Great Western Bancorp, Inc.
Q1 2016 Earnings Call Transcript

Published: 27 Jan 2016

[Operator:]

Good morning, and welcome to the Great Western Bancorp First Quarter Fiscal Year 2016 Earnings Announcement and Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Cheryl Olson. Please go ahead.

[Cheryl Olson:]

Thank you, Kate, and good morning, everyone. Joining us this morning on Great Western Bancorp’s first quarter fiscal year 2016 earnings announcement conference call is Ken Karels, President and Chief Executive Officer; Peter Chapman, Chief Financial Officer; Steve Ulenberg, Chief Risk Officer; and David Hinderaker, Head of Investor Relations and M&A. Before we begin, please note that some comments today may contain forward-looking statements that are subject to certain risks and uncertainties that could cause the Company’s actual future results to materially differ from those discussed. Please refer to the forward-looking statement disclosures contained in the presentation, we have made available on our website, as well as our SEC filings for a full discussion of the Company’s risk factors. Additionally, today we’ll be discussing certain non-GAAP financial measures on this conference call. References to non-GAPP measures are only provided to assist you in understanding Great Western’s results and performance trends and should not be relied upon as a financial measure of actual results. Reconciliations for such non-GAAP measures are appropriately referenced and included within the presentation. We have also included important disclosures about our potential acquisition of HF Financial Corp. We recommend that all listeners especially HF Financial Corp shareholders review those disclosures. Now, I'll turn the call over to Great Western Bancorp’s President and Chief Executive Officer, Ken Karels.

[Ken Karels:]

Thank you, Cheryl, and welcome everyone to our conference call to discuss our financial results. On the heels of finishing a pretty remarkable year in fiscal 2015 we began fiscal 2016 with equal enthusiasm. First quarter net income increased 14% to 30.5 million or $0.55 per share compared to 26.7 million or $0.46 per share for the same quarter last year. Total loans grew nearly 3% during the quarter with most of the growth focusing commercial real estate and ag segments of the portfolio. Deposits grew nearly 4% during the quarter including growth across both our consumer and commercial platforms. Revenue growth and a reduction in non-interest expense resulted in a highly competitive efficiency ratio just 45.1%, Great Western Bancorp's first quarter is providing great momentum for the year ahead. Now, let's take a closer look at the highlights for the first quarter of fiscal 2016. As I mentioned, our first quarter net income was 30.5 million or $0.55 per share compared to 26.7 million or $0.46 per share for the same quarter of fiscal year 2015, that represents a 14% increase. Net interest margin was consistent with the previous quarter at 3.98% while adjusted net interest margin increased by 1 basis points to 3.73%. Net charge-offs for the quarter were insignificant comprised of $0.8 million of recoveries and $0.7 million of charge-offs. The efficiency ratio for the quarter was 45.1% driven by a 4.5% increase in total revenue and a 2.8% reduction intangible non-interest expense compared to the same quarter last fiscal year. total loans grew $205.5 million during the quarter or approximately 3% deposits grew $275.6 million or 3.7%. During the quarter, both balanced across commercial and consumer accounts. Additionally, as we disclosed this morning, our company Board of Directors declared a dividend of $0.14 per common share payable on February 23, 2016 to honors of record as a close of business on February 11, 2016. Now let's hear from a Chief Financial Officer, Peter Chapman are in greater details the numbers for the quarter. Pete?

[Peter Chapman:]

Thank you, Ken. Welcome to everybody who is joining us. We're glad you are spending the time. As Ken said, we're very pleased with our fiscal quarter results. Net interest income was $87.8 million for the first quarter of fiscal 2016 an increase of $3.4 million or 4% compared to the same quarter in fiscal year 2015. The increase was driven by higher loan interest income attributable to loan growth and low deposit interest expense resulting from a lower cost of deposits. Net interest income, net interest margin was 3.98% for the quarter ended December 31, 2015 no change from last quarter declining 7 basis points from 3.91% in the same quarter of last year. The adjusted NIM for the quarter was 3.73% up 1 basis point compared to 3.72% last quarter with loan yield stable when comparing to the December 2015 to the September 2015 quarter. non-interest income was $8.6 million for the quarter ended December 31, 2015 an increase of $0.7 million or 9.4% compared to the first quarter of last year. Included within non-interest income a changes in the fair value of certain loans for which the company has selected the fair value option and the net gain or loss realized and unrealized of the related derivatives used to manage the interest rate risk on these loans. On a net basis these two components of non-interest income accounted for an increase of $2 million. While non-interest income from product and service fees declined by $1.3 million. The bulk of the declines was seen in the low mortgage and wealth management income as well as low recoveries on acquired loans. Deposits service charges increased by $100,000 largely due to the strong commensurate deposit service charges and changed income and other related fees, partially offset by a $0.6 million quarter-over-quarter reduction in overdraft or NSF fee income which we've seen is a trend across the industry. Total non-interest expense was $44.2 million for the quarter ended December 31, 2015, a decrease of $2.9 million or 6.1% compared to the same quarter last year. The decrease in non-interest expense was primarily driven by a $2 million reduction in OREO related expenses, with OREO balances down significantly from the prior year, a $1.6 million reduction in scheduled amortization of intangible assets, decreases in occupancy expenses from branch closings and also professional fees generated through the RPO process in the prior year, partly offset by a $1.2 million increase in salaries and employee benefits, driven by an increased cost of certain roles related to operating as a public company and a net increase in the number of business and ag bankers and also high health insurance costs, and also data processing charges increased as a result of investment in core infrastructure as well as the cash management platform which has been a great driver of deposit growth through the period. We continue to maintain our peer-leading efficiency with an efficiency ratio of 45.1% for the quarter compared to 48.5% for the same quarter in the prior year. On the balance sheet side total deposits grew by $275.6 million or 3.7% during the quarter. Deposit growth occurred within non-interest bearing and also interest bearing transaction accounts, saving and money market accounts, partially offset by continued decline in the higher cost of time deposits. Growth was balanced across both commercial and consumer accounts. FHLB and other borrowings were reduced by $130 million or 22.4% through the quarter as a result of the level of deposit growth and a small reduction in the balance of cash and due from other banks. Tier 1 and total capital ratios were 10.9% and 12.2% respectively as of December 31, 2015 compared to 10.9% and 12.1% respectively as of September 30, 2015. The common equity Tier 1 capital ratio was 10.2% as of December 31 and 10.1% as of September 30, 2015. The Tier 1 leverage ratio was 9.4% as of December 31, 2015 and 9.1% as of September 30, 2015. All regulatory capital ratios remain above regulatory minimums to be considered well capitalized. Our Chief Rick Officer, Steve Ulenberg will now talk to loan and asset quality trends seen through the quarter. Steve?

[Steve Ulenberg:]

Thanks very much, Pete. Loan growth for the quarter ended December 31, 2015 was $205.5 million or 2.8%. Growth was again focused in the agriculture and commercial real estate segments of our portfolio, ags to an increase of a $107.8 million or 5.8% growth with the majority of this ag growth coming from protein sectors rather than from grain. Commercial real estate accounted for a $116.3 million or 4.1% growth. Consistent with the prior years a portion of the growth in agriculture loan balances at the end of the calendar year represented certain customer’s tax planning strategies and is expected to be repaid in the fifth calendar quarter of 2016. The majority of commercial real estate loan growth was driven by construction lending as demand for commercial real estate investment continues to be strong in the many of the company’s key markets and a relatively modest impact of the winter allowed more construction activity the normal in certain geographic areas. Overall, loan growth continues to be focused on the commercial real estate and agricultural segments of the portfolio, in line with our strategy. With the broader concerns in the market about the impact of low oil prices and market turmoil it’s worth repeating as we have said before that overall our energy exposure is a very small percentage of our total balance sheet, at least 1% of our book is in the energy sector. We should also note that Home Federal also has limited exposure to energy in its North Dakota market. We do in fact see energy price declines as a positive for our customers especially farmers and transport industries and many others who use oil for fuel and heating. Provision for loan losses was $3.9 million for the quarter ended December 31, 2015 compared with $3.3 million in the same quarter last year. Net charge-offs for the quarter were negligible compared to prices with $8 million of recoveries and $0.7 million of charge-offs. For the comparable period in fiscal year 2015 charge-offs were a net recovery of $1 million. The ratio of ALLL and loan allowance to total loans was 0.81% at December 31, 2015 this was up from 0.78% at September 30, 2015 and 0.74% at December 31, 2014. Both the specific and general portions of the allowance increased during the quarter with a portion of the growth in the general reserving attributable to loan growth and our further strengthening of our reserve in coverage as mentioned. At December 31, 2015 non-accrual loans were $54.4 million with 4.9 million of debt balance covered by FDIC loss sharing arrangements. Total non-accrual loans decreased by $13.9 million during the quarter and by $14.1 million compared to the same quarter in fiscal 2015. The decrease is primarily due to our warehouse strategies with one significant payoff in the commercial non-real estate portfolio of $7.2 million and partial payments totaling $6.7 million within the agricultural portfolio. Total OREO balances were $15.5 million as of December 31, 2015 and that was a decrease of $0.4 million or 2.4% compared 30, September 2015 and a decrease of $27.9 million or 64.3% compared to last year. Loans on watch status were $298.6 million at December 31, 2015 and that was a decrease of $11.8 million or 3.8% compared to September 30, 2015. While loans on substandard status increased by $46.3 million or 25.2% to $229.9 million. Agriculture substandard lines increased by $46.7 million and commercial real estate substandard loans increased by $14.9 million and this was partially offset by a 15.4 million decrease in commercial non real estate that is C&I substandard loans. The increase in substandard loans is primarily comprised the small number of larger credits which in most instances represent the progression of some assets from our watch loans in fiscal year 2015 through the active workout prices. Management continues to believe that strong secondary sources of payment exists for the majority of substandard loans providing additional safe guards in the event that customers operating cash flows cease to cover debt service obligations. Total credit related charges of $3.5 million for the quarter ended December 31, 2015 decreased significantly from the $7.2 million that was charged in the same quarter in fiscal year 2015. Now, I will turn back to Ken for some closing remarks. Ken?

[Ken Karels:]

Thank you, Steve. We have a lot to be pleased about this morning. Our first quarter result showed strong loan and deposit growth as well as an improvement to our pure leading efficiency. We do expect some volatility and loan balance through the remainder of the year. But we are confident we will be able to deliver mid to high single-digit loan growth for the year. As we have said before and flagged in our last earnings call acquisitions have been a big part of our past and we anticipate there will be a big part of our future. Our announcement on November 30 on the acquisition of Home Federal reaffirms that commitment. We are working through the integration process and obtaining the necessary approvals and anticipation of a close date sometime in the second quarter of 2016. We will continue these types of conversations with other bank. Looking at acquisitions that are attractive, accretive and a line to our strategy. But acquisitions or loan do not shape our success. Organic growth is also key to our vision and we are seeing many opportunities within our footprint. Last month we filed applications for new branches in Scottsdale Arizona and Waterloo Iowa and anticipate opening these new branches sometime late second quarter to early third quarter. We see great growth potentials in these new markets. As always we will continue to invest in growth with an eye on efficiency. Now we are happy to answer any questions.

[Operator:]

[Operator Instructions] The first question comes from Preeti Dixit of JP Morgan. Please go ahead.

[Preeti Dixit:]

Hi, good morning everyone.

[Ken Karels:]

Good morning.

[Peter Chapman:]

Hi, Preeti.

[Preeti Dixit:]

Steve, if we are going to start the increase in substandard loans this quarter, could you give us a sense of how many loans these were and any color on loan sizes as well as what trends do you saw with these borrowers which are of the credit migration in the quarter?

[Steve Ulenberg:]

Look absolutely Preeti, I mean the majority of these I'd say probably three quarters of them reflect just the progress of our ag grand credits with being focused very much on helping the farmers through the more adverse conditions and so that would be the bulk of it. You've all noticed there's been nice steep up and the non-accruals and also we most of those haven't attracted in fact all of them haven't attracted any reserving so we believe we will secure there and we continue to work through to help those some through the tougher cycle they are going through.

[Ken Karels:]

I think Preeti, Ken here. Number wise one large ag credit was majority of the ag piece and one large commercial real estate credit was the bulk of it and as Steve mentioned before both have the strong secondary source of repayment. So obviously felt good about the reserved numbers.

[Preeti Dixit:]

Okay, that's helpful. And how much of the provision expense this quarter was tied to specific reserves on these?

[Ken Karels:]

That's $3 million.

[Preeti Dixit:]

Okay, got it. And just on the watch list loan reduction it seems like some of that was impacted by migration into the substandard bucket so maybe Steve could you give us some color on what inflows more to the watch list this quarter?

[Steve Ulenberg:]

Inflows if you look at the - bulk of the outflow was ag, there was a small inflow probably commercial real estate that comprises one primarily, one account one larger account which is a hotel, waterpark development which is behind the construction site we're just being prudent and managing that through carefully, through that watch process.

[Preeti Dixit:]

Okay got it. And I think last quarter you guys talked about being comfortable with the dollars of provision that you saw last year is that still the case, the cash we think about reserve build from here?

[Ken Karels:]

I would say we’re pretty comfortable. Pete any comment?

[Peter Chapman:]

Yeah, nothing, when you see the coverage we’ve moved up another 3.78 to 81 points over that quarter two.

[Preeti Dixit:]

Okay great. And then one more from me, Peter just outside of the OREO gains look like another really strong quarter on the expense front and cash expenses were down again, how should we think about a good run rate for expense here is this pretty sustainable and then I know you have the defect [ph] cost layer later this year but what’s a good base?

[Peter Chapman:]

Yeah, it’s pretty clean quarter Preeti, you probably get about probably a little over maybe 0.5 million to 1 million benefit on the salary line item just we've done PDO just with the holidays and Thanksgiving in this quarter so you get a little lower on the run rate there from an expense perspective on salaries otherwise it was pretty clean and then same thing is we’re expecting to you guys in the past about defects [ph] will come in probably not until Q3 probably Q4 actually when annualized you would expect a couple of million dollars increase but not until sort of that Q4 at the earliest, so a pretty clean quarter from an expense perspective.

[Preeti Dixit:]

Okay, great. Thanks for taking my questions.

[Ken Karels:]

Thank you.

[Operator:]

The next question comes from Dave Rochester of Deutsche Bank. Please go ahead.

[David Rochester:]

Hey good morning guys.

[Ken Karels:]

Good morning Dave.

[David Rochester:]

Hey sorry if I’d missed this but were there any interest recoveries and some workout efforts you guys talked about?

[Peter Chapman:]

Not material as I said earlier.

[David Rochester:]

Okay, great. And can you just update us on how the recent rate impact should impact NIM in the March quarter and then just update us on your outlook for NIM going forward generally?

[Peter Chapman:]

Yeah the interest rate we haven’t seen much of an uptake obviously given it was light in the quarter, generally, we’ve got a billion dollars in loans that we swap fixed to floating so we’ll going to get benefit on those [inaudible] about 30, 60 days which will be a positive for us, generally I think just over looking at Dave Hinderaker just over 60% of the loans is sort of floating rate so we should get a little benefit there Dave so I’d say a net positive but loan competition obviously stays high. The overall I'm pleased this is probably the first quarter in a long time that loan margins have held so we’re not seeing sort of a bit decline in those going forward but until competition eases up I’d probably wouldn’t say huge decline in those so look - a net slide to slightly up maybe as we move forward before - moving for us.

[David Rochester:]

Great. I appreciate the color and then switching back to credit on the increase in the substandard loans was this at all reflective of your analyzing the annual financial statements of the ag customers we're trying come in between January and April is this like the very beginning of that process or have you not been able to start that process yet?

[Steve Ulenberg:]

Steve here, Dave I’d be happy to answer that. Yes, predominantly that’s what happen I mean the farmers balanced at the end of the calendar year so that’s just that seeing is working through the annual results and we’re reasonably through that process so I'd say probably 50, 60.5 to two-thirds for that process already so that’s exactly what’s that reflecting.

[David Rochester:]

Okay great. And then I guess still on the lines of credit can you guys just talk about how you account for the resetting of the guaranteed price levels for grains that happens this quarter and then how you account for lower cal prices in your reserving methodology?

[Ken Karels:]

Yeah I mean obviously we’ll continue to take a look at cash flow on the grain side of it, so the crop insurance basically is what you’re referring today but that's reset your lower guarantees for the crop farmers and we’ll continue to watch that and it is definitely tight for the grain farmers and projections will be for tight for next year or two that’s where we’re managing those credits very, very carefully [indiscernible], we even set renewals sooner some of those renewals came into this quarter versus next quarter which is typically does, so it will be tighter but again there’s strong, strong collateral for many of these borrowers can withstand it. On the cattle side, we do a lot more called calf operations where there is still substantial profits there we’re seeing that they had strong gains in 2014 early 2015 made a lot of money, gave some of that back through the end of this last year first month or two we’re seeing that now washed through the system and these guys have survived that pretty well with the gains that they had earlier on and I think would then start coming back to profitability as their feeder cattle price has been reset so they can lock some profit in going forward.

[David Rochester:]

And then for your grain guys as you’ve been looking at these financial statements coming in I know you mentioned that it seems like last year the harvest was very good it seems like that was supported by the data are you seeing those trends confirmed now given what you’re saying?

[Ken Karels:]

Yeah, harvest was good that offset some of the commodity price lowering, you always have that reshift though as inventory levels are price down so according that was priced at $3.75 to $4 as now being priced at 3.05 to 3.25 so that necessarily leaned some net worth losses or drops in valuations on it too. Overall so I would say better results from most of them we anticipated but definitely we’ll see some stress and been managing that very-very carefully.

[David Rochester:]

Great. And then just one last one from me on the deposit side, can you just talk about what the main driver was for deposit growth you mentioned it was the two mix, commercial and consumer but is this thing primarily driven by new incentives or cash management products should we expect double-digit annualized growth from here?

[Peter Chapman:]

I wouldn’t expect double-digit growth on it we typically will see a stronger December quarter for us because of the year end and some things that are going with it, but we are focused and our business bankers are now incentivized on gathering deposits along with loans so we’re seeing the benefit of that we are starting to see the benefit in our cash management, we’ll be rolling out some more of that this next quarter and I think that will help us continue to grow. And we are focused on the business side of the - along with the consumer side of it. We’ve done some small specials in the money market side of it nothing out of the ordinary something similar we did a year ago to raise some money. But I think in general it’s more focused by our organization than it has in the past and that’s led us some growth. But I think along with loan growth we expect to see mid to high single-digit growth in deposits.

[David Rochester:]

Great all right. Thanks guys.

[Operator:]

The next question comes from Erik Zwick of Stephens. Please go ahead.

[Erik Zwick:]

Hi. Good morning everyone.

[Ken Karels:]

Hi Erik.

[Erik Zwick:]

I'm curious if can you provide our estimated percentage of the agriculture growth in the quarter versus related to the tax planning strategies?

[Peter Chapman:]

Probably about half of it I would roughly say a little bit less than we had last year about half of it.

[Erik Zwick:]

Okay great and with regard to the Fed fund increase late in the quarter have you seen any changes in the markets from your competitors and deposit pricing to this point?

[Peter Chapman:]

Actually haven’t Erik, it’s we haven’t, we’re monitoring that pretty closely with our retail managers and we haven’t really seen any moves in significance.

[Erik Zwick:]

And finally just are you able to provide any color into which markets provided the strongest growth in the most recent quarter loan growth?

[Peter Chapman:]

Yeah Arizona and Colorado, Erik from a growth perspective has been pretty strong as we noted in the releases there’s been a pretty mild winter in this part of the world as well so that’s led to some stronger drawdowns on the construction side that we ordinarily see and also in Nebraska region has had a really good quarter as well particularly in the Omaha market which is a pretty strong economy as well.

[Erik Zwick:]

Great, thank you. That’s it from me.

[Operator:]

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

[Damon DelMonte:]

Hey good morning, guys. How are you doing today?

[Ken Karels:]

Good, how are you doing?

[Damon DelMonte:]

Great, thanks. My first question relates to the increase in security yields this quarter. There was a reference in the press release is that more reflective of repricing of the current portfolio or were there additional purchases made?

[Peter Chapman:]

Probably a reflection of that rebalance stand we had over the last 12 months so we’re now at about 60% [inaudible] going back to this time last year, I don’t have numbers in front of me but it was significantly higher than that so really probably just a reflection of the re-balance of the portfolio as well as some purchases through the quarter at some opportune times.

[Damon DelMonte:]

Okay all right. That’s helpful, thanks. And then can you talk a little bit about the construction lending this quarter more along the lines of what size of loans you’re doing and what types of projects?

[Ken Karels:]

Steve.

[Steve Ulenberg:]

Steve here. You need to look at absolutely I mean this is, Pete mentioned some of you know some of the growth in Colorado-Arizona market so there’s been growth there. These are construction loans which we’re very comfortable with good equity and covering a range of industries, hotels, tourism, health, hospital, retirement, villages and so we’ve got a number of multi-million dollar exposures there where we’ve got strong support, strong equity but that’s predominantly the look and feel for it.

[Peter Chapman:]

And on those I would say that there’s no real outlines from the size perspective they're all in that sort of $5 million to $15 million range, so sort of in the range of where the rest of the portfolio is not really sort of a large exposure.

[Damon DelMonte:]

Okay, great. And then just lastly, I know you said you had minimal energy exposure about 1% of your portfolio. Have you seen any stress in that aspect of your portfolio yet?

[Peter Chapman:]

It’s actually less than 1% it’s very, very small and we would probably say none, so there really isn’t a…

[Ken Karels:]

The answer is no.

[Peter Chapman:]

Yeah.

[Damon DelMonte:]

Okay perfect. That’s all I had. All my other questions have been answered. Thanks.

[Operator:]

The next question comes from Tim O’Brien of Sandler O’Neil. Please go ahead.

[Tim O’Brien:]

Good morning.

[Peter Chapman:]

Good morning Tim.

[Tim O’Brien:]

Just regarding the substandard ag credit, I think can you mention that that’s predominantly related to one credit the $46 million uptick in ag?

[Peter Chapman:]

Yeah about 30 of its one credit right.

[Tim O’Brien:]

And so beyond that what’s the largest Ag credit core relationship to one borrower do you have?

[Peter Chapman:]

I think I don’t know have we disclosed that before or not I don’t think we’ve disclosed that Tim. Our internal limit, we have - our internal limit is 75 million and it’s obviously less than that we have to any one ag credit, dairy is I think our largest credit right now dairy relationship that we have on to something probably 20, 25 million below that…

[Steve Ulenberg:]

Yeah.

[Peter Chapman:]

So under $50 million would be our largest ag credit.

[Tim O’Brien:]

Great. And then it was good to hear about the branch expansion plans do you have any additional plans to perhaps consolidate branches here this year?

[Peter Chapman:]

Well, we also had announced last quarter we closed three branches so they're being closed January 31st is that correct…

[Steve Ulenberg:]

Yeah.

[Peter Chapman:]

And so we’ll continue to always looking at that and if it makes sense we will consolidate them. We did announce with the Home Federal acquisition that we’d be closing three of our branches, one of their branches with that acquisition and we’ll continue to looking at that too, but we’ll continue and see what makes sense. I would say though generally we’ve gone through most of the branch closings and the ones that will be ones, to these going forward.

[Tim O’Brien:]

Great. Thanks for the color there. And then last question on the construction, new construction footings you guys put on geographic markets specific is demand stronger in any of your specific markets?

[Steve Ulenberg:]

Yeah, Steve here. Tim, as mentioned we’re probably seeing more demand on the Colorado-Arizona region but there is a reasonable balance across for both of that would we saw the most growth in the last quarter.

[Tim O’Brien:]

Thanks for answering my questions.

[Operator:]

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

[Ken Karels:]

Okay. Thank you for taking the time this morning. Fundamentally, things remain very, very sound with Great Western Bank, even midst of turmoil that are in our country and the world’s going through right now, so we’re very, very confident about the future of Great Western Bank. We’ve had good balanced loan and deposit growth this last quarter. As I mentioned we’re very optimistic in maintaining mid to single-digit loan growth into the future. So, thank you for taking the time this morning. We appreciate it.

[Operator:]

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