Equity Bancshares, Inc. (EQBK) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the 2019 Q1 earnings conference call for Equity Bancshares, Inc. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call maybe recorded for replay purposes. It is now my pleasure to hand the conference over to Mr. Jacob Willis, Investors Relations. Sir, you may begin.

Good morning, and thank you for joining our Equity Bancshares presentation and conference call, which will include discussion and presentation of our first quarter 2019 results. Joining me today are Equity Bancshares' Chairman and CEO, Brad Elliott; and Equity Bancshares' Executive Vice President and Chief Financial Officer, Greg Kossover and Equity Banc Executive Vice President and Chief Credit Officer, Craig Mayo. Presentation slides to accompany our call are available for download at investor.equitybank.com. The presentation accompanies discussion of our first quarter results and is available by clicking the Presentation tab to download the PDF. You may also click the event icon for today's call posted at investor.equitybank.com. If you are viewing this call on our webcast player, please note that slides will not automatically advance. Please note slide two including important information regarding forward-looking statements. From time-to-time, we may make forward-looking statements within today's call and actual results may differ. 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 it over to Brad Elliott.

Good morning. Thank you for joining the Equity Bancshares' first quarter 2019 earnings call. Greg and I'll be discussing our first quarter 2019 results in a moment. Craig Mayo, our Chief Credit Officer is also joining us today. As noted in our 8-K earnings release, you know we will be discussing a credit relationship that we have taken a provision against as at March 31, 2019. Greg will walk through the impact of this credit on our financial performance as well as the operating performance of the company with and without this provision of credit loss. In 2011, we entered a relationship with a strong borrower, who is specialized in increasing revenues and profitability of underperforming companies. We had a significant banking relationship with this borrower for several years and they performed well and ultimately sold two of their portfolio companies for substantial profits. They bought a franchisor with approximately 80 operating licenses and grew it during the course of their ownership. We also financed the purchase of a second franchisor company that was underperforming but with good name recognition. We anticipated they could continue to manage as they had in the earlier concepts and turn them substantially profitable and generate terminal value. We were comfortable the new relationship remained adequately secured with personal guarantees cross collateralization with the profitable company and based on the extent of the pledged personal assets. Unfortunately, as they continued to borrow funds on personal assets from Equity and other financial institutions for capital injections, the ability to service debt on the overall structure begin to deteriorate. Craig, would you please take us through the recent events?

In the fourth quarter of 2018, these borrowers came to Equity and asked us to advance funds which we declined. Under the premise it was time for the companies to cash flow their obligations or to execute on the sale of the businesses which they had committed to complete in previous quarters. The approximate balance of the loans were $19.2 million for the larger company and $9 million for the smaller company. There were at least two letters of intent to purchase the larger company for amounts sufficient to pay off our credits on both companies. All the credits are cross collateralized and secured by personal guarantees from the borrowers. As of December 31, 2018 the loans were current. In January the borrowers filed for Chapter 11 Bankruptcy for both companies, one with a positive cash flow and one without a positive cash flow. We presumed this was not strictly because of Equity Banc's debt but also because of the obligations to other institutions. We prepared an impairment analysis in the first quarter for December 31, 2018 using the data points available at the time for the larger credit, including the most recent LOI from December 2018 and the early indications of a stocking horse bidder for the smaller company mentioned above. The calculation did not show an impairment and therefore no specific loan loss was provided on these credits, or warranted at that time. We did place the credits on non-accrual late in the first quarter. In late March the smaller company was auctioned in bankruptcy to a stocking horse bidder for an amount that was acceptable to us, and in the range of values we had used in determining that the overall valuation for the relationship was adequate. For various reasons the bidder did not close, and a second bidder was found in early April but for an amount substantially less than the first bidder. As of today, the second bidder has not closed but we believe it will complete the transaction in the next few weeks. In early April we received the most current trailing 13 periods of operating performance from the larger company. And our analysis shows that although profitable this company may not sell in the future at the level indicated in the previous valuations. This is due in part to a lower level of EBITDA than was performed and in part to our belief that the multiples of EBITDA used in the previous periods would be unlikely given our recent sales experience in bankruptcy. Greg?

Given the change in circumstances occurring in early April a new impairment analysis was performed utilizing the lower bid for the smaller company and applying the lower EBITDA number and lower estimated multiple on the larger company. This analysis determines the need for a $14.5 million total specific provision on these two credits and the other assets pledged by the borrowers. Brad?

As CEO of our company, I own this credit decisions. Our team extended credit to these borrowers based on a long history of success in their businesses, and with us as their bank. Unfortunately, circumstances changed and we did not discontinue advancing funds early enough. Fortunately this is an isolated credit of its type and is not related to any other industry or collateral type in our portfolio. Our net charge-offs for the first quarter were approximately $200,000 or less than 1 basis point without the interest charge of from this relationship. We will take questions on these credits and our overall portfolio at the end of our call. Greg will take us through the rest of the first quarter performance.

Thanks, Brad. We begin with our earnings performance and reconciliation of earnings per share back to core EPS. Stated diluted earnings per share is a loss of $0.26. Adding back merger expenses of $0.03 per share leaves a loss of $0.23 per share. Adding back the specific provision with associated interest write-off is approximately $0.73 per share and leaves core EPS of about $0.50 per share. We incurred approximately $0.03 per share in one-time platform expenses to convert to our new online digital banking to initiate a new debit and credit card platform and legal expense for the above mentioned credits. This takes EPS to approximately $0.53 per share. We also had accelerated bond premium amortization extending from the new accounting pronouncement of about $0.03 per share leaving EPS reconciled to $0.56 per share compared to street consensus of $0.65 per share. The miss to Street of $0.09 is further explained by misses in loan origination fees and interest on loans of about $0.04 per share from the slower origination quarter than expected, interest expense estimated at about $0.02 per share, about $0.01 per share in non-interest income from slower mortgage banking activities which we believe we will recover in the balance of 2019, based on our pipeline and about $0.02 per share in other non-interest expense, mostly attributable to miscellaneous overhead for the support of the new platforms and for the early on-boarding of the MidFirst locations. I'd also like to recap our net interest margin for the quarter. Our stated margin was 3.49% adding back lighter origination fees of about $500,000 plus about $500,000 of hurt [ph] from our identified problem credit relationship would leave a margin of 3.60%. Finally historical normalized bond premium amortization would have left us at 3.66%, exactly in line with Street expectations. As we have stated before, some quarters are slower than others for loan originations. Our first quarter was slower than expected but our pipeline remains strong. We are not relaxing our underwriting standards or reducing the expectations of our teams. We expect solid growth in the next few quarters to get back on plan for our loan growth. Our loan coupons continue to be strong, improving another 5 basis points from the 12/31 quarter. We continue to grow core deposits at an annualized rate of about 5% in Q1, not including the nearly $100 million in growth from our MidFirst three location merger in February. The deposit rate environment remains competitive especially in the area of public funds. We continue to work hard at managing the balance of cost of funds with our desire to grow core deposits and reduce our other borrowed money. The average balance of our Federal home loan bank advances reduced by over $200 million quarter-over-quarter. This not only gives us more control over our cost of funds but also converts borrowings into bank customers. Overall net interest earnings were $30.6 million, up from $27.8 million a year ago. The $30.6 million is against consensus of $32.7 million, the difference being accounted for primarily in the items previously discussed approximately $500,000 in lost interest on the bank credit, $700,000 in loan origination fees and over $550,000 in bond premium amortization. Moving on, non-interest income was $5.3 million for the quarter below consensus by about $300,000 accounted for in lower mortgage banking fees which we believe we will recover in the last three quarters of 2019. Indications are this slow quarter was primarily weather related. Non-interest expense was $24.9 million without merger expense and $1.1 million above consensus principally attributed to the expenses noted previously on the call, platform expenses of over $600,000 legal fees of about $125,000 and the cost of bringing the MidFirst locations on earlier than anticipated. Income taxes were modestly lower in the first quarter at about 22% and generally in line with expectations. Our overall balance sheet remains healthy and our teams continue to press on to achieve our goals for 2019. As we said earlier with the exception of this single credit relationship our credit quality is improving and funding continues to shift to core deposits away from other borrowed money. Our capital remains healthy and as you may have read we have announced a buyback of up to $1.1 million of our shares, or about 7% of the outstanding shares. Over the next 18 months beginning next month, this is subject to no objection from the Federal Reserve Bank. As previously mentioned our teams closed and converted three MidFirst locations in Oklahoma, for the merger we announced last fall. They also converted our entire customer base on to a new digital platform known as Q2. In addition we continue to entertain merger possibilities with interested banks in our geography. Our new trust and wealth management platform, and soon to be additional card services should enhance our non-interest income part of our bank's revenue stream in the future. We understand this is not a typical quarter for Equity Bank and the entire team and I will be working to responsibly protect shareholder value the way we always have. At this time we will entertain questions.

Thank you. [Operator Instructions] And our first question will come from Michael Perito with KBW. Your line is now open.

Hey, good morning guys. Thanks for taking my questions.

Good morning Michael.

I had - I want to start on the credit side. So I guess can you just give us a little bit more color on where you kind of expect this to go over the next quarter or two and what we can expect to see on the financial side as that plays out?

Yeah, I'll answer the question on where it should go and I'll turn it over to Greg on how it closes for the financials. So Michael there - currently in bankruptcy we currently got one company we think that will be liquidated this month. We will be hopefully liquidating the other company in the next quarter or two. We marketed the company that was not profitable first. The second company is actually cash flowing quite well and so we didn't focus our energies on that. But now that that - the first company is liquidated we will be able to focus our energies on getting that company marketed and moving it through the sales process. They've currently got their two or their three vacations - they have two second homes and one primary residence. They have those all three listed for sale. And we've been getting updates on selling. So we hopefully we'll get those under contract this quarter and get them sold within that reasonable timeframe.

And Michael, the financial impact really is in three potential areas. The first one is opportunity cost on these loans in the aggregate. Our quarterly lack of interest from non-accrual is about $600,000. So the sooner we take care of the resolution the faster we can put those assets back to work. The second is in the direct cost of dealing with the issue. I think a lot of that is in the rear view mirror because we now have the plan put in place. But there will continue to be a small amount of legal and administrative expense that goes with it. And then of course the third one is the possibility, although we don't think this will happen, the possibility of continued provision against these assets. We think we put the mark on appropriately given the data points that we had. So we do not believe that we will continue to have more provision but that remains a possibility.

Can we spend a minute on that. So you provided $14.5 million against this $28 million total relationship, is that the right way to think about it?

The total relationship is $28 million on commercial credits. There's roughly a little over $12 million on personal relationships as well.

So it's closer to $40 million all in?

Correct.

And right now that $40 million just has a $14.5 million allowance against it?

Correct. The primary residents are well secured, and we have taken this to replace, Michael where we don't think we'll have to talk about this in future quarters from a resolution standpoint.

So the expectation will be if you exit both companies and the three properties at a price point that you guys are trying to relate it to whatever recent market activity, that there should be no further provision or charge-off acquired around this total relationship?

That's correct.

Okay. And this $40 million how does that rate amongst some of the larger overall borrowing relationships on your balance sheet?

Well. So we don't - I mean these are separate credits in that single family residences aren't aggregated. I mean we do aggregate them when we look at the credit relationship. But from an individual risk standpoint one of these credits is currently current. One of these credits is currently not a pass due enough to make it a non-accrual loan. So the personal residences, the primary residences, I would separate from that. These were two separate individual operating companies. And the reason we aggregate them now is we a year ago got them to cross collateralize those relationships along with their personal residents. So we aggregated them together at that point.

Actually maybe asking the question differently, I mean what are the largest commercial relationships all-in on your books today and how does the $28 million value compare?

That would be the largest relationship we have.

Okay, and just to give us a sense, I mean where does it go to after that in terms of on average in the top five, I mean does it go from 28 to 20 or there's several on the $20 million plus range, any color there would be helpful?

Yeah so the large company had 20, less than 20, had $19.5 million loan against it. We don't have relationships over $20 million.

Okay.

We do several relationship that are $20 million. I think our legal lending limit is $78 million and so we're about 25% of our legal lending limit. That's our internal hold limit.

And both these companies the $19.2 million and $9 million company were both in the franchise business correct. Is that - can you maybe give a little bit more broader color? I'm sure you want to price [indiscernible] versus quick service food [ph] type of stuff or can you give us any more detail there?

Sure they were in the franchisor business not the franchisee business. And one of them is in the entertainment business and one of them is in the bakery business.

Okay, and can you remind us what the - whether it's franchisee or franchisor what the total exposure on the franchise lending is today on your balance sheet?

We don't currently have any franchisor relationships aside of these two.

Okay, and franchise - just broader just total franchise lending?

Total franchisee lending in one, two, three, four, five, six, seven, eight, nine, ten, 13 different concepts we have $94 million.

Okay, thank you guys. I appreciate that color. And then just one last one from me, I mean if you think about obviously the first quarter was a little disappointing for you guys and if we go back in the early part of '18 post tax reform, you guys were doing about a 120 ROA. It stepped down a little over the last three quarters even if we had a normalized provision here and I'm just curious as you kind of look forward what can get that moving again in the right direction. Is it just simply normalizing NIM and growth? Is there more that can be done on the efficiency side and in terms of managing expenses, as you kind of have some purchase accounting run-off? I mean how are you guys thinking about that dynamic as we move forward?

Yeah, that's a great question, Michael. The first thing that we've done which I think has a potential to be very impactful is we have reduced our other borrowed money from a high $600 million a year ago to less than $200 million today and typically about a $150 million on balance sheet at any given point in time right now. What that does is it converted that debt that we're paying to Federal Home Loan Bank to customers that we get to cross sell, number one and number two. It puts us back in control of those dollars from the rate standpoint. We can influence rates where before we were paying whatever Federal Home Loan Bank dictated. So that's a big change for us and a big opportunity as we think about moving down the road on both retail and public funds deposits. The second thing that we done in 2019 is we have begun to look hard at revenue generation from sources that we did not have before. We've talked in the past about trust in the wealth management that platform has been developed in the last 90 days. We have very talented people and very talented support staff in place to begin selling trust and wealth management in the second quarter. So we have expectations of growing that platform and increasing non-interest income. The other thing that we've done, Michael, it's no - there's no question that M&A activity has slowed down. So we've taken the resources that we have in house, that perhaps might have been more focused on M&A. And we've begun to look at how we now can take the bank that Brad and the team have built in the last - since we went public in the last 3 years will say and make it run better. So we're looking at all different expense categories and all different revenue categories for improvement and putting those parts and pieces into action. And it includes all things large and small. And so the way we get our ROA backup is to continue to work hard at controlling the parts of margin that we can. And we've done that on the loan side, we've increased coupon from our loan customers substantially in the last six quarters. We continue to look at ways to reduce our funding costs and tear apart the non-interest and non-interest expense.

All right, great. Thank you for all the color guys. I appreciate it.

Thanks, Michael.

Thank you. [Operator Instructions] And your next question will come from the line of Terry McEvoy with Stephens. Your line is now open.

Good morning.

Good morning, Terry.

Just looking at some press reports from January, in one of the publications it said a payment hadn't been made on one of these loans for 6 months and I'm guessing it's the smaller commercial loan. I guess I'm just curious why if that was the case, we didn't hear about this relationship until today?

That's - I think you're referencing an article that was written by an attorney who doesn't - who does not have the facts. I mean, we did not provide any of that information. None of the loans were - all the loans were current as of December 31, Terry.

Thanks for clearing that up. And the franchise portfolio, the 13 concepts and the $94 million. Would these two credits be included in that or had you been included in that portfolio in the past?

We did not include them in that portfolio because they're not a franchise concept. They are a franchisor and they don't own any - or operate any stores. So they're not included in that aggregation. And our franchisor operates a lot differently than a franchisee. And franchisee is operating a business and a franchisor is dictating how business has operated. And so they're completely separate. And the large company in this situation is actually cash flowing rather well. And as always cash flowed rather well, it's actually the debt of the smaller company that has dragged the relationship down.

If we took this total relationship and just put it in a box, it would appear that the underlying credit trends on the rest of the portfolio were stable to improving? I wonder if you could just confirm that maybe put some data behind that.

Craig, you want to take that question?

Sure. We did a comparison and did exactly that. We pulled this relationship out of the 3/31 numbers and 12/31 numbers and all the major credit metrics improved slightly in the first quarter. Delinquency was a little better, nonaccruals were better, NPAs were better and our classified assets were better. So there is continued improvement in the underlying portfolio.

Great, thank you. And then I guess, Greg, just one last question for you. Thanks for running through the margin dynamics. That additional callable bond premium amortization, it sounded like that was unexpected and three months ago, maybe not built into your forecast, if you could confirm that. And then what are your thoughts now going forward on the margin? I don't think you ran through that in your prepared remarks?

Yes, you are correct on the first comment, and we expect that to taper off over time, but probably not in 2019 the bond and premium amortization I'm talking about. And then that gives, that leaves guidance on a normalized basis of 360 on the margin. But with the opportunity cost of this particular credit we're talking about, I think a new normalized margin for us until that credit is resolved is somewhere between 350 and 355.

Okay, thank you.

Thank you.

Thank you. And our next question will come from Jeff Rulis with D.A. Davison. Your line is now open.

Good morning. Expense run rate, you talked about these platform investments and some other kind of legal and other I guess that 25.5 this quarter, where could we assume that and maybe there's a tail on some of the legal front, but could you kind of range bound what you think non-interest expense could look like in coming quarters?

Yeah, you bet Jeff. We've likely said we made some investment in platform depending upon the tail of the administrative costs of this credit, the guidance that we give for non-interest expense would be somewhere between $24.0 million and $24.3 million for Q2. And I would expect that given what we know today, that number to be fairly constant in Q3 and four.

Okay, so we step anywhere from a little over a million down from this quarter and hope to kind of carry that through the balance of the year.

Correct.

And then the long growth outlook for the full year, you've mentioned started the year off slower than you had expected but have you put a number out there on 2019 full year growth?

We have not put a number out there for full year growth. We always anticipate somewhere between recently between 8% and 10%. I don't know that we'll get fully back to that 8% or 10%. But guidance today I think can still be in the 6% to 8% range.

And then on the - I guess the provisioning level, I suppose we revert back to maybe 2018 averages about a million a quarter is that - would that be reasonable to assume?

That is correct. I actually think, Jeff, that we're forecasting 1.1

And then I guess just a question back to the credit. I guess, would you hazard a guess and maybe a little too early. But any possibilities for recoveries here, do you think that the marks are conservative based on maybe moving some of these businesses, you hope a potential out there for also possible recoveries?

So what we did, Jeff s we had to look at it as a point in time. If we sell this as fast as we can sell it, we think we have it marked appropriately. If we are able to get them to use an investment banker and liquidate this in a fashion that we think is more reasonable, we could do better than this. But at this point in time, we do not have that agreement with them, and so we think we have an appropriately marked. We - this relationship was sold for substantially more - enough to clear out both of our relationships in December, the buyer would not close on that, or the seller would not close on that. And so if we can get them to reasonably look at this and how to market this company, there's the potential to do better than the loss that we currently have reserved against it.

Okay. And then just the last one I have is just to clarify that the total credit relationship with this borrower is $42 million, is that correct, both their business credits and their personal real estate?

Right and it's not actually - and it's actually separate - there's actually separate guarantors and separate individual borrowers on the individual houses as well. So it's not one single owner of the business, there was actually multiple owners of the business and multiple loans to individuals on their residences.

So the - I'm just trying to parse out the - I guess the 33 million that was placed on non-accrual. Could you break out, what is the piece that is currently occurring is that what the $9 million business is that what's still…

No, none of the businesses are accruing, it's our personal residences.

Personal residences, the piece that's not on non-accrual.

Correct.

Okay, thank you.

Thank you. And our next question will come from the line of Andrew Liesch with Sandler O'Neill. Your line is now open.

Hey guys. You've covered most of my questions. Still on the buyback fill on capital, I mean you TC ratio is 7.5% right now and buying back 7% of the stock, and a pro forma basis would bring it below 7%, I was just curious how did you arrive at this 1.1 million share number and how active you do intend to be with this, there's just seems like it's a maybe a little bit larger than I would have expected of any buyback.

Yeah, so Andrew, we think that acceptable ranges for stock buybacks are in the 3% to 7% range. And we had been working on our stock buyback, by the way before this credit issue, had a resonance. So they really are separate and distinct from each other and to be clear. So when we perform the analysis for the stock repurchase, we look at that over an 18 month period and we show on our performance by example, that we would be standalone at the end of the 18 months at 8.67% without the stock buyback on normal earnings, and a little right at 8% on a pro forma basis. So when you look at it over a period of time with the accumulation of retained earnings from earnings, it does not put stress on capital.

Got you. And then, what right now, have you guys done and prepare for CECL coming in next year? And how would that affect your preliminary expectations for capital levels and provisioning, what can you provide there?

Yeah, well, so we've, we're still in the modeling phase, we're getting ready to wrap up the modeling phase. And we're not prepared at this point to give guidance on its impact. But we are working diligently to finish up our internal modeling and there'll be more to come on that.

Okay. Thanks that covers my question.

Thank you, Andrew.

Thank you. And I'm showing no further questions at this time. So now I will hand the conference back over to Jacob Willis for any closing comments or remarks.

Thank you for joining our Equity Bancshares first quarter of 2019 earnings call. Have a great day.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect everybody have a wonderful day.