Great Western Bancorp, Inc.
Q2 2021 Earnings Call Transcript

Published: 1 May 2021

[Operator:]

Good morning, and welcome to the Great Western Second Quarter Fiscal Year 2021 Earnings Announcement and Conference Call. 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, Emily, and good morning, everyone. 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. The presentation for today’s earnings review is available for webcast and download through our Investor Relations website at ir.greatwesternbank.com.

[Mark Borrecco:]

Thank you, Seth, and good morning, everyone. I would like to start by thanking our employees for their continued efforts in supporting the Great Western Bank mission

[Pete Chapman:]

Thanks, Mark, and good morning to everybody. Looking at Slide 3, you’ll see we had another strong quarter of earnings with net income of $51 million, supported by low credit costs and underlying pretax pre-provision earnings of $60 million. Net interest income benefited our focus on managing down funding costs, combined with accelerated PPP fees, helping to offset the impact of lower loan balances and our excess liquidity. Noninterest income was supported by good core revenue generation amidst a seasonal slowdown in select items. And expenses have been below guidance with this quarter benefiting from lower OREO operating costs and also reduced FDIC insurance. On Slide 4, we see adjusted net interest income was $101 million compared to $106 million in the prior quarter. And our adjusted NIM was 3.4% compared with 3.52% in the prior quarter. When excluding one-off items, like nonaccrual interest recoveries, along with PPP accretion this quarter, underlying NIM decreased 18 basis points from 3.36% to 3.18%, primarily related to excess liquidity as deposit growth has been strong, coupled with the decline in loan volumes. We expect further pressure on NIM from the full effect of higher interest-earning assets. And we’ll be prudently managing our cash position going forward. Our average cash and securities of $3.1 billion was an increase of 27% on the linked quarter with $818 million of that in cash compared to just $57 million a year ago.

[Steve Yose:]

Thank you, Pete, and good morning, everyone. As Mark stated, priority number one continues to be improving our asset quality. And we have made further progress following improvements from last quarter. Our stronger credit culture is evolving in parallel with our focus on credit risk management, portfolio management and specialized credit administration. We saw a consecutive quarter of improvements in our nonaccrual and classified metrics with success in exiting problem loans, along with making a few risk rating upgrades. Loan deferral requests have dropped significantly with the balance of our loans on some form of deferral down to only $19.7 million or 0.24% of total loans excluding PPP. And the majority of those are making interest payments.

[Mark Borrecco:]

Thank you, Steve. And operator, we are now ready for the question-and-answer portion of the call.

[Operator:]

The first question comes from Jeff Rulis from D.A. Davidson.

[Jeff Rulis:]

Looking at the progress made on the credit cleanup, it sounds like you’ve got continued loan workouts occurring. Wanted to just check in on the net loan growth outlook in terms of the progress you’ve made and maybe when that could turn potentially positive. And then sort of related to that, if you could speak to the provisioning level, are we going to have to wait until net loan growth before we see potentially a positive provision?

[Mark Borrecco:]

Yes, sure, Jeff. I’ll start. This is Mark and then I’ll turn it over to Pete and Steve for additional comments. So when we think about our net loan growth or where we are, from an organizational standpoint, we have been focused on ensuring that we get to a place where we are working those either problem credits out and/or looking at the portfolio and being proactive around how we start to manage those credits out before they deteriorate. It also institutionally has taken some time and attention away from our normal business calling activities as has the pandemic. So when we talk about where do I think or where do we think our loan growth is, I would say that the engine has started again. We are seeing increased pipelines. We are seeing increased activity. But for us, because of the current asset quality focus, it has, in some ways, slowed down what growth we would have seen over the last couple of quarters. So am I encouraged about our opportunities for our growth in the future? Yes. Am I encouraged that we’re seeing that activity and that our pipelines are increasing, and this last quarter, it was a material increase over the prior quarter? I am. I don’t want to get overly optimistic about what that means. But I do believe that the second half of the year, things will be better for us. And as that engine gets revved back up again and as our focus turns to more business development activities as we have the other parts of our hotel portfolio ring-fenced with a specialized group, our normalized -- our normal workout group, I feel like we’re in a better place than we were before and that activity is starting to increase. Pete, Steve, other comments?

[Pete Chapman:]

I think it’s really well-said, Mark. Overall, though, Jeff, I’d expect loans to be flat to slightly down just as we continue to run off the classified book and the loans that are causing us some stress from a top line perspective. But as Mark said, pipelines are increasing and we’re seeing some really good activity in the market.

[Steve Yose:]

And Jeff, as Mark mentioned, our Strategic Business Services, which is our workout group for commercial credits, handles most of our classified credits. Those are not handled in the field so that they can focus on bringing in new business. As well as Mark outlined, we have our specialized hotel group that dealing with the more challenged hotel credits. So the plan is that those group will focus on continuing improving our asset quality and the other groups will focus on growing assets.

[Jeff Rulis:]

And the provisioning, that might oversimplify it as a flip to growth, but just some thoughts on that provisioning level.

[Pete Chapman:]

Yes. We’re really comfortable with it, Jeff. Obviously, it depends on the level of nonperforming assets. But as you saw during the quarter, we’re comfortable, coverage is adequate based on asset quality. And as we said, the decline this quarter was really as a result of the decline in balances. Outlook, we’re not really releasing reserves due to the improved outlook as yet just as we wait to get customer financials in and also look to see how some of those hotel exposures perform through the summer.

[Operator:]

Our next question comes from Jon Arfstrom from RBC Capital Markets.

[Jon Arfstrom:]

Steve, one of the comments you made in your prepared comments, you used the word momentum on nonaccruals since quarter end. Can you talk a little bit more about that? And from 30,000 feet, it seems like everything is getting better from a credit perspective. And you’ve made some progress on nonaccruals. But is there going to be a quarter where you think we’re going to see a big step-down in nonaccruals? And is that coming relatively soon?

[Steve Yose:]

As I’ve learned with asset quality and what’s the makeup of our portfolio, it can be lumpy when we show improvement. Like last quarter, we had the hotel sell and we had some really good improvement on nonaccruals. I see that hopeful in the future. So I am encouraged as I look at our workout loans and what I’m seeing for the next quarter, I’m very encouraged that we can see progress in the nonaccrual. We just don’t really outline where that’s going to be until money is in the bank, so to speak, until we’re -- we actually see the actual payoff. So I’m very encouraged by what I see. And I’m hopeful that we’ll see some momentum there. And I don’t see anything that would discourage me from that statement. We just want to be very careful until we actually see those loans paid off.

[Jon Arfstrom:]

Could you maybe give us the top 3 to 5 nonaccrual balances? How concentrated is this at this point?

[Steve Yose:]

So our top nonaccrual balances are concentrated more, I would say, in ag, and more.

[Pete Chapman:]

2/3 is ag, yes.

[Steve Yose:]

2/3 is ag. And that’s more of our legacy from a few years ago. And so we’re working those extremely aggressively and hard to work through those. And we have appraisals on all of those. We feel that we’ve got those marked with the right balances. We do have a hotel loan that’s also on a larger nonaccrual balance that we see continued improvement on. And so we also don’t see significant amount of specific reserves in that nonaccrual balance. And so with all those factors, we are encouraged, especially with the improvement in ag, that we -- it further validates my comment on the momentum.

[Jon Arfstrom:]

Mark, maybe a question for you. It kind of goes to overall confidence, I guess. But talk a little bit about capital allocation, of what you’d like to see happen for the next few quarters in terms of dividends or even potentially thinking buyback.

[Mark Borrecco:]

Yes. And we have had internal conversations around that. I think for us, it’s still too early, given where our nonaccruals are and where our overall asset quality is. With that momentum that Steve referred to and with some of the other elements that we are seeing throughout our performance, I am comfortable to say that let’s see that asset quality improve. Once we see that material improvement, then discussions around dividend or share buyback, all of those things are back on the table. But consistent with our conservative approach that we’ve taken over the last 12 months, I want to see that material improvement and then we can have the conversation about how to best put that capital to use.

[Jon Arfstrom:]

Last question, and this again goes to the same topic, but you’ve spent a lot of time digging through the company, looking at the economy. Are you more optimistic? It seems like a silly question. But we’re still seeing this elevated nonaccrual balance and we’re seeing the loans come down, but you’re talking about improvement, you’re talking about potentially better loan growth. Just how are you feeling about things, Mark, in general?

[Mark Borrecco:]

Yes. And it’s a question that we ask ourselves or I ask myself often. I do feel much better about where we are. And while I would love to see faster improvement in our nonaccrual and classified levels, the fact is if we did see that faster improvement, it would likely mean that we were accelerating our losses. And so the fact that we are being prudent, the fact that I know, based on Steve’s team and all the hard work they are doing, that I would expect to see continued and even a more sizable improvement this quarter. And I see how and what the organization is responding to some of our key initiatives, like the small business center, the overall end-to-end lending process revamp we’re going through, the fact that pipelines are improving, the fact that overall sentiment in our markets is getting better, economic activity is higher, employee engagement is better. All of those elements for me lead me to that increased optimism. And I also know that we have an engine of performance that, like I mentioned before, it was maybe a bit in neutral last year as we were trying to solve some issues. It’s now clearly in drive and we’re getting revved up. So I am far more optimistic about the second half and going into 2022.

[Operator:]

Our next question comes from Ebrahim Poonawala from Bank of America.

[Ebrahim Poonawala:]

I guess, just wanted to follow up again on credit. If I heard you correctly, your reserves are at 3.5% ex PPP, 2/3 of nonaccruals are ag lending, which I think you mentioned there are no specific reserves. Historically, this has had de minimis loss content. So I appreciate you don’t want to give any specific guidance or outlook on reserves. But talk to us in terms of what you think the loss recognition is going to be as some of these things move through the pike? And is it safe for us to assume that a lot of that 3.5% of reserves, one comes back into capital, which is already very strong? And Pete, remind us what steady-state day 1 CECL reserves would look like for you if we get back to a normal environment 6 months from now in terms of your balance sheet?

[Pete Chapman:]

Yes, sure, certainly. So Ebrahim, in terms of loss timing, Steve, do you want to make any comments around that?

[Steve Yose:]

Yes. So we -- as I mentioned earlier, we do see significant loss in our nonaccrual book in the form of specific allocation of the appraisals that we have against those properties, those agribusiness properties that we spoke -- that I spoke to earlier. There are a few COVID-impacted nonaccruals, a hotel that we have a decent allocation against as well as a theater that we have a decent allocation against. So I don’t want -- I just want folks to know that those COVID-impacted industries have the higher specific allocations. And then as far as future reserves, and I’ll let Pete speak to the specifics, because of the uncertainty of hotels and hospitality, we are by everything we say and everything we’ve talked about. But until we see the actual improvement come in the next 6 months, we are being very careful with how we’re reserving against our hotel and hospitality book, which has minimal nonaccrual at this point and minimal classified. We are just being very careful on how we view that because of the uncertainty over the next 6 months.

[Pete Chapman:]

Yes. Ebrahim, I think the more normalized provision level in terms of that 6-month time frame, I think that’s a little bit too soon. As we’ve seen with some of these nonaccrual assets, they just take time to work down. So I think it will be more than a 6-month period to move back to a more normalized level. But when we do, certainly from provision coverage level, Ebrahim, we certainly hope we don’t have to be where we are now and we hope we can move back more in line with peers, maybe a little bit more elevated just because we have that ag book, where you see a little bit more volatility. So certainly, we might carry a little bit more in the reserve there compared to peers. But certainly, our hope is to get back more in line with where others are at the moment as we move down those nonaccruals.

[Ebrahim Poonawala:]

Got it. And I guess the other question, Mark, for you. Just give us an update in terms of things that you are doing, I think, to improve, transform the franchise. You highlighted some of the progress made over the last few quarters. As we look forward, I mean, it seems like Pete’s expense guidance is actually lower than where you’ve been. So talk to us in terms of does that take into account any future investment spend on technology and personnel? And how are you thinking about in terms of just adding bankers and what markets are you looking to expand into?

[Mark Borrecco:]

Sure. So yes, the guidance for the expenses is down a bit from our previous guidance. For us, as we do our deeper dive into the organization, look at where our strategic initiatives are, we are very comfortable that with that guidance, we are able to make the types of investments that we need to, to move the organization, or to use the words that you used, transform, what we want to do. I am encouraged by the -- our ability to get some of the benefit of these key initiatives early on. We talked about the small business center. We know that we have our commercial end-to-end lending process revamp, which the level of engagement from our bankers is exceptional. We have Deloitte coming in to help us to provide additional counsel and accelerate some of those improvements. I think about where and how we want to continue to support the markets that you mentioned growth. So we think about Tucson. We think about Colorado Springs, about Fargo, about Kansas City, additional growth in Omaha and Des Moines. We have opportunities in Eastern Iowa. And so for us, it’s not a shortage of markets where we want to grow. We will look to hire either experienced bankers and/or teams of bankers in some of those key markets. We’ve had some significant upgrades in Colorado Springs, for example, in our commercial leadership. And so just expect us to do that on a continued basis to make targeted investments in those key markets as well as making sure that we make it easier for our employees to do their jobs through those technology improvements and process improvements. I feel really good about how that’s progressing and knowing that there’s a lot more work to do. But we’re clearly making that kind of progress we need to.

[Pete Chapman:]

Yes. And Ebrahim, lower expense guidance really is just recognizing OREO expense run rate is tracking lower than what it has done historically, Ebrahim. So still very much investing in the business but just acknowledging that with OREO balances sort of flat to declining, that we’ll be doing a little bit better there, we think.

[Operator:]

Our next question comes from Andrew Liesch from Piper Sandler.

[Andrew Liesch:]

Just, Steve, question on just the overall allowance level and not necessarily in the near term because you have the classified and some of the nonaccruals yet to work through. But you’ve looked at loan portfolios for many years, so where do you think -- and it’s like, look, I’m talking about 2, 3 years down the line from here, where do you think the reserve ratio ultimately settles out?

[Steve Yose:]

Well, I would like to see nonaccrual loans stabilize at about $100 million to $125 million at a stable state. I hope to be better than that in 3 years. I hope I definitely would have a better goal for myself than that, but I think if we can get at that level of nonaccruals. And then I’ll let Pete talk to the allowance with that. But I think if I can get to that level of nonaccruals, we as a bank can get to there, that we will -- you’ll ask me less questions about asset quality and we’ll be talking about other questions. So I think that, that’s kind of where I see us and where I hope we can get to. And the allowance will probably follow suit with that.

[Pete Chapman:]

Yes, I 100% agree, Steve. So Andrew, if we’re getting back to more normalized peer levels in that quarter level then, I think, from a reserving perspective, then we fall back a little bit more in line with some of the peer analysis I know you’ve released over the course of the quarter, Andrew. Maybe a little higher, as we said, due to ag and just to protect around some volatility but not materially away from peers.

[Operator:]

Our next question comes from David Long from Raymond James.

[David Long:]

I appreciate the color that you guys have given on some of the progress the bank has made. And maybe, Mark, I know still early in your tenure, you’ve talked about building on a more competitive small business presence. Just curious where you stand there and if there’s any tangible evidence you can point to of some success at this point.

[Mark Borrecco:]

Yes. We launched the pilot March 29. So I would love to have more tangible evidence, and we will definitely for the next call. But so far, the pilot is very much in its infancy. I did have a chance to check in with the team and also with the several of the pilot bankers. And again, early returns, albeit a small sample size, is very positive. The thing that’s most encouraging, and I keep going back to this within the organization, the small business initiative really has 3 key elements. The first is just really improve and simplify how we originate and manage our small credit. That improves the client experience, but it also significantly improves the employee experience. Because historically, we have originated those smaller credits and managed those smaller credits the same way we manage $5 million, $10 million credits. So the amount of work involved, the amount of oversight was significant and yet the upside or the benefit to the organization was not necessarily in line with all the work and costs to put into it. The second benefit for us is that we can now be much more efficient with how a banker can handle a bigger pool of clients within those markets. So they could maybe help 50 customers before, now they can help 100 to 150 customers. The last piece for me is that small business is a great way to grow low-cost, sticky deposits. It’s also a way, through a packaged program, to also increase our noninterest income through treasury management, merchant services or other activities or services, where today, we don’t really have a large portion of that business. So the small business element is really important for those reasons and again, on top of that, creating additional capacity for the organization to go out and grow those larger credits as well. So we’ll have more tangible evidence for you in the next conversation, David. But that right now is really all we have because the pilot again just began March 29.

[David Long:]

Sure. I appreciate that color. And then my second question relates to the PPP program. And just curious on your thoughts, and I know you talked about $13 million left in fees, how do you see the forgiveness playing out with the rest of round 1 and then with round 2 through the end of the year? And do you think it maybe goes into next year at all?

[Pete Chapman:]

Look, I think it does go a little bit into next calendar year, if you’re talking calendar, just to keep it clean. But yes, I think it probably will drift out a little bit, but you saw this year -- this quarter, with just over $9 million of the revenue, it’s starting to accelerate. So I think materially the next couple of quarters and maybe less material after that.

[Operator:]

Our next question comes from Damon DelMonte at KBW.

[Damon DelMonte:]

So my first question just -- my first question just relates to the margin and the outlook there. I think, Peter, you had mentioned the expectation is for some core pressure on the margin. I was wondering if you could talk a little bit about that and kind of your thoughts around the excess liquidity and how you’re managing that. Will that just stay in low-yielding Fed funds? Or would you look to move that into securities in the interim?

[Pete Chapman:]

Yes, thanks, Damon. Yes, look, I would expect to see some pressure there because we had some -- some of that liquidity increase was actually towards the end of the quarter. So in terms of that liquidity drag, you’ll see some of that with the full effect come through this quarter. And we’re not seeing significant deposit outflow at this stage. So we think that will stay around for the moment, Damon, so that will cause the pressure. And then, just in terms of deploying that, being measured. But look, we’re trying to just take advantage of where we do see some opportunities. So we’ve put on some BOLI in the last quarter. Certainly, we bought a little bit of bank sub debt as well. So the team will just continue to chip away at that and look at opportunities. But I would expect cash and low-yielding balances to be elevated here for the next quarter as well.

[Damon DelMonte:]

Okay, great. And then Mark, I think you kind of touched on this in one of your other responses. But when the growth returns, as you’ve characterized very well in your commentary about being ready for opportunities, could you just kind of remind us again where some of the greatest opportunities in the footprint lie and just from a geographic perspective, please?

[Mark Borrecco:]

Yes, sure. So we’ll start kind of in the Midwest and the Northern part. So I think Fargo, for example, I feel like we have a really best-in-class commercial team. And so being able to leverage that and make some additional investment in the Fargo market, I see opportunity. As we work our way down the Midwest, clearly, in Omaha and Des Moines, we have opportunities for continued growth. Within South Dakota, obviously, not -- I’m geographically challenged in that regard. South Dakota, we still think that within Sioux Falls and some of our other key South Dakota markets, there’s growth opportunities. Kansas City, I see really big opportunities for us and opportunities for us to go out and get some bankers and really make a difference in that market. We talked a bit about Eastern Iowa. We had a nice win in Eastern Iowa this past week, and I would expect to see additional wins as we continue to expand in our Eastern Iowa footprint. As we move over to the Arizona market, I think about Tucson, an area where we have some presence but again much bigger upside and opportunities to grow in that market. Colorado Springs, in the Colorado market, we have a new banker leader out there, and we’re starting to see some early progress there. And then just overall, the Arizona and Colorado markets are clearly our areas for growth. We’ve shown over the years that we can grow in that market. And I would expect us with the leadership and team in place there to continue to see a nice growth pattern for those 2 states moving forward.

[Damon DelMonte:]

Excellent. That’s a great rundown. I appreciate the color.

[Operator:]

Our next question comes from Janet Lee from JP Morgan.

[Janet Lee:]

Following up on Mark’s comment about having to see a material improvement in nonaccrual before assessing buybacks or raising dividends, what level of nonaccrual ratio are you referring to? Is that like 1% to 1.5% as Steve referred to as being a goal? Or could it be higher than that to consider increasing capital returns?

[Pete Chapman:]

Yes, it could be a little higher than that, Janet. So that’s a long-term goal from Steve that we’ll look towards. But yes, it could be a little bit higher than that when we look to deploy some capital. Absolutely, it could be.

[Janet Lee:]

Could be like 2%, or is it...

[Pete Chapman:]

Look, we haven’t got any specifics yet. I think the key for us really is sustainable improvement. It’s not moving to a number in 1 quarter, it’s really just getting comfortable over 2 to 3 quarters that we’ve seen sustainable improvement in that number, Janet. It is sort of more the thing we’re looking at rather than just sort of a black and white line, to be honest with you.

[Steve Yose:]

And the number I was referring to is really where we believe that asset quality will be at an adequate state and a state where it will no longer be a high focus. I mean, it will always be a high focus for me and make sure that we retain good and strong asset quality. But as far as us being able to go where we want to be, but that doesn’t mean that before then, there’s a lot of other things we can do as a bank.

[Janet Lee:]

Got it. And I understand it’s hard to predict. But given the improved prospect of the economy reopening and tourism and travel coming back, so on an overall basis, assuming that the recovery continues to take hold, is it fair to say that this may be the last quarter where we may see additional sort of material hotel downgrades down the road? Or should it be another quarter or 2 where we see additional hotel downgrades? Are you still sort of assessing how your hotel relationship, like hotel borrowers, are working out, or are we basically largely done?

[Steve Yose:]

So we are taking a very cautious approach. We try to be very timely in our risk rating. And I would say that tourism, we anticipate doing well the next 2 quarters. I think people are getting back to going out and visiting. When you look at our footprint, we have a lot of great places to visit, a lot of great places for people to go and stay in hotels. But we also have some business hotels. I do not see business travel being to the degree that has been in the past and it will hopefully improve in the future. But I don’t see that getting much lift in the next 2 quarters. So that uncertainty and the fact that we really don’t know what’s going to happen with the vacation and tourism season makes me want to pause and also wants -- as I look at financial statements coming in, we have to make sure we have documented cash flow going forward. So I do want to be careful. The next 2 quarters, I would say, is uncertain. I’m optimistic and hopeful, but it’s uncertain.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Borrecco, CEO, for the closing remarks. Mark Borrecco Thank you so much, Emily, and thank you all for joining the call today. As we’ve mentioned, we’re excited about our continued progress. Please reach out with any follow-up that you have, and have a wonderful day. Take care.

[Operator:]

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