive]

Sure, Matt. Really, 2 main drivers that produced the small change from Q1 to Q2. One, our level of repricing assets increased as we added a higher mix of variable rate loans in the quarter. We also carried a bit more cash.

Then, on the liability side, we've shifted our time deposit maturities out a little bit further. They're now a little bit more spread out than they were in the first quarter. So, between those 2 things, we've shifted a little bit more neutral, but we will continue to position in such a way that will benefit from a rate cut.

[Operator]

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

[Michael Maddox, executive]

I just want to thank everyone for joining the call today. Again, we're really pleased with our quarter, and I want to thank our teams for all their hard work, and we continue to see improving conditions, and we believe that the rest of the year should continue to be strong, and we'll continue to focus on really profitable growth and continue to take advantage of the opportunities we're seeing in our dynamic markets. So, thank you again for joining us, and you have a great day.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.