West Bancorporation

Good afternoon. Thank you for attending today's West Bank Corporation fourth quarter 2022 earnings call. My name is Megan and I'll be your moderator for today's call. All lines will be muted in the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host, Jane Funk with West Bank Corporation. Jane, please go ahead.

Thank you. I'm Jane Funk. I'm the CFO of West Bank and West Bank Corporation. Just want to welcome everybody to our fourth quarter and year-end 2022 earnings call. Today I've got with me Dave Nelson, our CEO and President, Harley Oleson, Chief Risk Officer, Brad Winterbottom, President of West Bank, and Brad Peters, our Minnesota Group President. I'll start out with our fair disclosure statement. Comments made during this conference call may contain forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements made by us during this call is based only on information currently available to us and speaks only as of today's date. The company undertakes no obligation to revise or update such statements to reflect current events or circumstances after this call or to reflect the occurrence of unanticipated events. And we'll go ahead and kick off the comments. We'll start with Dave Nelson.

Thank you, Jane, and good afternoon, everyone. Thank you very much for joining us, and thank you for your interest in our company. I have just some general comments, and then we'll turn it over to others for more details. During 2022, West Bank had the second strongest earnings year in our 130-year history. During 2022, we fell a little short of our 21 earnings, but I'd like to point out that our 22 earnings were about 47% higher than what they were during 2020, and 2020 was also a record year. During this past year, we experienced growth in all of our markets, which resulted in net loan growth of about 11.7% on the year, and our credit quality remains very good at year-end 12-31-22, and also end of the fourth quarter represented the sixth consecutive quarter where we did not have a single loan past due 30 days. The Fed rate hikes have put pressure on our margin, and Jane will speak more on that topic. But based upon our fourth quarter performance, our board of directors declared a quarterly dividend of 25 cents per common share. The dividend is payable on February 22nd of 2023 to stockholders of record as of February 8th. And with that, I'll now turn the call over to our Chief Risk Officer, Mr. Harley Olofsson.

Thank you, Dave. I am happy to report credit quality continues to be a major strength at West Bank. As Dave said, for a sixth consecutive quarter, we have zero past dues over 30 days. I believe this not only attests to the strong payment ability of our customers, but also attests to the administrative ability of our bankers. We have no OREO and only one loan on non-accrual. That one loan continues to perform as agreed and is well secured. Our watch list is less than 2% of total loans. Financial information received from our customers would suggest that a majority of what is currently on the watch list will be upgraded after receipt and review of year-end financial statements. Rising interest rates will and have slowed residential and commercial development. Four percent of our total portfolio consists of land for development, land being developed, and completed lots for sale. The customers holding these assets have significant equity and ability to hold property until economic times are more favorable. Our top five concentrations by type are C&I business 20%, multifamily 13%, construction 13%, and office and medical office 13%, and warehouses at 10%. Even though current information looks really good, we continue to stress test our portfolio and our individual borrowers. Our practice of doing business with customers that have strong financial positions and good management has served us well. We expect the economy will provide challenges this year, but we feel we are in an enviable position to deal with those challenges. Before I turn it over to our bank president, Brad Winterbottom, I will mention that our Eastern Iowa team has continued to thrive. Loan assets grew substantially this last year, and the group has continued to bring in new relationships. With that, I'll turn it over to Brad.

Thanks, Harley. For the quarter ended December 31, 22, excluding PPP loans, our loans outstanding grew just under 5% or $128 million to $2.7 billion at the end of the year. This growth during the quarter was driven primarily by some significant commercial real estate transactions. Significant and some long-term customers closed on real estate purchase transactions, which we assisted, along with a few refinance transactions. For the year ended 22, excluding PPP loans, our loans outstanding grew just over $300 million, or 12.7%. This is the third consecutive year in a row and four years out of five that loan growth has exceeded double digits annually. We saw growth in all markets, roughly equal growth from the Iowa and Minnesota markets this year and are pleased with these results. As for the loan pipeline, as we enter 2023, there is some slowness in the activity with the rising interest rate environment, refinance opportunities are much less. We also hear from our customer base that they are much more cautious going into this year. Our sales team, though, continues to set appointments and see customers and prospects on a daily basis looking to enhance a relationship. Regarding the deposit gathering side of the bank, our retail customer base produced a 4% increase in total deposits held at the bank. Our commercial customer base, on the other hand, experienced a decrease in total deposits. This decrease was the result of excess funds held by the customers either looking for a better return or using these funds to fund their growth or making acquisitions. We have not lost customers, rather just a reduction in deposits maintained. We continue to focus on deposit gathering activities with our sales team and their calling process, as mentioned previously. I'll also add that in early January, we added another seasoned banker in our eastern Iowa market that is beginning to make positive marks in terms of moving assets to the bank. With that, I will turn it over to Mr. Peters.

Thanks, Brad. Good afternoon, everyone. I'm going to provide a brief update on our expansion into Minnesota. Our team continues to make solid progress in growing each of our Minnesota regional centers. Our bankers are focused on relationship building and our activities and targeted calling are creating ongoing new business opportunities. We continue to grow our business by adding new relationships focused on CNI. This focus has driven strong core deposit growth and treasury management business. We're also seeing line usage increase, which has benefited our margins. The Mankato Market has begun construction of a new facility with plans to open this summer. The Owatonna Market is exploring sites for a new building, and we're close to finalizing plans to purchase the land. Those are the end of my comments. I will now turn it back over to Jane.

Thanks, Brad. I'll just make a couple comments on our financial highlights. For 2022, this was, as Dave mentioned, our second best financial performance year in the company's history. 21 and 22 were both very strong compared to the years prior to that. We recorded no provision for loan losses in the fourth quarter and had a negative provision of $2.5 million for the year. As Harley mentioned, our credit quality remains extremely strong. We continue to closely manage our expenses during this period of inflation and and experienced a very reasonable 3.9% increase in non-interest expense in 2022. And that would have included increase in salary and benefits related to the addition of five bankers through late 2021 and into 2022. As it relates to margin, our non-interest margin was 2.49% for the fourth quarter compared to 2.78% for the third quarter. Our loan yield increased to 4.63% for the fourth quarter compared to 4.34% for third quarter of 2022 and 4.07% for the fourth quarter of 2021. This yield improvement was outpaced by the increasing cost of funding. Our deposit costs increased to 1.99% for the fourth quarter compared to 1.16 for the third quarter and 36 basis points for the fourth quarter of last year. Brokered deposits and short-term funding increased in the second half of the year. With the drop in longer-term rates since October, we've been evaluating and executing various long-term funding and swap transactions to convert some of our short-term funding into three- to five-year fixed-rate terms. Our deposit-based sensitivity to the rate changes has been magnified by the extreme nature of the rate movements this year and the competitive deposit activities in our markets. Our efficiency ratio has increased to 50% in the fourth quarter from the low 40s earlier in the year, primarily due to the decline in the net interest income. That's the end of my prepared marks, and now we will open it up for questions.

Absolutely. If you would like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason you would like to remove that question, please press star followed by 2. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. Our first question comes from the line of Brendan Nozzle with Piper Sandler. Your line is now open.

Hey, good afternoon, folks. How are you doing?

Hi, Brendan. We're doing good. How are you?

Good. Thanks. Good. Maybe just to start off here on the asset side of the balance sheet, another very strong year for organic loan growth for you folks. No surprise there. I know you mentioned kind of some softening in the pipeline, given where rates are today. Just kind of curious if you have any early thoughts on how you expect the loan growth to shape up for 2023.

Really? No. I mean, our, our, Pipeline's okay. I've seen it stronger, but I'm aware of transactions that will be funding, but I'm also aware of transactions that will be paid off due to the sale of the assets. So I would not anticipate the kind of growth that we had in the fourth quarter and the first, but our guys are out busy.

Understood.

No doubt.

Okay. That's fair. That's fair. But helpful color nonetheless. Maybe turning to the securities portfolio, just kind of curious in the context of trying to fund future loan growth, how much of the securities book cash flows in 2023?

There will be about $70 million of principal that will roll off, that's projected to roll off of the investment portfolio in 2023. Okay.

Okay. And then I think that probably ties into my next question on just funding future loan growth. Certainly seems like securities roll off and can help with part of that. But just kind of curious, how do you view the balance of the funding question for, you know, whether it's core deposits or wholesale funding? What are the ambitions for this year?

Well, I think that the funding side will come from various sources. There's not a magic bullet or an all-in process here. So we are certainly focused on building core deposits. That is as much of the efforts of the bankers as lending is. So core deposits, we will continue to use brokered deposits and federal home loan bank advances and really just kind of manage the cost side with those options and evaluating whether, you know, short-term versus long-term pricing makes sense, depending on our success with the deposit side. But certainly deposits are a strong effort for the organization this year.

Yep, yep, okay. maybe on deposit pricing itself. What is your sense for where you folks are in this deposit pricing cycle? Are we partway through? Are we nearing the end here? What's your sense?

Well, I would say that probably depends on what the Fed does. Our deposits are a little bit more sensitive, I think, to the Fed rates than some other portfolios, which you can see in our fourth quarter numbers. So, you know, the sooner the Fed slows down or stops, the sooner that we can start making gains on and improvements on the cost of funding.

Okay. All right. I would imagine at this point, Fed rate cuts would probably be a benefit to your margin. Is that correct?

Yes. We're liability sensitive. So to the extent that these, you know, 425 basis points of Fed rate increases has had a pretty good impact on us, a reversal of that would have some immediate impact benefit.

Okay. All right. maybe on the margin more broadly. You know, certainly more pressure than I was expecting, but that's kind of a universal theme out of the bank space this quarter. I mean, for the NIM going forward, I would imagine it's pressure until the Fed does pause or hopefully kind of reverse course here. I mean, is a quarter like this not out of the question in terms of, you know, compression in the first quarter?

You know, I think... Our net interest margin, there's so many variables, it's hard to necessarily provide some future guidance or forecast. But, you know, depending on our success with deposit efforts, if the Fed, you know, we can certainly handle like 25 basis point increments of Fed rate changes as opposed to 75 basis points. So, you know, there's just a lot of variables that will go into net interest margin. these next few quarters as hopefully the Fed slows down or pauses on their rate increases.

Yeah, of course. I know that it's certainly not an easy thing to conceptualize. Okay. Maybe on the moving to the expense side of things, just kind of wondering what leverage you have, if any, at this point to combat the impact of margin depression. And any thoughts on kind of the pace of expense growth as we move forward?

Yeah, I would expect expense growth to be very modest. I mean, certainly we're very cognizant of you know, our non-interest expenses. We've always been very efficient. You know, our efficiency ratio has always been one of the best in the industry. So, you know, to that extent, there's not a lot of places to necessarily trim expenses, but certainly we are monitoring closely any additional expenses, you know, looking at the purpose, the benefits, the investment that those relate to. Our biggest, like I mentioned, our biggest increase in 2022 related to the addition of bankers. And so we will see the benefit of those costs as they have a little bit more time to season with West Bank.

Okay. All right. That's helpful, Collar. Maybe turning to credit quality, obviously the book remains impeccably clean. Not a single number I can look at that suggests that anything could go wrong anytime soon. But just kind of curious what you're hearing anecdotally, whether there's any number or conversation you can look at and say, hey, this indicates we might be heading for a turn.

The portfolio that we have has... stood a pretty good test of time in regard to what they do. The issues with our CNI customers have been that they have had a lot of liquidity and have had a lot of success the last few years. And that stayed that way from what we can tell in 2022 regarding the information we've received so far. So I don't see a issue there. Multifamily, the has been strong in regard to strong rents have increased and in fact are probably increasing their NOIs as we go. Office and medical stayed very strong and warehouses are very strong. So we are vigilant to continue to review quarterly financials, monthly financials, but I don't have anything today that says this is go in the wrong direction.

Got it. Perfect. Perfect. Um, and then on, on the allowance, um, so kind of a, a bit of a bleed down in the reserve to loan ratio this quarter. And did you feel like we're, we're nearing a point where you want to kind of hold the line at that 93 basis point level?

Well, we, yeah, I mean, that was, you know, pre-pandemic, we were in the low 90s. So that was kind of a, you know, a benchmark, I think, for us for normal operating procedures. We will be adopting CECL effective 1.1. So that's going to, I guess, throw a whole other layer of complexity into the provision and the allowance for 23.

Yeah, yeah, of course, of course. Okay. Okay. And then maybe one final question from me before I step back. Just hoping you can kind of lay out your capital priorities as we turn the calendar on a new year. Certainly not to see TCE and tangible value start to move back up, but just kind of curious how you're thinking about that this year.

Well, probably the same way we always do. I mean, we did some capital injection in – in June 22 with sub debt issuance. So we think our core capital regulatory capital, our bank level capital is very strong. I mean, we're well above the wealth capitalized requirements. The investment portfolio, the impact of AOCI has actually improved in the last couple months of the year. So as the portfolio kind of pays down and rates stabilize a little bit more, that in and of itself kind of stabilizes that number. So as Dave mentioned, we declared a dividend this week that's in line with historical dividend payments. And so I don't see us making any wholesale changes in our procedures or our processes for that.

All right, perfect. Well, thank you so much for taking all the questions.

Thanks, Bryn.

Thank you. There are currently no additional questions waiting, so as a reminder, it is star 1 on your telephone keypad. Our next question comes from the line of David Welch with River Oaks Capital. Your line is now open.

Thank you. I don't know who to address this to, so I'll just throw it to the group. And as a kind of background, I grew up in Iowa and I made a career in Minnesota. I see a lot of banks like yours that have great ability to generate loans, not so great the ability to bring up core deposits. And I'm not advocating the following, but I'd like your thoughts. Minnesota and Iowa are both just littered with rural trade center banks and that have, you know, 40, 50, 60% loan to deposit ratios would fit really nicely in this environment. For you, I know it's not a short-term fix, but do you see any interest in augmenting your funding base like that over time?

David, hi. This is Dave Nelson, and we appreciate you joining the call, and thank you for that question. And What you're suggesting is something that we've certainly always would be open to. But when it comes to having or developing an interest like that, what would be very important to us is to what makes West Bank so unique and enviable is really our business model and our efficiency and focus on being a commercial bank. And so if we were to look towards any type of strategic partner would be in alignment with our own business model.

Okay, yeah, no, again, I'm not advocating. I'm sure you're familiar with Bridgewater Bank up here. They announced results, same timeline. They're down 10% today because they can't fund their loan growth. And I was just wondering if you were going to possibly modify the strategy over a multi-year period. But I thank you for your thoughts.

Thank you.

Thank you. There are currently no additional questions waiting at this time, so I will pass the conference back over to the management team for any closing remarks.

Well, this is Jane again. I just want to thank everyone for joining the call today and listening in, and we look forward to our next call at the end of the first quarter at the end of April. So thanks for joining.

That concludes the West Bank Corporation fourth quarter 2022 earnings call. Thank you for your participation. Have a wonderful day.