Bridgewater Bancshares, Inc. (BWB) Q1 2024 Earnings Report, Transcript and Summary

Good morning, and welcome to the Bridgewater Bancshares 2024 First Quarter Earnings Call. My name is Andrea, and I will be your conference operator today. [Operator Instructions] Please note that today's call is being recorded. At this time, I would like to introduce Justin Horstman, Vice President of Investor Relations, to begin the conference call. Please go ahead.

Thank you, Andrea, and good morning, everyone. Joining me on today's call are Jerry Baack, Chairman President and Chief Executive Officer; Joe Chybowski, Chief Financial Officer; Jeff Shellberg, Chief Credit Officer; and Nick Place, Chief Lending Officer. In just a few moments, we will provide an overview of our 2024 first quarter financial results. We will be referencing a slide presentation that is available on the Investor Relations section of Bridgewater's website, investors.bridgewaterbankmn.com. Following our opening remarks, we will open the call for questions. During today's presentation, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We caution that such statements are predictions and that actual results may differ materially. Please see the forward-looking statement disclosure in the slide presentation and our 2024 first quarter earnings release for more information about risks and uncertainties, which may affect us. The information we will provide today is as of and for the quarter ended March 31, 2024, and we undertake no duty to update the information. We may also disclose non-GAAP financial measures during this call. We believe certain non-GAAP financial measures, in addition to the related GAAP measures provide meaningful information to investors to help them understand the company's operating performance and trends and to facilitate comparisons with the performance of our peers. We caution that these disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP. Please see the slide presentation and 2024 first quarter earnings release for reconciliations of non-GAAP disclosures to the comparable GAAP measures. I would now like to turn the call over to Bridgewater's Chairman, President and CEO, Jerry Baack.

Thank you, Justin, and thank you, everyone, for joining us today. During the first quarter, we were pleased to see the continuation of many of the same trends we saw over the back half of 2023 as we continue to navigate the current economic environment. Most notably, business activity continued to pick up in the Twin Cities. As we mentioned last quarter, our loan pipeline increased due to rising loan demand. This translated into stronger-than-expected loan growth in the first quarter with balances up 6.5% annualized. Even more encouraging was the deposit growth outpaced loan growth once again, including annualized core deposit growth of 14.3%. As a result, our loan-to-deposit ratio dropped below 100% for the first time since the first quarter of 2022. We have several initiatives in place to help drive continued core deposit growth over time. This include investments in our treasury management team through the hiring of a new sales lead as well as the creation of a new deposit coordinator position that will be focusing on proactive outreach. We are also continuing to see traction in our business development initiatives, including implementers of the entrepreneurial operating system and the network of women business leaders and entrepreneurs we've mentioned in the past. While market demand and business activity remain encouraging, the interest rate environment remained challenging in the first quarter as we wait for more progress on inflation and ultimately, a more normalized yield curve, a scenario that would be favorable for Bridgewater. With interest rates remaining elevated, we continue to see slight net interest margin compression as expanding loan yields were offset by a slower pace of rising funding costs. Joe will provide more details in a few minutes. Expense control was another highlight of the first quarter as noninterest expense declined 3.5% from the fourth quarter. Identifying new operational efficiencies remains a bank-wide effort across the organization in 2024. These could be initiatives that help us reduce costs, get things done quicker or eliminate tasks that no longer add value. Bridgewater has always operated very efficiently, but we continue to look for ways to take this to the next level. On the other hand, we are continuing to make investments in the business through people and technology. For example, we have selected a new online banking platform that will provide an enhanced experience for our retail and small business clients. We are also on track for implementation of a new CRM platform later this year that will allow us to provide more customized support across our client base. Asset quality was a superb once again with no net charge-offs, very low levels of nonperforming assets and increased provision due to stronger loan growth. While our loan portfolio continues to perform well, we also recognize the broader industry concerns around office and multifamily over the past several months. Jeff will share some thoughts on what we are seeing in the Twin Cities in just a few minutes. But overall, we have been pleased with the performance of these portfolios given the experience and expertise of our teams and remain bullish over the long term. We also continue to see steady, tangible book value per share growth, up another 11.8% in the first quarter. This marks the 29th consecutive quarter of tangible value per share growth at Bridgewater. Turning to Slide 4. You can see our tangible book value is up over 190% during these 29 quarters compared to a median of just 60% with banks between $3 billion and $10 billion in assets. We continue to feel that this is a true differentiator for Bridgewater and in the way we can provide shareholder value going forward. I would also mention that we continued repurchasing shares during the first quarter, we bought back nearly 194,000 shares or $2.3 million. With that, I will turn it over to Joe.

Thank you, Jerry. Turning to Slide 5. The pace of net interest margin compression slowed again in the first quarter, down just 3 basis points compared to a 5 basis point decline in the fourth quarter. While earning asset yields continue to reprice higher, deposit pricing pressures also persisted, albeit at a slower pace given market competition and mix shifts within the deposit portfolio. Loan fees have also continued to decline in the current rate environment. With the outlook for potential rate cuts less favorable than it was a few months ago, we expect similar trends in the near term, which could result in continued modest margin pressure. However, our focus remains more on the revenue side in the absolute dollars. Even with modest margin pressure, we believe we are reaching an inflection point on net interest income, supported by stronger balance sheet growth. I would also remind you that our balance sheet remains well positioned for potential future interest rate cuts and a more normalized yield curve. We have over $1 billion of adjustable funding tied to short-term rates and a loan portfolio that is positioned to continue repricing higher even in a rates-down environment. Turning to Slide 6. You can see the portfolio loan yield steadily moving higher. While the more moderated pace of loan originations over the past year has slowed the repricing of the portfolio, we did see an uptick in loan growth in the first quarter, which could provide some additional support as new money loan yields come on in the mid- to high 7s. In addition, the impact of loan fees on the portfolio loan yield was down to just 7 basis points in the fourth quarter compared to a 30 basis point impact in mid-2022 as payoffs have declined in the current environment. Our securities portfolio continues to support our overall earning asset yields as securities yields increased another 17 basis points to 4.8%. We have continued to grow our AFS portfolio as loan growth moderated. However, given the loan pipeline build, we do expect the pace of securities portfolio growth to moderate. While funding costs continue to increase, the pace has slowed. Deposit costs increased 13 basis points in the first quarter, while overall funding costs were up 11 basis points, both lower than last quarter. With the increased uncertainty around the timing of potential interest rate cuts, we would expect these trends to continue in the near term. Slide 7 shows the pre-provision net revenue stabilization we have seen in recent quarters as the pace of margin compression has slowed and loan growth resumes. Turning to Slide 7. Expense control was another highlight of the quarter as noninterest expense declined 3.5% from the fourth quarter of 2023. The decrease was primarily driven by lower salary and benefits, FDIC insurance and other expenses. You may recall that we saw a similar decline in noninterest expense in the first quarter of 2023, with expenses building throughout the rest of the year. We would expect a similar expense trajectory throughout 2024 with full year expenses again tracking in line with full year asset growth. We also saw a decline in our efficiency ratio in the first quarter for the first time since the third quarter of 2022, keeping in mind that our efficiency ratio remains well below the industry median. Overall, we feel good about our ability to control expenses, while still making key investments in the business, technology and our people. With that, I'll turn it over to Nick.

Thanks, Joe. Turning to Slide 9. We generated strong deposit growth in the first quarter with total balances up 10.5% annualized. This included core deposit balances, which increased $90 million or 14.3% annualized. We have continued to see good core deposit momentum since last March as balances were up 6.8% year-over-year. I would remind you that given the nature of our client base, core deposit growth isn't always linear, and may have some ups and downs from quarter to quarter. The second quarter, for instance, tends to be a seasonally low quarter for deposits due to tax season and industry cyclicality. We also continue to see various deposit mix changes during the quarter, including some noninterest-bearing deposits moving into interest-bearing accounts. This was not surprising as our noninterest-bearing deposit balances had actually been quite resilient during much of 2023, increasing each of the past 3 quarters. On the other hand, for the first time since the third quarter of 2022, we saw a nice decline in brokered deposits with balances down $32 million during the quarter. We will continue to leverage brokered deposits as a way to supplement core deposit growth over time as needed. These overall deposit mix changes have contributed to funding costs continuing to slowly move higher. However, from a broader funding perspective, we have ample repricing opportunities if rates move lower. As Jerry mentioned, we are executing on several initiatives to support our focus on core deposit growth and have been pleased with the progress so far. Turning to Slide 10. Loan balances grew 6.5% annualized in the first quarter as a result of the increased demand and growing loan pipelines we started seeing in late 2023. We were pleased to see this activity translate into such strong loan growth so early in the year. The level of loan demand in the Twin Cities continues to be higher than last year, which we think will create additional opportunities for growth throughout the year. However, we continue to be disciplined in our lending approach, prioritizing core client relationships. As we look ahead to the rest of 2024, we would expect to see loan growth continue in the low to mid-single-digit range. There are several factors that will impact this, including ongoing loan demand, the interest rate environment, pace of payoffs and our core deposit growth. Even with the strong loan growth, we were able to lower our loan-to-deposit ratio below 100% due to our continued momentum on the deposit front. Slide 11 shows the increase we have seen in new loan originations over the past few quarters. In fact, new loan originations exceeded loan advances in the first quarter for the first time since the fourth quarter of 2022. On the other hand, loan payoffs and paydowns remain at relatively low levels given the higher interest rate environment. On Slide 12, you can see the loan growth during the quarter was spread across our various portfolios, led by nonowner-occupied CRE and C&I. Construction and development balances continue to decline as deals completed their construction phase. I'll now turn it over to Jeff.

Thanks, Nick. Slide 13 provides some additional information on our multifamily and office portfolios, asset classes that have been in the headlines recently. Over 90% of our multifamily loans are in the Twin Cities, a market in which we have a tremendous amount of multifamily experience and expertise. This is a big reason why we have only experienced $62,000 in net charge-offs in the portfolio since we started the bank in 2005. The Twin Cities multifamily market has historically been a stable market, with less volatility than some of the coastal and high-growth markets. Key attributes of the market include relative affordability, low unemployment, strong wages and a shortage of single-family housing. That said, this market is not immune to normal real estate cycles that can impact any asset class. For example, we have seen an uptick in multifamily vacancies due to the amount of new multifamily construction and deliveries in the past few years. Looking forward, market vacancies are expected to peak later this year and then decline as absorptions now exceed deliveries and new construction has slowed due to the current interest rate environment. We continue to monitor the portfolio closely but have been pleased with this performance to date and remain bullish on multifamily in the Twin Cities over the long term. Looking at our nonowner-occupied CRE office portfolio, our exposure remains quite limited, making up just 5% of total loans. This includes only 4 loans located in the central business districts totaling $35 million. During the first quarter, we moved one of these loans, a Central Business District property in St. Paul to the watch list due to potential lease rollover risk. Similar to multifamily, we continue to monitor this portfolio closely, especially the few Central Business District loans that we have. Looking at the office portfolio as a whole, we continue to feel good about the outlook given the lower average loan amount, diversified client base and primarily Midwestern suburban office exposure. Turning to Slide 14. We continue to see strong performance across the entire portfolio as we had no net charge-offs in the first quarter, and nonperforming assets declined to $269,000 or 0.01% of total assets. This is a result of our measured risk selection, consistent underwriting standards, active credit oversight and experienced lending and credit teams. We remain well reserved at 1.36% of gross loans. This included $850,000 of provision during the quarter, primarily due to stronger loan growth. Overall, we continue to feel good about our loan portfolio. That said, as this higher interest rate environment continues to put pressure on businesses, we do expect to see some credit normalization over time. On Slide 15, you can see that our Watch and Substandard both declined modestly during the quarter. As I mentioned, we moved one Central Business District office loan to watch, while a couple of other relationships migrated out. We feel good about the risk profile of the portfolio and believe it is well positioned moving forward. I'll now turn it back over to Joe.

Thanks, Jeff. Slide 16 highlights our strong capital ratios, including CET1, which increased from 9.16% to 9.21%. In addition, we were able to repurchase additional shares during the first quarter as we bought back nearly 194,000 shares at a weighted average price of $11.75 per share for a total of $2.3 million. We still have $18.2 million remaining under our current authorization. We'll continue to evaluate future repurchases based on a variety of factors, including capital levels, growth opportunities and market conditions. Share repurchases are just one of our capital priorities. Our primary capital priority remains organic growth. Beyond that, we continue to review and monitor potential M&A opportunities. Turning to Slide 17. I'll recap our expectations over the next couple of quarters. We expect loan growth in the low to mid-single-digit range over the next few quarters as we continue to see increased levels of loan demand. Our pace of growth will ultimately be impacted by ongoing loan demand, market conditions, the pace of payoffs and core deposit growth. With uncertainty around the interest rate outlook, we expect to continue seeing modest net interest margin pressure in the near term. However, even with additional margin pressure, we believe we are reaching an inflection point on net interest income, supported by stronger balance sheet growth. Our margin is also well positioned to benefit if we start seeing rate cuts and an upward sloping yield curve. On the expense side, we expect full year noninterest expense in 2024 to track relatively in line with asset growth, similar to prior years. However, we would expect to see a similar trajectory throughout the year as we saw in 2023, with expenses starting out low in the first quarter and building in subsequent quarters. The provision expense will likely be tied to our pace of loan growth and the overall asset quality of the portfolio. Finally, we believe we can continue to maintain strong capital ratios through earnings retention and disciplined growth. I'll now turn it back over to Jerry.

Thanks, Joe. Finishing on Slide 18, I'll provide a quick update on our 2024 strategic priorities. First, as we look to optimize our balance sheet for longer-term growth, we made strong progress on core deposits with annualized growth of 14.3% during the first quarter. Second, we continue to focus on expanding our client base through additional, affordable housing efforts as well as hosting successful networking events at our corporate office for local women business leaders and entrepreneurs. In addition, with cannabis becoming legal in Minnesota last year, we are even doing our due diligence on this space to prepare to respond to inquiries from entrepreneurial clients. Third, departments across the bank have been identifying ways they can incrementally improve operational efficiencies within their groups. In addition, we lowered our efficiency ratio in the first quarter for the first time since 2022. Finally, we remain proactive in monitoring our portfolios to get ahead of any potential concerns. As a result, our overall asset quality has remained superb. Overall, we were pleased with the strong balance sheet growth we saw in the first quarter, including both loan activity and core deposits as well as our ability to consistently grow our tangible book value per share through various economic environments. With that, we will open it up for questions.

[Operator Instructions] And our first question comes from Brendan Nosal of Hovde Group.

Maybe start off here on kind of thoughts around the margin. Do you guys think that there's a path for NIM inflection without help from the Fed? And then kind of along those lines, if we don't get any cuts from the Fed, until like late in the fourth quarter, higher for longer, where do you see the margins settling as we get to the end of the year?

Yes, Brendan, this is Joe. So yes, to reiterate, I think we've said, and we've obviously seen it, we've messaged to it that we've seen a slowing pace of margin compression certainly over the last couple of quarters and have been pleased with that slowing compression. I just think just given the Fed more of a policy pivot here and the prospect for higher rates for longer is really where we see potential near-term margin pressure. And I think it's really 2 things, and we've talked about it in the prepared remarks, it's the mix shift from noninterest-bearing to interest-bearing. So again, we've been pleased with how resilient the noninterest-bearing book has been. But the longer we sit here, you certainly see clients more actively managing their money. And so we have seen some migration, which certainly puts some pressure on the margin itself. And the other piece is just client acquisition. I mean, the market continues to be very competitive, and we're really pleased with the core deposit growth we had in the quarter, but it's competitive from a cost standpoint. So I think you put those 2 together and that's where we see that you could see some near-term pressure just the longer that we sit here in this higher-for-longer environment. I think the other thing that I'll say, though, is we're more focused and less fixated on the NIM itself and more just on incrementally building NII. And I think as we've talked about, we see inflection to that just given the pickup in loan growth, especially in the back half of the first quarter. So that remains our focus on really growing the net interest income contribution rather than the margin as an output.

Yes. That's totally fair. Maybe one more for me. Longer term, is there like a desire or even ability to alter the bank's rate risk positioning to bring the balance sheet closer to neutral should we find ourselves in a similar environment at some point in the future? Just wondering the thought process there given how spread dependent the revenue base is?

Yes, I can talk -- I mean, probably 2 sides to that, one on the net interest income perspective and then more from a noninterest income perspective. But yes. I mean the balance sheet and the positioning of that, I think, certainly, just given kind of the rate outlook over the last couple of quarters, I think we've really tried to balance out and neutralize but also not dramatically change the liability sensitivity profile potentially in the face of Fed cuts. So I think we're really cognizant of where the exposure is across the balance sheet. And I think we remain focused on maintaining options on both sides of the balance sheet. Composition is a key piece to the loan portfolio. So I think we've been really focused on the fixed rate composition. And to the extent we can broaden that by more variable rate funding, or variable rate lending, I should say, as well as can you get more creative from a swap standpoint, and just being really cognizant of the sensitivity on the asset side and then obviously maintaining optionality on the deposit side. So I think we consider across the balance sheet, various instruments. And I think the other piece to that, just you mentioned on the revenue side is, we continue to look at opportunities to incrementally increase noninterest income. And I think for us to really move the needle, as we've always said, that likely comes through M&A, I think we certainly don't want to build a mortgage company brick by brick. But to the extent that resides in an M&A transaction, that's certainly something that we would strongly consider.

The next question comes from Nathan Race of Piper Sandler.

Just going back to the last line of question around the margin outlook. Just digging deeper into that, curious maybe, Joe, if you can provide us with the amount of loans that you have kind of maturing or repricing higher over the next year. And obviously, you guys had nice growth in the quarter, and I imagine new coupons are relatively above the portfolio yield. So just trying to kind of think about some of the additional earning asset tailwinds that you could have this year?

Yes. So on the loan side, we've got a slide in the appendix that talks about just the fixed rate portfolio and the adjustable rate portfolio. So just north of $500 million rolling off kind of in a blended 5%. So I think when we think about new money yields, like I said, I mean, it's coming on in the mid- to high 7s. So definitely, meaningful repricing opportunities there. That's just considering the roll-off and then obviously, any sort of net new growth. Does that answer your question, Nate?

Yes. That's helpful for sure. And just as you guys kind of look about the composition of the pipeline, which it sounds like it's fairly healthy thus far in the second quarter. Is it more C&I weighted? Obviously, you had a nice C&I growth in the quarter, but just trying to get a better sense in terms of the drivers, low to mid-single-digit growth outlook.

Nate, this is Nick. I mean our pipeline is pretty consistently spread across what our portfolio looks like. I think we have been pleased to see some growth within our C&I portfolio. I think some of that in Q1 was some line utilization, which we expect to sort of bounce around through the year. But across the pipeline, I think it's pretty consistent with our overall portfolio mix. We continue to see good opportunities in both multifamily and non-owner occupied CREs, we did have a pullback in rates sort of at the end of last year and throughout first quarter that did start driving some transactions to pencil. So we're pleased to see where the pipeline has been built to and how it's sort of maintained here through Q1.

Yes. And I understand it's fairly difficult to kind of gauge the deposit gathering pipeline, but obviously, you had nice core deposit growth in the quarter. Curious in terms of to what extent maybe some of the hires that Jerry alluded to earlier, can perhaps kind of accelerate some of the core deposit gathering efforts going forward?

Yes. On the deposit front, I mean, the hires that we brought on board were super happy with and those are all things we expect to pay off really in the long term. I think it really adds a depth of talent and capacity to our team that allows us to serve our clients better on the whole. I think on the deposits overall, we are really pleased with how Q1 came together. I think a lot of that was good core deposit wins with some new client relationships and deepening and expanding some existing client relationships. There was some sort of excess liquidity build through a couple of clients in the first quarter. And Q2 does tend to be a seasonally low quarter for us. So with tax time and property tax time, and the sort of nature of our client base, we do tend to see Q2 be a little slower from a deposit perspective. So we're anticipating that a bit. But on the whole, the initiatives we put in place, the hires that we have, the brand that we have in the market, we really feel like that's a good competitive advantage for us that will continue to pay dividends long term.

Okay. Great. And then just one last one. Obviously, we're seeing a nice slowing upward trajectory in terms of deposit costs here in the first quarter. Just curious if you had a spot rate on deposit costs coming out of March.

Yes, it was [ 337 ].

Okay. But it sounds like, Joe, that pace of deposit cost increases is steadily slowing over the course of the last several months still?

Yes, definitely. It is slowing. I think like I mentioned, the mixing piece is harder to anticipate, but I do think that impact of from NIB to interest-bearing is there. But yes, we are seeing the absolute level moderate for sure.

The next question comes from Jeff Rulis of D.A. Davidson.

Just a question on maybe if we could, Jeff, on the multifamily book. Could you give us a sense for the percent of those that book that matures in '25 and beyond?

Yes, we'll have to get that for you after the call. I don't have it exactly off hand. I just think if you look at the fixed rate the [ 500 ] we show, obviously, multi-families within that.

Yes, it's Jeff, what I would say is similar to 2023, we were getting front of our relationships regarding pricing standpoint. So we've identified everything that's maturing in 2024, even maturing or repricing in 2024, we've reached out with those customers, and we're developing plans in terms of what they're planning on doing with the property whether the property, the loan needs to be rightsized based on performance, if they're going to refinance with agency or potentially sell the property. So I think that we seem to be on top of it, we haven't seen anything that really causes us a lot of concern, and we'll just continue to move forward with those sponsors.

Okay. And Jeff, I think you mentioned, certainly, the dynamics of the Twin Cities market with supply and inventory pretty light and not a lot of new construction coming on. Anything else to kind of pitch in on the Twin City market relative to other kind of headline risk. What amount of kind of rent control or regulation, do you see just any other separating kind of characteristics of your market?

Yes. I think that we do feel good about the overall market, I had seen in an article recently that it ranks in the top 2 or 3 in the country just in terms of consistency of [ rent growth ] that may not be a high-growing market, but it's something that both from an absorption standpoint and from a rent growth standpoint, it's kind of a steady eddy. That being said, that you're always going to have some properties that exhibit some level of a stress due to potential vacancies in the pocket where the property is located at, could be expenses, could be interest rates. Fortunately, we know the market really good, we have really good sponsors, have always had a good strong client relationship and are able to work with them in terms of identifying solutions for those problems. The rent control that you mentioned the St. Paul rent control that was implemented, I think it was 2 years ago had been somewhat a nonevent. I think that it has, in part, reduced the amount of new development that's going on in St. Paul, which meant that it's been better for rent growth for the existing properties are there. And the jury is still out on the Minneapolis rent control. That was the city council for the voters have passed that a year ago, they still have a task force that they put together and they're trying to come up with what that would look like. I would say that the mayor has come out publicly and said that he is against any type of severe rent control, as he feels it would impact development in the city.

Given the low loss history in multifamily and CRE in general, at the bank, I'm interested in your view of the greater risk to the portfolio, either in CRE or even C&I. We're starting to see a lot more C&I one-offs perk up from other banks. Just curious as to what -- how would you peg the risk to C&I versus CRE?

I think our C&I is relatively limited. I don't see a lot of risk. We've always been more of a heavily CRE multifamily institutions. So if you look at pure dollars out the door, those would probably be the ones that are most exposed. As I said, we feel good about the portfolio at this point in time, but there's always going to be when you have a portfolio that's $3.7 billion, you're always going to have specific properties that may or having some type of an issue that needs to be dealt with. And our credit department is working really hard in order to identify properties that aren't meeting performance so that we can get in front of them and work with the client. We felt really good when we have identified properties that are underperforming that our clients are willing to step up and inject capital. And when they're willing to work with us and they can do that, we're usually able to find solutions. I think it all really starts with the sponsor, the client that we're working with. And I think we've had a really good history of picking the right players that are doing business in the Twin Cities. And I think that bodes well for us going forward.

Great. And one last one. Joe, do you have the March net interest margin. I think the December margin was maybe a bit of a head bake relative to the Q4 average, but just wanted to see what March margin was?

Yes, March was [ 223 ] [indiscernible] basis point lower than the quarter.

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

Thanks, everybody, for joining our call today. We continue to be encouraged by our loan deposit growth and our overall business model, continue to have a very strong brand and our team members have done a phenomenal job here. Today is Bring Your kid to Work Day. So it's odd when we're sitting here during the conference call, and there's little kid joining all over. So if anybody wants free babysitting, there's 60 to 70 kids here. Thanks, everybody. Bye.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.