Great Western Bancorp, Inc.
Q1 2021 Earnings Call Transcript

Published: 27 Jan 2021

[Operator:]

Good morning, and welcome to the Great Western Bancorp First Quarter Fiscal Year 2021 Earnings Announcement and Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Seth Artz, Head of Investor Relations. Please go ahead.

[Seth Artz:]

Thank you, Andrew, and good morning. Joining us for today's presentation and discussion we have Mark Borrecco, President and Chief Executive Officer; Pete Chapman, Chief Financial Officer; Steve Yose, Chief Credit Officer; and Karlyn Knieriem, Chief Risk Officer.

[Mark Borrecco:]

Thank you, Seth, and good morning. Thank you for joining the call. I hope that you remain safe and healthy during these continued times. Before we share our results for the quarter, I want to first thank our employees for their continued efforts in supporting the Great Western Bank mission; to make life great by strengthening our customers and enriching our communities. For the first quarter of fiscal year 2021, we reported net income of $41.3 million. Pete will walk through the specifics on our financials shortly. I am pleased with our progress on our current financial performance, but I'm also excited about the progress and our priorities to better position Great Western for the future. With regard to our top priorities after ensuring the safety of our employees and customer’s, credit risk management remains priority number one. We made progress with our asset quality this quarter, particularly as successful loan workouts and upgrades helped support a 10% decrease in nonaccrual loans and a 7% decrease in classified loans. We made progress in derisking the bank's balance sheet by completing the sale of $209 million of hotel loans at a 12% discount. We made progress in working with our customers regarding COVID payment deferrals. We decreased our referrals to $113 million or 1.29% of total loans excluding PPP as of January 13th, down from a peak of $1.69 billion that was on deferral in round one. Agriculture commodity prices, specifically soybean and corn continue to improve, which will likely result in future upgrades over the next few quarters.

[Pete Chapman:]

Thanks, Mark, and good morning everybody. Just looking at slide 3 here, you'll see we had a strong quarter of earnings with net income of $41 million, an increase from $11 million in the prior quarter with pre-tax pre-provision income of $66 million, an increase from $52 million in the prior quarter as well. Net interest income did benefit this quarter from net interest recoveries of $2.9 million driven by payoffs of non-accrual loans and from a $1.7 million of accretion income of other loan payoffs. Strong mortgage revenues and swap fees helped support non-interest income and expenses, which tend to track lower in fiscal Q1 were further assisted by lower OREO consulting and travel spend.

[Steve Yose:]

Thank you, Pete. And good morning everyone. We have been heavily focused on improving our asset quality in the past few quarters and we are showing progress on that commitment. Looking at slide 12, you'll see the three pillars of our focus fall into effective credit risk management, portfolio management and specialized credit administration. First, effective credit risk management. Our approach to identifying and managing risk in the portfolio is more consistent in spite of a challenging backdrop and is driven by the new risk rating system and by cultural alignment on risk-based decisioning. We saw improvements in our non-accrual and classified metrics with success in exiting problem loans along with a few upgrades. Second, portfolio management. As Mark and Pete touched on earlier, we made significant progress in improving our portfolio risk by completing the sale of $209 million of hotel loans in three separate transactions. Loan deferrals are now 1.29% of total loans excluding PPP. And third, specialized credit administration. As Mark touched on earlier, the small business initiative will allow us to be much more efficient with administration of our smaller credits. Our commercial loan workout groups are making progress on work out of criticized loans and on assessing ways to further optimize our hotel concentration. I am pleased with our progress on asset quality and credit management, particularly in how much of what we are doing is strengthening our position long-term. We have more work to do, but tactically and culturally, we are making headway. On slide 13, we have further details on the hotel loan sales completed in the quarter. The sales impacted $209 million of loans across 27 properties with proceeds of $183 million reflecting a 12% discount. That discount led to a charge-off of $26 million for the quarter. The sales involved a combination of pass rated and criticized loans, ultimately leading to a decrease in criticized loans of $131 million. The locations of the properties were spread out across the footprint and helped reduce market concentrations. The sales reduced the hotel, excluding casino hotel segment by 20.2%, which ended the quarter at $823 million. Also on slide 13, you'll see updated information on loans on deferral, which are now down to $113 million or 1.29% of total loans excluding PPP. Hotel loan deferrals decreased to $70 million or 7% and the remaining balance is spread across several other segments. We have given just five deferrals in the latest round for a total of $23 million and we would expect a decline in requests going forward.

[Mark Borrecco:]

Thanks, Steve. I am proud of our team's continued focus on improving performance, addressing asset quality concerns and implementing our win big initiatives all the while dealing with emerging business needs such as PPP origination and forgiveness, stimulus payment processing and branch lobby decisions as it relates to the pandemic. We made good progress in Q1 and I look forward to continued progress in the quarters to come. With that I will turn the call back to the operator and we will begin the question-and-answer session.

[Operator:]

The first question comes from Terry McEvoy of Stephens. Please go ahead.

[Terry McEvoy:]

Hey, guys. Good morning.

[Mark Borrecco:]

Good morning.

[Pete Chapman:]

Good morning, Terry.

[Terry McEvoy:]

Maybe, Steve, if we could start with you. Could you just talk about the loan sale of the hotel loans, the level of interest from buyers? I'm just curious, how did pricing change, or could you comment on any pricing change before? And maybe after the vaccine and when these transactions occurred? And then maybe the last part is, if you think about the quality spectrum of your hotel portfolio were these more distressed-type properties middle of the road? Any color there would be helpful. Thank you.

[Steve Yose:]

Well I would say in the last part of your question, we focused on those that were either criticized classified or declining trends. So we did focus on more -- they were not nonaccrual, but they're more of our distressed properties. We also focused on end market concentrations. So anywhere where we felt we had a higher concentration the hospitality loans. We focused on seeing if we could sell some of those, and the loan buyers that we went to were really focused on not distressed properties as much as performing loans. So they were not on nonaccrual performing. When we've been pursuing this for well over 90 days to look at a hotel loan sale to see if we had the potential and if we did not need to take too big of a discount. And I will say after the vaccine was announced, we found that things accelerated much more quickly as far as being able to consummate the sale. So I do think the vaccine announcement did help us. I don't know if it helps significantly on the pricing because the pricing discussion prior to the vaccine wasn't any different really, but it did accelerate the sale I believe because of the interest in those particular properties.

[Terry McEvoy:]

Thanks for that Steve. And then maybe a question for Mark or Pete. Just thinking about the operational alignment and how that relates to spending in 2021. The last couple of quarters we've heard about some hires and some specialization and focus on things like small business. Is there more to come? And then, how is that going to impact the spending and expenses in 2021? Thanks.

[Pete Chapman:]

Yes. Look I think you'll see a little pick up there. Terry, as I said, we're usually a little slower in Q1 just as people finalize budgets and get spending lined up for the year. So look I'd still expect to tick up. I think previously, we've sort of said low 60s sort of 62% to 64% as sort of a run rate. So we feel the investment we're going to make is sort of manageable within that range for the year. We've certainly got some projects up and running that will come on in the next couple of quarters, but we still feel it's a manageable run rate.

[Mark Borrecco:]

Yes. And I think for me Terry, the things that comes back into focus is as we make some of these investments, as we improve the technology, as we rework some of our processes, I do feel comfortable that not only will we be able to improve the client experience, make it easier for our employees to do their jobs. But also we can start to do more with what we have. And so that will help fuel that future growth and that will help us to do more with those investments without having us again see a massive increase in our overall spending.

[Terry McEvoy:]

Great. Thank you.

[Operator:]

Next question comes from Jeff Rulis of D.A. Davidson. Please go ahead.

[Jeff Rulis:]

Thanks, good morning.

[Mark Borrecco:]

Good morning, Jeff.

[Jeff Rulis:]

Maybe a question for Pete. On the margin it looks like if you etch the recoveries and accretion down 6 basis points linked quarter. Is -- maybe speak to if more recoveries are anticipated in that figure and/or just the core margin outlook?

[Pete Chapman:]

Look probably not Steve -- Jeff sorry. In terms of recoveries, recoveries are obviously hard to predict. So certainly hopefully get some, but they're pretty hard to put in a forecast, I would think. And then just in terms of margin I'd see just a general tick down trend there. I think once again part of that will be driven by mix just as this quarter the assumption is, we'll see more of those PPP loans forgiven just with where the balance sheet is at, at the moment, I'd expect sort of cash and investment levels to continue to tick up here in the next quarter which I think will drive sort of a softer -- a slightly softer margin in the next quarter as well.

[Jeff Rulis:]

Okay. Great. And on the -- switching gears on the -- just interested in the reserve balance at this level a pretty healthy number. And I guess as -- some volatility here but looking at -- for the balance of the fiscal year kind of net charge-offs versus provision, do you think those track relatively in check? Do you start to release those reserves, any thoughts there? Thanks.

[Pete Chapman:]

Look I'll get Steve to jump in and help with this one. But obviously we need to get NPAs down Jeff. That will be a big driver as well of provisioning levels over the course of the year I think, but Steve?

[Steve Yose:]

I believe what we looked at as you look at our portfolio and our mix is there's still uncertainty of where we're at in the economy of this part of the cycle. So we definitely looked at that in our qualitative factors within the CECL reserve. But to Pete's point, if you look at our level of nonaccrual loans and our coverage of the allowance as we are able to improve in those nonaccrual loans we will hopefully be able to look at where we go with the allowance.

[Jeff Rulis:]

All right. Thanks.

[Steve Yose:]

Thanks Jeff.

[Operator:]

The next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead.

[Jon Arfstrom:]

Thanks, good morning.

[Steve Yose:]

Good morning.

[Jon Arfstrom:]

Steve a question for you maybe more an emotional touchy feely question to start, I guess before we get into the meat of it. But how do you generally feel about credit? And this follows up on Jeff's question, but kind of the timing and magnitude of when we can see these non-performers come down? I'm thinking about your ag comments and the loan sales and the deep dives that you guys have done and it has to be better. But it's just kind of the one thing that I think still nags at your stocks. So I'm just curious how you feel about all of it kind of off script if you can?

[Steve Yose:]

Well as the Chief Credit Officer, it's always fun to get a touchy feely question. I don't get those too often. But when it comes to -- I believe one of the big things that I feel very comfortable with and positive is the cultural change we've had as an institution as the way how we look at credit risk and how we look at risk-adjusted returns. And as we look at future growth, I always look at not just loan growth, but is it the right risk and are we bringing -- putting the right loans on. So it's not just loan growth for loan growth's sake, but -- and we definitely are focusing on how we grow the book of business going forward to make sure that we continue to retain a consistent credit risk culture. So I feel we've made huge strides in the last six months culturally. I think also because of our mix of agribusiness, we do anticipate we've seen stable to improving trends. We saw improving asset quality in the ag book this quarter. We anticipate that in the next two quarters as well. So I'm very encouraged in our agribusiness book. As we look at our hotel portfolio that is an area that because of the vaccine and other things I'm much more encouraged as we look to the next six months and I feel very good about the loan sale and trying to derisk our hotel portfolio. But we are really not looking at future portfolio of sales. We're looking at more strategic focused how can we right-size that portfolio over time rather than another big portfolio. So like we did this last quarter, we felt it was necessary to get -- to derisk it, but that is not a strategy going forward. So at this point, I feel very comfortable and positive about our cultural change. Now we just need to continue to stay focused and improve quarter-by-quarter.

[Jon Arfstrom:]

Okay. That helps. And then another maybe bigger picture question for you. Longer term, what's an acceptable reserve in nonperforming level for a bank like yours in your eyes? I know it's a difficult question and CECL complicates it. But where would you like to be longer term?

[Steve Yose:]

Well if you look at -- I came from a similar-sized, mid-tier bank when I -- at my prior institution. And we moved non-accrual loans there down to 50 basis points. And I think that's a good non-accrual balance. So I mean we have a long ways to go to go there. If you look at us close to 3% today, but if we can keep focused and the way we've looked at when we say, risk focused decisioning, we look at those by risk rating. We've changed our hold limits. We've done a lot of things to -- so that going forward that we have a different risk in our portfolio. But I would like to see us consistently be definitely less than 1% on non-accrual and long-term 50 basis points non-accrual. And I think I feel like we've arrived where we should on the asset quality. And then your questions will all be about loan growth after that.

[Jon Arfstrom:]

I was just going to pivot to Mark. That's the other part of this Mark, because I think expenses and Steve's work on credit and fees, they all kind of line up. But the one thing is growth and I know you've done a lot to kind of change things. But when do you think we might see some resumption in growth? And are there any signs of life in your markets? Thanks.

[Mark Borrecco:]

Yes. Sure. I think from a – I'll answer the second part first. So from a signs of life in our market, I would say that, I feel good and every day getting better as it relates to the activity levels in our markets. We see the number of COVID cases coming down. We see in many ways businesses getting back to kind of some sense of normalcy. That normalcy is different than obviously it was a year ago but still things are resuming. I know that I'm having a chance to go to have dinner with the client tomorrow night here in Sioux Falls. And so from that standpoint, I am seeing and we are seeing activity levels start to come back to I think very reasonable levels. As far as loan growth, I would say that for the next two quarters, I would expect to see us to continue to have, continued erosion in our overall loan balances, as we continue to have focused workouts, as we continue to derisk the balance sheet, as it relates to our hotel portfolio. And so I would say for the next two quarters, I would expect those numbers to go down. And then I would expect after those two quarters for things to get back and to see us start to have the asset generation that we need to have to grow this organization. I see pipelines today are improving and so I'm encouraged by that. We've had an internal focus of back to business. We have been playing defense a bit over the last nine months and that wasn't necessary evil given our asset quality. But that is now changing and we are pivoting the organization to be more focused on asset generation. We have some I think very aggressive offers in the market and we have a very focused set of commercial bankers. And so from that standpoint I would think that we would see those pipelines grow and then that asset growth to follow two quarters from now.

[Jon Arfstrom:]

Okay. Good. Thanks. And congrats on hopefully seeing some of those credit issues rest. Thank you.

[Mark Borrecco:]

Thank you.

[Operator:]

The next question comes from Andrew Liesch of Piper Sandler. Please.

[Andrew Liesch:]

Hey, everyone. Good morning. Nice to see some of this derisking here. Just want to kind of continue on the same theme here just with the hotel and the casino loans, now down to about 10% of the portfolio. Where do you think is a good level, a good concentration mix for that book as we move through the year?

[Steve Yose:]

So in the longer term I would like to see that portfolio under $500 million. So as we – and that wouldn't be like overnight over the next few quarters but over a period of time we would like to long term have that portfolio be under $500 million basically.

[Andrew Liesch:]

Got it. And it sounds like it might be masked by continued runoffs of that book in the next couple of quarters. But it sounds like there's some good optimism in other loan types. Where should we see – what portfolio do you think we'll see growth here in the next couple of quarters?

[Steve Yose:]

Well agribusiness is still a continued focus of Great Western Bank. And I wouldn't say we'd have a lot of growth there but we've got continued focus in agribusiness. And we also anticipate improved asset quality in agribusiness. So I think that will be a place that we'll continue to focus. And then of course with our initiatives on small business, we're hopeful that we'll focus more on small business and other areas of the portfolio. But Mark might have some other views on growth as well.

[Mark Borrecco:]

Yes. I think Steve mentioned, the focus on ag, and I would expect that to be a focus and to see some moderate growth there. Nothing to overwhelm, but again consistent growth. I look at the C&I sector and I look at some of the initiatives that we have as it relates to growing, the C&I book at Great Western. And so I would expect growth in that. And then overall just more owner-occupied real estate as well. So that's where I want to see us continue to again get back to business and start to see those three sectors or those three segments help fuel our future growth.

[Andrew Liesch:]

Okay. That's helpful. And then I guess just going back to the reserve ratio it's one of the highest in the industry right now. And I recognize that there's still some credit uncertainty out there and the level of non-performers need to be worked down. But you guys seem pretty well reserved. So I'm just – any commentary on why the provision would even need to stay near this $12 million level going forward?

[Pete Chapman:]

Oh as in the P&L charge Andrew you mean?

[Andrew Liesch:]

Yes, it seems like there's opportunities for much smaller provisioning in the coming quarters.

[Pete Chapman:]

Look too early to declare victory on that. We'd certainly hope, so but I still think we're a few quarters away from the world getting back to normal. So a little early to declare that. Obviously, we hope so Andrew, but maybe a few quarters on we can revisit that one.

[Andrew Liesch:]

All right. Thanks for taking the question. I’ll step back.

[Mark Borrecco:]

Thanks, Andrew.

[Operator:]

The next question comes from Damon DelMonte of KBW. Please go.

[Damon DelMonte:]

Hey, good morning, guys. I hope everybody is dong well today. So my first question just kind of curious on your PPP loan forgiveness process. I think you guys noted like $28 million of loans were forgiven during the quarter, which as kind of as a percentage of your overall PPP loans was a lot lower than what we're seeing with others. So, just kind of curious on what some of your experiences were with that during the last quarter.

[Pete Chapman:]

Yeah. Look just a little slow to get going. If you look at our loan balance in that category though Damon about 80% is below $150,000. So the feedback we've got from a lot of customers is CPA firms and the like are advising just to hold off until that – the lower level of forgiveness documentation was required. So I think that drove quite a lot of it to be honest with you Damon. So hopefully, it picks up here a little bit this quarter.

[Damon DelMonte:]

Got it. Okay. That makes sense. Thanks. And then Pete, can you just give a little bit of perspective on your expectations for fee income as we go through the next few quarters?

[Pete Chapman:]

Look, I think it will hold up Damon. Mortgage volumes are still unseasonably strong just due to lower rates. So maybe not the pickup we've seen in the last couple of quarters, but I think that will at least hold in as well as other the fee income line item. So look I don't think you'll see huge growth there. Just seasonally, it gets a little bit slower here in this quarter. But certainly, I think it will hold in pretty well.

[Damon DelMonte:]

All right. Great. Thank you very much.

[Pete Chapman:]

Thank you.

[Operator:]

The next question comes from Janet Lee of JPMorgan. Please go ahead.

[Janet Lee:]

Good morning. On reserves I feel like I'm asking this question that other people have asked in a different way. So apologize for that. But on reserves, it sounds like it might be several quarters away before we see release – reserve releases and that being accompanied with a steeper step down in NPAs in order for us to see that. What kind of NPA step down or levels would that be in order for you to be more comfortable releasing reserves?

[Steve Yose:]

Well, we have – if you look at our non-accruals our coverage of those is about 1.05. I think, if we're successful in reducing those nonaccrual loans, I think the reserve would go in concert with that. I mean, we'll look at other issues too like for example some improvement in the economy in relationship to hotel loans and others will also impact that. But we just are taking a careful approach to just see what happens in the next two quarters, but I think it really is driven by those nonaccruals. And the nonaccruals, we do have we have four or five that are larger nonaccruals. So if we can make success on those loans they are well secured. We have an updated appraisal. So we are encouraged that, we do not see a lot of loss exposure there. So our hope is that as we reduce those and show improvement in the hotel portfolio that that's when we'll feel we've turned a corner.

[Janet Lee:]

Great. Thanks. And also on loan growth. So it appears that the loan growth over the near term will be relatively modest with more upside over the intermediate term. Can you just provide more color around what's your plan around deployment of excess liquidity?

[Pete Chapman:]

Yes. Certainly, from a balance sheet perspective Janet, I would expect us to be elevated here for the next couple of quarters as well. We've got a little bit of term FHLB borrowings left, but it doesn't really make a lot of sense to prepay those. So look really we'll carry more elevated levels of liquidity certainly run off any higher cost deposits that we've got, and really just carry that here for the next couple of quarters as loan volumes as Mark said are expected to be a little softer here before redeploying that in a couple of quarters' time.

[Janet Lee:]

Great. Thanks. Just one follow-up for me. So given the improved outlook on credit for the industry and for you guys as well, can you just elaborate more on your capital deployment plans including potential of paying a dividend again or share repurchases? Thanks.

[Pete Chapman:]

Yeah. Look no plans at this stage, Janet. As I said in my comments, NPAs are still more elevated than we'd like and substandard so probably consistent with the provisioning discussion. Let's see those metrics improve before we move forward on any sort of capital actions here.

[Janet Lee:]

All right. Thank you.

[Pete Chapman:]

Thank you.

[Operator:]

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

[Mark Borrecco:]

Thank you, operator. And again, thank you everyone today for joining us. If you do have any follow-up questions, please do reach out to us. Stay safe and have a great week. Thank you.

[Operator:]

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