Equity Bancshares Inc
NYSE:EQBK
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Earnings Call Analysis
Summary
Q3-2023
The company's margin outlook reveals a cautious stance, citing liabilities as a significant unknown, which leads to uncertainty in the net interest margin (NIM) leveling out. Provisioning continues at a cautious rate, maintaining a reserve ratio around 130-140 basis points. Despite a degree of asset sensitivity, the balance sheet is prepared for rate reductions with a mostly variable rate deposit portfolio, enabling quick repricing to adapt to market conditions. Expense management is focused on rationalizing vendor relationships, with expected cost savings of roughly $3 million next year from reduced noninterest expenses due to changes in solar tax investments. M&A activity is deemed probable, suggesting a strong outlook for potential deals.
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Good day, and thank you for standing by. Welcome to the Q3 2023 Equity Bancshares, Inc. Earnings Conference Call.
[Operator Instructions] 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.
Good morning. Thank you for joining us today for Equity Bancshares third 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.
Good morning, and thank you for your interest in Equity Bancshares. We're excited today to take you through our third quarter results, including beating consensus earnings, continued improvement in credit quality and a 20% increase in our quarterly dividend as we continue to emphasize shareholder return. Before we get into the details, I'm pleased to introduce my fellow speakers, CFO, Chris Navratil, who many of you have met over the years during his tenure as our bank CFO and our Chief Credit Officer, Krzysztof Slupkowski. Each has been with our company for more than 5 years in senior leadership roles. Their promotions provide for a seamless transition of job responsibilities, while assuring the company has capable operators with proven track records and alignment with our company's core values. .
Also joining us today is our President, Rick Sems. Let's look back at the third quarter. Our balance sheet strength, including high levels of capital, robust loan loss reserves and available liquidity has continued to provide stability in a dynamic and challenging operating environment. We believe this environment is right with opportunities, and we are excited about our prospects for organic growth in both deposits and loans as well as M&A opportunities.
Our teams continue to focus on value creation. The value begins with an engaged employee base, which drives excellent outcomes for our customers and shareholders. Our commercial and retail teams continue to deliver positive outcomes during the quarter and look to build additional momentum into the fourth quarter and 2024.
Our credit and commercial teams successfully encouraged several undesirable credits to find new banking partners this quarter. Some classified and others just flagged as outside of equity's current tolerances. We're being proactive in coming our portfolio and working with customers to get ahead of any potential down cycle.
Capital in all forms tangible people, community is a bank's differentiator in potentially challenging times. We believe we have an abundance of all to be deployed for the benefit of our stakeholders. I'll let Chris talk you through our financial results.
Thank you, Brad. Last night, we reported net income of $12.3 million or $0.80 per diluted share as compared to $0.74 per diluted share in the second quarter. Net interest income was up $1.6 million linked quarter, while net interest margin improved to 3.51% from 3.38%. We will discuss margin dynamics in more detail later in this call. Noninterest income, adjusted for a loss on repositioning of investment in Q2 was up $500,000 linked quarter. The positive trends included a 4% increase in service fee revenue. Noninterest expenses totaling $34.2 million were higher quarter-over-quarter, primarily due to onetime incentive compensation reversals in Q2 that were not expected to repeat. Our GAAP net income included a provision for credit loss of $1.2 million 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. September 30 coverage of ACL to loans is 1.35%. I'll stop here for a moment and let Krzysztof talk through our asset quality for the quarter.
Thanks, Chris. As of the end of the third quarter, asset quality continued to trend positively. With total classified loans closing the quarter at $37.3 million (sic) [ $37.6 million ] or 6.3% of total bank regulatory capital, its lowest level since we started the company. Nonaccrual loans as a percentage of total loans remained below 60 basis points. Net charge-offs when year-to-date annualized or 11 basis points of average loans. Nonowner-occupied office is an ongoing area of concern for the banking industry.
Equity Bank's portfolio totaled $77 million and represents just 2.3% of the total loan portfolio and was reduced by $14 million this quarter. Our average loan size was $2.2 million. We were able to successfully reposition our largest exposure to office during the quarter with another financial institution further reducing risk within our portfolio.
Nonowner-occupied CRE and CRE construction balances ended the quarter at 187% of total bank capital. As compared to the industry, our exposure is limited. We have stress tested our top relationship exposures at 300 basis points from today's rates without repayment concerns based on current income streams. We believe our portfolio is diverse, both in nature and geography, which when combined with our disciplined underwriting, loss reserves and capital position us well to navigate any challenges that may arise in the future.
Thanks, Krzysztof. End of period loans declined in the quarter. As Brad mentioned, during the quarter, management worked with our borrowers to exit a number of credit exposures, which were no longer within our risk appetite, which contributed to the realized contraction. Loan originations in the third quarter totaled $149 million with a weighted average coupon of 8.46% compared to $153 million with a weighted average coupon of 7.80% in the second quarter and $173 million with a weighted average coupon of 5.95% in the third quarter of 2022.
We continue to successfully originate loans in the current interest rate environment, contributing to expanding yields on interest-earning assets. During the third quarter, the yield on the loan portfolio increased 34 basis points to 6.67%, increases the fee and purchase accounting accretion accounted for 8 basis points of the periodic improvement.
Cost of interest-bearing deposits increased 26 basis points to 2.40% in the quarter, while the contribution of noninterest-bearing deposits to the mix remained relatively flat. The velocity of liability repricing continues to slow as compared to the peak quarter-over-quarter increase of 68 basis points in Q1 of 2023.
Net interest income totaled $41.0 million in the third quarter, up $1.6 million from the second quarter driven by appreciation and earning asset yields in excess of cost of interest-bearing liabilities. Equity maintained enhanced liquidity on our balance sheet from actions we took to respond to market dislocation in the first quarter, average interest-bearing cash increased to $268 million in the quarter from $185 million in the second quarter.
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 calculated that the excess liquidity has the effect of reducing margin by 6 basis points for the current quarter.
Salaries and benefits increased $600,000 in the quarter due to forfeiture and vested restricted stock in Q2, which was not expected to repeat. Marketing expenses are elevated from advertising to continue to attract deposits. Our outlook slide includes the forecast for the fourth quarter as well as our preliminary view of 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 10 basis points to average loans.
Rick?
Thanks, Chris. I am pleased with what we accomplished this quarter and all that we are positioned to accomplish moving forward as we continue to emphasize value creation in our markets. During the quarter, our non-brokered deposit base declined by $98 million attributable to seasonal outflows in our municipality operating accounts of approximately $110 million. Important to note, this trend was not due to loss of relationship.
These operating accounts typically spin down in the third quarter and are replenished by the collection of tax revenues in the fourth quarter. Excluding these seasonal outflows retail deposit funding was up during the quarter as our teams continue to develop and grow customer relationships while maintaining deposit pricing discipline. We believe that we have the team and 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 Q3 as in Q2, but improved yields and ROEs to the bank. Overall balances were hampered by payoff headwinds. Although approximately $26 million were deteriorating or criticized loan, $35 million were lower yielding loans we chose not to chase and $34 million were loans tied to sold projects.
Of note, our Tulsa region, led by Ryan Morris and our Western Kansas region, led by Levi Getz have been strong. As we look to the fourth quarter, our markets led by regional CEOs, Mark Parman, Josh Means and Brad Daniel, our growing pipelines back from lows felt in early Q3, and our teams are motivated to build into the end of the year.
As of the end of the quarter, our 75% probability pipeline stood at $300 million, while our 50% probability was $400 million. We have the strategy, discipline, tools and people in place to drive organic customer-centric growth while achieving the proper return on our capital. I look forward to assisting the team in execution as we move forward. Finally, service revenue was up quarter-over-quarter, primarily driven by our credit card, insurance and wealth management business lines. Each of these lines are in their infancies in terms of income statement impact and along with treasury management, have the capacity to be meaningful contributors to service revenue in future periods.
Thanks, Rick. 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. We conducted our off-site board strategic meeting this quarter. And we all left that meeting very optimistic about what equity can accomplish over the next year and more so over the next 3 years.
We are positioned with great products that Julie Huber and Charlton Laird are driving into the fabric of the company. I believe we have the best products and technology in our region. And with a great team of leaders, we can accomplish a lot over the next few years. We continue to see momentum on the M&A front and expect to see that to continue over the next several quarters. Equity will remain disciplined in our approach to assessing these opportunities, emphasizing value while controlling dilution and earn-back time line.
With that, we're happy to take your questions.
[Operator Instructions] Our first question comes from Terry McEvoy with Stephens.
Good morning, everyone. Maybe Brad, a question for you. Can you just discuss loan growth opportunities in 2024. There are certain markets that stand out? Is it CRE, C&I? A little bit more specific there would be helpful. And as a part of that, do you expect to continue to strategically push out certain credits that you mentioned earlier on the call?
Yes. So 2024 loan growth. I think our teams are really focused. Terry, we've had some strategic meetings over the last couple of months. And so I think all of our markets are very focused on how do they grow loans. I think Kansas City and Wichita, Tulsa are always the leaders of that. We've got some good momentum going in Tulsa, which that team has really worked hard on getting moving that direction, but also our Western Kansas markets, our Western Missouri markets are also focused on those.
So I would just say we're really laser-focused on. This is a great time for Equity Bank to attract customers. I think we've been a very balanced organization. So I think it will come in small business lending, C&I and CRE, and we've never really been focused on one area. So I think it will come in all aspects of those categories. On the -- are we pushing out, we've got 1 credit that's actually already paid off this quarter that we are pushing out. We don't have a lot of other credits that we are putting pressure on to move at this time. But if something pops up, we will use the tools we have to make that credit move.
And then maybe a follow-up for Chris. Could you just talk about the excess liquidity, which has impacted the margin? What are your thoughts for 2024? And what type of assumptions are you making for the initial 2024 outlook. That's in the slide deck today?
Yes. So for that initial outlook, we're looking at more of a normalization of that excess liquidity position. The bank term funding program borrowing that we have on the books now matures in the first quarter of next year and the end of the first quarter, it basically was put on commensurate with [indiscernible] situation.
So think of that same time horizon as to when that matures. At that point, the arbitrage that exists today will go away. We won't have the same need to keep that on balance sheet liquidity. So pending other material concerns arising, I think we'll go back to a normalization of cash. Any expectation that more target is depicted in the outlook is repositioning that cash into earning asset classes, predominantly loans that is advantageous to the earnings stream next year. .
Our next question comes from Jeff Rulis with D.A. Davidson.
Brad, on your kind of M&A commentary. Just interested in obviously, we've seen some deals of late just nationally, given where we are in great world, we've seen some pretty large great marks and therefore, some pretty sizable tangible book dilution numbers. I guess the figure to focus on would be the earn-back period. And I guess as you look at deals, is there a watermark on tangible book earn back that you'd like to stay within given opportunities that you see? .
Yes. We've been very consistent on 3 years and under. And I would say we're probably south of that as well. So we've not stretched that tangible book value earn-back period for us. We still think it's got to be within that period for it to be good for the investors and shareholders of Equity Bank because we just -- we can't take the risk that it's going to take longer to earn that back than what the 3 years because things just changed so much in 3-year periods.
Yes. And you talk about some of the credits you pushed out that would signal a little bit of credit wariness. But I guess, given that backdrop, the comfortability of acquiring someone and you guys seem to be kind of actively managing that. How do you square that with going and buying another bank under that credit backdrop?
Yes. I think the institutions we're looking at have good credit. We aren't currently looking at anything that has a bad credit, although we don't mind cleaning up somebody else's credit, if that's part of the strategy that we need to do. We just put an appropriate mark on that. We bought a bank in '07. We bought a bank in '09.
We bought banks in '10 and '11, which were some of the worst credit cycles that we've ever seen. We've never missed a credit mark during the cycle, knock on wood. And so we feel very confident in our underwriting ability and the person who's done all of that underwriting and all those marks is Julie Huber, who is still with us. And so she's been through this war and has been very seasoned about going through that process.
Got it. Maybe just a last one. And if you know, I guess, of those credits that you kind of pushed out any sense for where those borrowers are landing and not specifics, but just generally speaking, is there a competitor that broad-brush who is taking that credit on in some cases?
Yes. They're smaller institutions, nonpublic that are taking those credits on. But the community banks just aren't as sophisticated in their underwriting is what I would say. They're leaning more on the net worth of the borrower that's on a stated personal financial statement. .
And so there may be a little truck factor in there and that they may not have the most accurate financial statement and so they're relying on that personal guarantee more than the project. The project is not cash flowing. And so you have to really look at that personal guarantee and have to believe in that, that personal guarantee continue to pay that back. .
[Operator Instructions] Our next question comes from Andrew Liesch with Piper Sandler. You may proceed. Andrew, your line is open, please unmute if you're on mute.
So just wanted to touch base about the margin here in the guide. I would have expected to be a little bit higher going into next year. I know you had the 8 basis points of higher-than-expected accretion this quarter. So that might be some headwind in the near term. But even at the low end of that for the fourth quarter using as a jumping off point into 2024, I would have expected based on what we just saw this quarter or even that you would be [ 2025 ] or even more.
Are you seeing out something out there that might suggest that the margin is going to top out at 3.55%, maybe at the high end? It just seems to me that there's more room to run there.
Yes, Andrew, I'd say there's some conservatism built into that number just based on unknowns on the liability side of the balance sheet. We understand pretty well our asset repricing and our capacity to continue to drive some asset repricing via being opportunistic in the bond portfolio and other means. But the liability side is just too much of an unknown as we move forward as to how deposits might reprice where the real kind of top of the cycle is going to be and how long it's going to extend and based on that, there's just some uncertainty as to where we'll level out on NIM.
We're very optimistic, a lot with you that on the asset side will continue to drive up, and we'll continue to realize the appreciation in the marketplace, but the liabilities are just uncertainty at this point, what's driving that forecast figure.
Got it. All right. That's really helpful. And then just shifting gears just to the allowance and the provision reserve ratio has been in mid-130s now for the last few quarters. Just kind of -- I mean, [ an outstanding ] any major shift in Tulsa modeling or the credit environment, just kind of the level that you guys think that we should be forecasting out those here?
Yes. We continue to think about provisioning and 10 basis points of average loans. We've kind of been running CECL in this challenging economic environment for a while, which has led to a continuation of that 130-ish basis points, 130 to 140 of total loans. I don't know that I have a number post any economic constraint of where we would think that CECL levels out in a normalized operating environment.
But it's less than 135 basis points based on historical loss experience to date. So if the economic turmoil was to resolve itself and losses work to be realized, you're going to release some of that provision via credit provisioning. But as we stand today with the level of uncertainty, it still exists, keeping it around that 135 basis points continues to make sense.
Our next question comes from Damon DelMonte with KBW.
Just wanted to circle back on the margin outlook as we look into '24. How would you characterize the positioning of the balance sheet should the Fed start to cut rates in the back half of the year?
Yes. So we're working continually on assessing sensitivity, both asset and liability to manage the risk as it relates to downward trend in the Fed stance as we move forward. And today, we're -- we continue to be a little bit asset-sensitive, which is what you'll see in our changing NIM period-over-period. But the majority of our liability book is still a variable rate deposit portfolio.
So capacity to reprice very quickly. The challenge just becomes how does the market dynamic behave as we go into a rate reduction cycle from the [ fact ]. So if competition is aggressive, very irrational and rates continue to go up, even if the Fed begins to drop down, we're going to see some asset sensitivity, which is detrimental to NIM in the near term. But the majority of the guide of our liability book is variable rate deposit pricing. So we do have capacity to reprice it quickly, just depending on overall market dynamic.
Got it. That's helpful. And then with respect to expenses, it looks like the outlook for '24, if you basically take your forecast for the fourth quarter and add that to the first 3 quarters of '23. It seems very minimal growth, '23 over '24. What are some of the things you guys are doing? Or what gives you confidence that you can kind of keep the growth at a very minimal level kind of in light of the inflationary backdrop that we continue to deal with.
Yes. So we're working hard on a number of things to rationalize some vendors and to the extent that we're adding folks into our vendor mix, replacing legacy vendors. So it's not incrementally additive cost. And there's some things that are just built into noninterest expense that won't repeat next year from a baseline perspective. So we've talked about in the past, solar tax investments that we've made that historically have been reflected above the line as part of noninterest expense, that's going to go away materially next year.
So this year, we're modeling about $4 million in total expense above the line. That moves into tax expense next year and will essentially be pulled out of noninterest. So that's incremental cost saves of about $3 million because there will still be some dollars in that NIE line. And then just being strategic on some contracts, I think we have opportunity to mitigate some additional cost there as well where we can hold the line a bit and the expansion of NIE on a normalized basis when you pull out that solar tax. Those solar tax dollars.
And those solar tax dollars coming out of the noninterest expense are probably what's driving the higher effective tax rate as well?
Yes, that's right.
Okay. And then just lastly, on the M&A, Brad, you imply that kind of optimistic that some deals will be happening in the future. How would you kind of handicap the odds of you guys signing up a partner in the next call, 6 to 9 months?
I would handicap -- I'm not giving you a percentage, but I'd handicap it as pretty strong.
Our next question comes from Terry McEvoy with Stephens. .
Just one follow-up. When you think about your TCE ratio, are you using the 9.55%, which excluding the AOCI or the 7.29%. And I'm asking the question to better understand some of the capital deployment comments, specifically around buyback.
Yes. Truthfully, I can answer first and then Brad can jump in. I think we look at both numbers, Terry. We're very aware of both numbers. As we think about capital activity, we're being cognizant of both of those figures and understanding how trying to assess the best utilization of our capital, be it repurchase, be it M&A, be it a security repositioning, for example, right?
So a number of different potential capital usage we did leverage today that are meaningful into the future, and we're thinking about both of those ratios as we're assessing on. Brad, you want to add to that?
Yes. I would say exactly what Chris said, we look at both ratios and are very cognizant of both of those ratios and then we look at what we think the odds of deploying capital in the best form for shareholders. And so what moves the needle most from an earnings per share basis. Right now, there's not a lot of dilution. So we really are looking at doing that. We've been holding capital back recently because we think there are some things that are -- that we could deploy that capital in versus buybacks in the very near future. So we've been a little light on the buyback lately. .
Thank you. And this concludes today's conference call. Thank you for participating. You may now disconnect.