WTBA (2020 - Q2)

Good morning, and welcome to West Bancorp quarterly earnings call. [Operator Instructions]. I'd like to turn the conference over to Mr. Doug Gulling, Chief Financial Officer. Please go ahead. Douglas

Okay. Thank you, Nick. Good morning, everyone. Thank you for joining us. With me on the call today are Dave Nelson, our Chief Executive Officer; Harlee Olafson, our Chief Risk Officer; and Jane Funk, our Chief Accounting Officer. And I'll begin 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 statement 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. I'll turn it over to Dave Nelson to start us off.

Thank you, Doug. Good morning. Thank you, everyone, for joining us. We appreciate your interest in our company. We had an excellent quarter, and we are significantly ahead of where we were at this point during last year's record year, plus we have set aside more in reserves for potential future loan losses, and Doug will provide more detail on the drivers behind the performance with a large one being the performance of our Minnesota expansion. While we currently have an absence of past due loans or overdrawn accounts, we have extended many helpful payment modifications where needed. In terms of what the economic impact of COVID and the shutdown will ultimately have on our customers and our community, remains to be seen. We will hope for the best but plan for some trouble and challenges. Harlee will have more comments on credit quality, but we believe that being a bank of first choice versus a bank of last resort will prove to be strongly in our favor. And in terms of COVID-19 operational issues, we have implemented many protocols, no doubt, similar to what all of you have done. But despite limiting physical access and many employees working from home, I remain unaware of a single example of where a West Bank customer has been unable to receive requested service. Pertaining to the PPP, proud to say we really outpunched our weight class with the PPP program. We did over 900 PPP loans. I think we actually have 914 active PPP loans totaling approximately $224 million, and we are all anxiously awaiting final instructions on the forgiveness process. Based on our quarterly performance, our Board of Directors has approved a $0.21 dividend with a payment date of August 19 to shareholders of record as of August 5. That's -- those are my prepared comments. And with that, I'd like to turn the call over to Harlee Olafson, our Chief Risk Officer.

Well, thank you, Dave, and good morning, everyone. I'll talk about our credit and where we're currently at, and then more importantly, some color in regard to our modifications and what's been going on there. Currently, our watch list is very low, and it has actually declined from $51 million at the end of last quarter to $33 million on June 30. We had one past due loan at the end of June over 30 days, and that was in the amount of $15,000. So we currently don't have any as Dave mentioned any past due issues or overdrafts or things such as that. All of the concern, of course, is for the future, where will credit problems come from? And when will that happen? The major segments of our commercial real estate portfolio, for example, are: we have $260 million in apartment loans; $110 million in senior living accommodations; office, commercial real estate of $159 million; medical office buildings of $120 million; warehouse, warehouse real estate of $180 million; hotels of about $150 million. Most modifications that we granted were in the commercial real estate portfolio. The length of the modifications range from 2 months to 6 months. About 75% of the modifications still require monthly interest payments. Deferral of P&I payments have been granted to businesses that were virtually closed in April and May, mainly the hospitality business. On our hotel portfolio, we are tracking monthly occupancy and revenue on the hotel properties that have reopened. In April, most of the properties were either closed or marginally open. In May, most reopened and the range of occupancy that we saw in our hotel properties went from a low of 10% occupied to a high of 59%. In June -- and we don't have all of the reporting in June on the hotel properties, but the range of occupancy improved from 19% to a high of 64%. And then I would also qualify that our average loan-to-value in the motel portfolio was around 65%. And the majority of the flags are Hilton or Marriott with a couple of Holiday Inns. So as Dave said, currently, we're not showing the stress right now due to the fact that some of the properties are in modifications. We had a number of borrowers that ask for modifications, I think, from just being careful perspective of saying, "Hey, we can just pay interest-only for a few months here, we'll retain cash and put ourselves in a position of having liquidity in case there's -- this situation lasts longer and becomes more troublesome than they know what is at the current time." So we are trying to stay in close touch with our customer base, and they're being very good at providing information to us and telling us where they're at. Currently, we don't have the problem -- any problems that have surfaced in payment problems or lack of cash or anything such as that. But as Dave said, we are prepared to deal with problems if they do occur. And with that, I'm going to switch horses and talk about what are -- what's been happening in regard to our sales side and our outlook and those type of things. In the last 2 months, we have closed over $140 million in new business. That's in addition to all the PPP loans that we did. And of that $140 million, about $30 million of it was medical office property, $25 million in manufacturing, $25 million in C&I and about $50 million in other commercial real estate. We still have a very active pipeline. Obviously, we have more markets and more bankers out selling product right now, which helps us be very efficient and athletic, I'd say, in our markets. The pipeline, I believe, will slow down to a certain degree as we keep going, especially if the economies continue to be modestly closed, and people are going -- are delaying their ventures that they had had started on or were preparing to do. So we do see some pullback in areas such as that. But I do think there still is room for some modest growth in our portfolio overall. When we did our PPP loans, we also noticed that we had a number of our customers that were paying down lines of credit or augmenting their DDA balances as the PPP loans came in. And if you'll note, even in our financials, you'll see our noninterest-bearing deposits in our accounts are about $200 million higher than they were a year ago. So with that, I'll sign off on my portion and give it back to Doug.

Okay. Thanks, Harlee. I've just made some general comments regarding our results year-to-date. And here's how we would summarize our performance so far. Net interest income is up nicely due to 2 things. One, our earning asset base is higher due to a number of factors; the Minnesota expansion; the PPP loan program; and then our margin has expanded primarily due to the fact that the Fed dramatically cut rates in the middle of March. And as a result, we adjusted a lot of our -- well, we adjusted all of our deposit rates. And so our interest expense on deposits has declined quite a bit. And then in addition, our expenses -- our noninterest expenses are actually a little bit lower this year than they were last year. And that's attributable to the fact that we had some onetime Minnesota start-up costs last year. We do have fewer FTEs this year than we had last year. And we renegotiated our core processing contract. And so that expense is lower than it was a year ago. And so all of those positive attributes allowed us or more than covered the fact that we have added a lot more to the provision -- or to the allowance this year through the provision for loan losses, putting in $3 million here in the third -- second quarter and $1 million in the first quarter. So we have provided for $4 million of potential losses so far this year. I suppose people may wonder, okay, what are we going to do going forward? Well, of course, sitting here today, we don't really know for sure. We make the determination on the allowance at the end of each quarter. And what we end up putting in the allowance will depend upon how long this pandemic is predicted to be with us, how soon is a vaccine coming, so on and so forth. But sitting here today, I think we would not be surprised if our provision in the third and fourth quarters were similar to what it had been in the second quarter. But with that, we will pause and answer any questions.

[Operator Instructions]. First question comes from Brendan Nosal of Piper Sandler.

Just want to start off on the deferrals here. So it looks like they moved up quite a bit from kind of the initial number you disclosed last quarter. And now they're sitting at 28% of total loans outside of PPP. So can you just talk about some of the dynamics within the deferral bucket that drove the increase from last quarter?

Sure. This is Harlee. Depending upon the timing of when those occurred, probably was generated, depending on what time of the month they happen, when the discussion happened. And a lot of the deferrals that occurred, we asked for specific information from the borrower regarding what's your cash burn going to be? What's your balance sheet going to look like at this time? What are your sources for additional capital? Do you really need a deferral or are you asking for deferrals so you can retain cash because of the ongoing uncertainty within the market? So really, that's what the flavor is. And I think what you need to remember again, about 75% of the deferrals are still paying their monthly interest charges. So really, they're only deferring principal payments for a fairly short period of time.

Got it. Okay. And then with kind of the range of the deferral from 2 to 6 months, I'm just curious, when is the bulk of the $553 million start to roll off? And then as they do, is your expectation that most will request an extension of some form? Will they return to normal payment activity? Or how much movement will they be to nonaccrual?

I would guess that most will not request an extension. And our -- again, I feel our portfolio and borrowers are really -- are very strong across the board and have significant ability to accomplish and pay their debts as they come due. So I do not have anything flagged at the current time that will move to TDR or to nonaccrual.

Okay. All right. Great. And then moving on to the reserve, I appreciate your comments of kind of a provision potentially similar to this quarter for the rest of the year. I mean, as you think out across the next couple of quarters, is that enough in your mind to get the reserve to where you think it needs to be kind of just given how high the level of deferrals is? Or is there a potential for -- in a couple of months, you kind of look back and say, maybe we need a little bit more?

Well, I think, Brendan, at this point in time, based on the information we have, we really -- I don't have anything else to say other than what we have. I mean, as time moves on, and we get better or different information, we'll react accordingly. But I think it's -- if indeed our modifications track, as Harlee indicated, I wouldn't anticipate that we would have to add more than what we've talked about. But it just really depends on what -- how things have -- what happens over the next couple of months.

Yes. I totally understand. I guess, in my mind, I was just trying to balance how clean your traditional credit metrics are today versus the number of loans that I've asked for assistance. But I appreciate the color. I wanted to move on to the dividend. And obviously, you guys opted to hold it stable as opposed to increasing it this time of the year like you have in the past, but still stable nonetheless. Just spend a moment on how you feel about capital levels overall and your thoughts on how committed you are to maintaining the dividend where it is?

Well, we'll look at capital levels first and projected capital levels when determining the dividend level. I mean, we certainly want to maintain it where it is. But if things really would deteriorate from what we believe will -- the case is now, we may have to look at a dividend cut. But right at this point in time, we don't anticipate that happening. As far as capital levels, our pure equity-to-asset ratio has declined here at June 30 from where it had been in the past, but that's really for 2 reasons. One, our accumulated other comprehensive income is negative due to the valuation of the interest rate swaps we have that with the decline in interest rates, the value of those swaps are more negative. And of course, over time, all things being equal, that will improve just as the age of the swaps get greater and get closer to maturity. But the other thing that has happened is the denominator in that calculation is probably artificially inflated due to all the PPP loans. And so we would expect over the next 6 months or so, a lot of the PPP loans will pay back. And our asset size will decline a little bit. And the pure equity-to-asset ratio will improve somewhat. All of our regulatory ratios are well in excess of the requirements to be well capitalized, and we have an informal policy, if you will, of maintaining those ratios at least 100 basis points in excess of the requirements to be well capitalized and that's the case with all of the regulatory ratios.

Got it. Perfect. And then last one for me before I step back. Just looking at the NIM, obviously, a really nice result this quarter as you guys benefited from the reduction in funding costs quarter-over-quarter just in reaction to what the Fed did. I'm just wondering, how much more room is there to run on the deposit cost side and then as it pertains to the margin outside of the volatility from PPP, is there any more room for expansion next quarter and through the end of the year?

I doubt it, Brendan. There might be a few basis points, but nothing significant because I really don't believe that there's much more room on the deposit side. Now we did have Federal Home Loan Bank advance, mature in -- on June 22, I believe it was. And we had a forward swap in place and have kind of rolled that borrowing into short-term borrowings, but with a long-term swap around it, and we save a couple of hundred basis points there, and we've got another Federal Home Loan Bank advance coming due on September 20th, give or take, for $30 million, and the same thing will take place there, we'll save a couple of hundred million -- or a couple of hundred basis points on the cost of that borrowing. So we do have that coming. But beyond that, I don't see anything that's going to impact the margin significantly.

[Operator Instructions]. At this time, we have no additional questions. We'll return the call back to Mr. Doug Gulling. Please go ahead.

Okay. Well, thank you, Nick, again, and thank you, everyone, for joining us. That is all of our comments, and we appreciate you joining us and having an interest in our company. Thank you.

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