Bank7 Corp. (NASDAQ:BSVN) Q4 2022 Earnings Conference Call January 26, 2023 10:00 AM ET
Company Participants
Tom Travis – Chief Executive Officer
Jason Estes – Chief Credit Officer
Kelly Harris – Chief Financial Officer
Conference Call Participants
Nathan Race – Piper Sandler
Thomas Wendler – Stephens Inc.
Woody Lee – KBW
Operator
Welcome to Bank7 Corp.’s Fourth Quarter and Full-Year Earnings Call. Before we get started, I’d like to highlight the legal information and disclaimer on Page 22 of the investor presentation. For those who do not have access to the presentation, management is going to discuss certain topics that contain forward-looking information, which is based on management’s beliefs, as well as assumptions made by and information currently available to management.
Although management believes that the expectations reflected in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove to be correct. Such statements are subject to certain risks, uncertainties, and assumptions, including, among other things, the direction in direct effect of economic conditions on interest rates, credit quality, loan demand, liquidity, and monetary and suppository policies of banking regulators.
Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may vary materially from those expected. Also, please note that this conference call contains references to non-GAAP financial measures. You can find reconciliations of these non-GAAP financial measures to GAAP financial measures in an 8-K that was filed this morning by the company.
Representing the company on today’s call, we have Brad Haines, Chairman; Tom Travis, Chief Executive Officer; J.T. Phillips, Chief Operating Officer; Jason Estes, Chief Credit Officer; Kelly Harris, Chief Financial Officer.
With that, I’d like to turn the call over to Tom Travis.
Tom Travis
Thank you very much. We are excited about our year and our recap. For those of you that have been on the call with us before, we generally don’t spend a lot of time with comments, but since we’re recapping the year, we’ll take a few minutes here to highlight some of the things that excite us.
So, once again, we delivered strong results. We’re very happy about that, and we must acknowledge and we do acknowledge and thank our team members for their contributions. They not only grew our loan and deposit portfolios in a meaningful way, they did it while satisfying our customers.
As we recap our results for the year, we began with record earnings. And again, we acknowledge our commercial banking team. And we have to give credit where credit is due because our record earnings is a function of a loan growth, and it should not be confused or attributed with the Fed rate hikes. That’s pure organic loan growth. We didn’t buy loans. The team went out and captured new loans and deposits.
So to best understand what occurred last year, we look back to the quarterly time line, and we start with the first quarter. The first Fed rate increase didn’t occur until mid-to-late March and then was followed by the next few rate increases during the second quarter. So, in those first two quarters, we had very little benefit from the rate hikes because we had many loan floors. And also, at the same time, our loan growth had not yet materialized in a meaningful way.
In essence, we spent the first quarter and most of the second quarter filling up our loan floors. Beginning in late May and early June and continuing into the third quarter, loan growth was exceptional, and we posted a strong third quarter. Although we finally did start seeing some benefit from the rate hikes in the third quarter, it was not much.
In fact, we refer you to Page 35 of our prior third quarter 10-Q as it illustrates the nine-month period ending September 30, and it clearly shows that our income increase was attributable to the growth in the loan portfolio, which had grown significantly compared to the prior period end.
In fact, the data shows that our gross loan yield through that period was actually 3 basis points lower than the prior period, further highlighting the growth contribution and component that caused the income lift. We cannot emphasize enough how pleased we are with our commercial banking team and all the people who support them.
Wrapping up the year, as you look into Q4, we continued to increase the loan book. And when combined with the Fed rate hikes, the full benefit of a higher loan book and strong rates in the NIM can be seen, and you can see how well we’ve done. Regarding our NIM and reflecting back on the full-year is a similar story regarding steady increase throughout the year.
In late 2021 and early 2022, we had signaled and discussed the expected NIM compression associated with our December 2021 acquisition, due largely to the loan yield – to the low yield on the incoming bond portfolio. Our expectation of a lower NIM was realized, and we began in Q1 with a core NIM of [3.91] [ph].
As the loan book begin to grow in the late spring and into the summer and fall, the NIM began to recover, then late in the year, the Fed rate hikes were being more fully realized, we grew our loans even more and the core NIM returned to exactly where it was for the prior year.
So, from an earnings and NIM perspective, it was a great story and a story based on our commercial banking team and their ability to price loans properly and to grow loans. And so, I think that’s a good start with the income and the NIM component. And I’d like to ask Jason if he would cover the asset quality aspect of that loan portfolio.
Jason Estes
Thanks, Tom. We’re very pleased with our loan portfolio as the calendar turns. We’ve not seen a change in past due levels of problem credits as rates have increased. NCOs were minimal for the year. And our disciplined underwriting combined with seasoned lending teams will continue to serve us well as we operate in this higher interest rate environment. Construction loan balances have started to decline.
Our hospitality construction activities have significantly reduced. And the homebuilding industry, they’ve started to lower their inventory levels to match current demand. Just as a reminder, our homebuilder portfolio is primarily starter homes in the Oklahoma City and Dallas metro areas with very little locked and land lending activity. We’re not concerned with this segment.
Our energy portfolio has grown over the past year, but we continue to closely monitor that growth as we selectively remain active, originating high-quality new loans. Overall, we continue to lend money the same way we have for decades. The economies in Oklahoma and Texas are healthy, and our credit quality continues to benefit from both.
And Tom, I’ll hand it back to you.
Tom Travis
Jason, thanks for that report. And again, just a real shout out to the commercial banking team and all those efforts. So, as we move into our capital, we’re pleased to have quickly reestablish our risk-based capital. And we’re back to our higher levels, especially considering it was done, while at the same time experiencing record growth and a 33% increase to our dividend.
Regarding our dividend, even with the 33% increase, our dividend payout ratio is still significantly below the average payout ratio for all dividend paying banks. It’s especially comforting and gratifying that Bank7 has top 5% earnings. I believe once all the numbers come in for the year, we might even be in the top 1%. And because of those strong earnings and consistently strong earnings, it enables us to build capital rapidly.
It is a real source of strength for our company as it provides flexibility for acquisition, dividend payouts or share repurchases are simply to support growth. We will refer you to Page 15 of this IP as it shows the great earnings strength and the buffer based on industry and examiner based DFAST stress parameters. And then moving into liquidity, it’s remained strong, and our Cornerstone acquisition provides additional meaningful runway for future growth.
Our team members from Cornerstone have done an outstanding job of retaining and, in some cases, growing our core deposit base and we thank them very much. Our bankers rarely take a day off from their focus on core deposit gathering and it’s evidenced by our healthy noninterest-bearing component of core deposits even when our growth was so strong in 2022.
So in conclusion, we had a very strong year, and we’re pleased to provide exceptional returns to our shareholders. We’re blessed to have such great team members at Bank7, and we benefit from being located in a dynamic part of the country. And therefore, in-spite of the current macroeconomic headwinds, we remain cautiously optimistic for the near future.
And so with that, we’ll stand by for any questions you might have. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Nathan Race with Piper Sandler. Please go ahead.
Nathan Race
Hi guys, Good morning and congratulations, Jason, on the promotion to President.
Jason Estes
Thank you.
Nathan Race
First question, just maybe, kind of thinking about, kind of the loan growth and overall kind of balance sheet trajectory from here. Obviously, you guys had nice core deposit growth in the quarter on loan deposit ratio is still south of 90%. So, just curious, how you guys are seeing the pipeline [indiscernible] today entering 2023 and just kind of overall expectations for both loan and core deposits in 2023?
Jason Estes
Yes, Nate, thank you for the question. And I would just say that we wouldn’t expect the growth to be exactly what we did last year. That was an exceptional year. There are some known payoffs coming in the loan portfolio that we think will be able to overcome and show growth for the full-year.
It wouldn’t surprise me if we had a quarter or two that were flat or probably even down during this year, but overall, I think you should – I think most years, we’re saying low double-digit growth on the loan book. This year, I’d probably couch it as a high-single-digit that maybe even a mid-single-digit growth, but we do expect to grow throughout the year.
And on the deposit side, we have several initiatives that we’re continuing to focus on to continue to generate enough deposit growth to keep up with the loan side. So, hopefully, we could do, as well as we do on the loan side with the deposits this year. The banking team is very, very focused on both. And they’ve been very successful over the last few years at grabbing both new loans and new deposits from existing and new relationships.
So, optimistic we’ll be able to grow this year, but won’t be as much as last year. I wouldn’t expect it to be as much as last year.
Tom Travis
And I would say, Nate, this is Tom, that Jason is spot on. And I would say that we’ve remarked over the last four to five weeks on this is probably the most difficult budget environment that we have been faced with. And so, we have budgeted for more muted growth based on those economic headwinds and just the uncertainty around the Fed and what they’re going to do. So, even with that, we’re still budgeting a nice increase as we always do, but I do echo Jason’s comments regarding the budget matching up to slightly lower expectations given all those factors.
Nathan Race
Got it. That’s great color. And one theme, I think a lot of investors are thinking about these days on banks is just, kind of the timing of kind of peak margin and peak NII? And assuming the Fed raises by another 50 basis points between now and the next couple of months, how are you guys, kind of thinking about just the trajectory for NII and margin over the next couple of quarters? And if the Fed, kind of pauses in the middle of this year, give or take, how do you guys think the, kind of margin trajectory plays out thereafter?
Tom Travis
What margin are you talking about?
Jason Estes
Net gross margin. NIM.
Tom Travis
Oh NIM. Do you want to take that, Kelly?
Kelly Harris
Yes. So, we ended the year fourth quarter at 4.87% core NIM, and we’re projecting, obviously, we’re already seeing that the cost of funds is increasing at a faster clip than the loan side. And so, we are seeing some NIM compression, you know where that ends in Q1, that’s to be determined based on what the Fed does, but I would say, we reached peak NIM in Q4 unless something else changes.
Tom Travis
Yes. And I would add to that the challenge that we’ve had relates to really quality and long-time loan customers that across the industry push back and say enough is enough. And so, it’s not just a matter of loan and deposit beta, it’s a matter of strategically and tactically negotiating with customers to keep those customers. And so, when we did our budget, we actually budgeted a certain percentage of the loan portfolio, even though the loans would not mature this year, we actually budgeted for a certain percentage of those loans to be priced downward a bit for retention of customers.
And so, that factor is in addition to the factors that Kelly uses when calculating loan and deposit beta, and it, kind of goes back to Jason’s comments regarding the tougher year and the slower growth, and that’s why we’re hedging instead of the usual low-double-digit, we’re back into the high-single-digits, just in case. But it’s very comforting to us because I guess another side of the coin would be a group telling you we’re not sure we can match earnings from last year because of these factors, and we’re absolutely not saying that.
Nathan Race
Okay. Understood. And then just maybe thinking about a potential more [dovish Fed] [ph] later this year into 2024, are you guys, kind of having success, maybe getting loan floors on new originations or are you guys maybe exploring any hedging or derivatives that may, kind of lessen the impact in terms of loans repricing lower if the Fed were to cut later this year or into 2024?
Tom Travis
We’ve looked at some of those programs. And there’s still, as you know, Nate, and your firm does a great job of presenting us with material. As you know, there’s still a bit of speculation involved in that. And so yes, some of it is “hedging and buying insurance,” but it could also be money that you don’t need to spend.
And so for us, because we are so asset-sensitive and we’re starting with a high book of loan floaters and a really nice healthy margin that’s higher than where we would normally be. We don’t feel like we need to aggressively pursue some of those instruments take on that cost for that what-if.
Now, we say that with the expectation. We actually budgeted more of a 75 basis point increase versus the 50. I think the 50 didn’t really emerge until the last two weeks. And so, if we get into the March and April time frame and it looks like those instruments could really help the bank based on the current landscape, and clearly, we reevaluate, but for right now, it’s not something that we need to worry about because we have some built-in defenses.
Jason Estes
I think it’s worth mentioning as well that the concept of loan floors, that’s not new, our portfolio because it’s so heavy on variable interest rates, the floors have been long established. And some of those, as you get into a higher rate environment, well, yes, the floors, they get lifted. And as we’ve seen in the past, you may have to renegotiate some of those on the way down if we end up back in the same, kind of rate environment we’ve operated in the last few years, but for now, the floors are moving up with rates.
Nathan Race
Okay. Great. That’s helpful. And if I could just ask one more, just in terms of, kind of the reserve outlook from here. You guys are adopting [fees] [ph], I believe, in the first quarter, which kind of complicates I think the reserving methodology to some degree, charge-offs were zero last year. You guys still adjusted the reserve at a pretty healthy clip to support loan growth. So, I guess I’m just curious if you guys are seeing anything on the foreseeable horizon that would cause a meaningful increase in charge-offs and just, kind of how you’re thinking about the reserve trajectory on either an absolute dollar basis or just relative to loans within that, kind of high single-digit loan growth outlook that was described earlier?
Tom Travis
Let me start with the macro and then Jason can get into specifics. Listen, we’d be foolish not to understand the headwinds that are out there. And so, yes, it’s a loan growth story, which made us motivated as to make sure that we increased our reserve, and we’re really in that low 1.2 to 1.25 area, which we’re comfortable operating in. And so, I think from a macro perspective, we’re going to keep our eye on the ball relative to those overall conditions, and of course, CECL. And then I think Jason may have some color on a few credits on what we might see.
Jason Estes
Yes. I think the important thing, you know if you go back and you look over the last five seven years, we’ve really had the one credit that stung us twice and that deal is looking better. There’s a new team in there. They’ve got some green shoots. And for the last two quarters, it’s been positive results and encouraging results, but we’re still not 100% sure that that is totally behind us. Anything that would be left has been well reserved for.
We don’t have a specific reserve on the remaining loan balance, but that’s the one that’s out there that would cause me some level of concern in the future. For the rest of the portfolio, as I stated earlier in my comments, the portfolio is performing very, very well. And we continue to see a healthy deal pipeline, and we just – we feel really good about the book, overall.
Tom Travis
And I would just follow up on that [loan credit] [ph]. It’s really that further out tail risk in-spite of the green shoot. So, we feel they’re greener and longer than they were two quarters ago. So, we’re encouraged, but we’re still keeping one on nonaccrual, and we’re doing that as a matter of prudence relative to that unknown tail risk, which we’ve always said for the COVID cycle-in to cycle-out, it was at close to 1%, and we haven’t hit that 1%, but if that tail-end risk didn’t materialize and things went the other way on that credit, it’s a small number, but that’s really it.
Nathan Race
Understood. And if I could just ask one last one on that specific credit that we were just discussing. Can you remind us kind of what the specific reserves that exist on that credit today relative to [Multiple Speakers]?
Jason Estes
There is no specific reserve on that credit today.
Nathan Race
Got you. But I believe you charged-off already a good chunk of it?
Jason Estes
Yes.
Nathan Race
Can you remind us what that amount is relative to [no-value] [ph] originally?
Jason Estes
It’s approximately $7 million in total that has been charged-off related to that credit.
Nathan Race
And that credit was how large, Jason?
Jason Estes
[$14.5 million, $15 million] [ph].
Operator
Our next question comes from Thomas Wendler with Stephens Inc. Please go ahead.
Thomas Wendler
Hey, good morning everyone.
Jason Estes
Good morning.
Thomas Wendler
Most of my questions have already been asked, but one final one for me is, we saw a pretty large step-up in salary expense last quarter, can you give us some commentary there? And then maybe how you’re thinking about expense growth for 2023?
Tom Travis
We did a – we’ll call it a one-off. When you look at our year, at the end of the year, we were very close to a 30% increase in net income, and we evaluated that relative to, I think, our best estimate was the industry was going somewhere around 5% to 6%. When I say industry or competitive set, and we were so pleased with the banking team and the employee base. And as we said, it was a function of organic loan and deposit growth and everyone hitting on all cylinders. And so, we made a decision towards the end of the year to expense money and pay people for sharing the fruit of that labor. And so, we would expect to – we’re already reverting, – I don’t know what our number is, but we really don’t have disjointed increases or decreases in our salary expenses. We’ve managed the company. This was purely a payout based on that phenomenon.
Thomas Wendler
Alright. I appreciate the color. That was my only question. Thanks guys.
Operator
[Operator Instructions] Our next question comes from Woody Lee with KBW. Please go ahead.
Woody Lee
Hey good morning guys.
Jason Estes
Good morning.
Woody Lee
Was just hoping if that you could give some color on just, sort of the deposit pricing competition in your local markets. I mean is it – are you competing more with other institutions? Is it more the treasury market, just any dynamics there?
Tom Travis
It’s really all over the board. You have to segment it when you think about it. You’ve got your older more retiree-based that are more in that CD space. The CDs are a real small portion of our funding, I think only 100 million or 110 million or 120 million – it’s a 175 [indiscernible] smaller portion.
So then when you really roll into and you think about the bank and our profile, and we’re a commercial bank. And so, we have a lot of high-net-worth individuals and entrepreneurs, and they tend to be in money market accounts. And so, when you segment the liability section of the balance sheet, there’s just different factors. And so, it’s really hard to nail down one competitor or not.
I mean, look, like I’ll tell you, Raymond James, they constantly run newspaper ads in the small towns and so they’re paying high rates and so the retirees look at that and they come into the bank lobbies. Fortunately, for us, the data shows that our ability to maintain our cost of funds and do a good job with deposit betas is centered around the fact that a great percentage of our deposits are based on credit. And so, when we have customers that we’re very responsive to on the credit side, they don’t push us as hard on the deposit side, but it’s something that we fight every day on a relationship by relationship basis and it’s just across the board.
Woody Lee
Yes. That’s great color. And then switching to the [Technical Difficulty] loan growth outlook, it makes sense that the growth would be coming down a little bit. Are there any segments you’re seeing a pullback in growth? And are there any concentrations you expect to, sort of drive to growth in 2023?
Jason Estes
I would say that you can see a clear pullback in our construction activity. Part of that’s driven by cost, part of it is driven by the home buying market. So, you can see that pretty clearly in the change for this last quarter, you’re starting to see those numbers show that change. Our energy concentration is one that I mentioned that we watch very, very closely. There’s a little bit of growth room left there, but we’re still sticking to.
We don’t want to get too far into the energy markets. And so, we’re doing that on a very selective basis with rapid amortization. And so, I would say those are two areas you’re seeing a pretty good shift. And our hospitality activity, if you go and you look at the last three years, that’s been a pretty high growth. That balance has changed significantly. And so, it’ll move more in-line with the whole portfolio at this point and kind of for – with our – we’re intending to keep that in that kind of range that it’s at as far as a percentage of the overall portfolio mix. And so, those are the few areas I would highlight.
Tom Travis
That’s one of the delightful parts of the story on the loan growth, and we have that slide in the deck, and it’s got the broad and deep loan growth as the header. And as Jason said, that we’re very disciplined on our concentration. And when you get to where you’re almost at your max and in your few categories, you’re always concerned about how can I grow the portfolio or how can we grow the portfolio. And when you look at that slide, you can go back to 2018, and you can see that in 2018 energy was 18% of the book.
And as of year-end, it was 14% of the book and then you look at hospitality and it stayed exactly where it was. And so, it’s very comforting to know that the bank has the ability and as we’ve grown to broaden that, we have that ability to continue to grow in those other segments. And I think it’s a testament to the team to stay disciplined and stay focused because if we didn’t have a discipline, and we didn’t have that focus, Jason, I would argue that it would have been really easy for us to run our energy book to 20% or 22% in hospitality to 25% and we’re just not going to do it.
Jason Estes
Sure. Very easy.
Woody Lee
Alright. That’s very helpful. That’s all from me. Thanks guys.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Tom Travis for any closing remarks.
Tom Travis
Thank you again. We’re really pleased. We’re excited about the year. In-spite of the headwinds, we’re really blessed to be in this part of the country. We’re excited about the year. We’re continuing to look at opportunities on the acquisition space. They’re more limited due to the mark-to-market issues in the securities portfolio, but we’re truly excited and we’ve reverted back to our good-old-fashioned NIM numbers and our efficiency ratio, even with the increase that one-off in the salary, we’re still below 40% on the efficiency ratio.
So, delighted, I think with these new records they’re comforting, and our team is committed to, I would say, more of the same, and we’re excited about it. So, we thank you.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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