WTBA (2020 - Q3)

Good day, and welcome to the West Bancorporation Third Quarter 2020 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Doug Gulling, Chief Financial Officer. Please go ahead. Doug Gul

Yes. Thank you, Andrew, and good morning, everyone. Thank you for joining us this morning. Also on the call today are Dave Nelson, our CEO, Harlee Olafson, our Chief Risk Officer, Jane Funk, our Chief Accounting Officer and Brad Winterbottom, our Bank President. 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. And to begin the call, Dave Nelson will start us off.

Thank you, Doug, and good morning, everyone. Thank you for joining us. We appreciate your interest in our company. I have just a few general opening comments, and then I’ll turn it over to others for more detail. As I think you all know, we just had a record quarter and hopefully on our way to yet another record year despite setting aside significant higher provision this year. Just a couple of general COVID comments. We continue to have people working from home and are observing and practicing all the appropriate COVID protocols that no doubt all of you on the phone are doing as well. We’re very – in terms of our PPP participation, as I think you know, we’ve really outpunched our weight class with that, and we are now busy working through the forgiveness phase. Based on our performance, our Board of Directors declared a dividend of $0.21 per share, which remains unchanged, still at the highest level that we’ve paid. The payment date is November 25 to shareholders of record as of November 11. I’d also like to add that our Minnesota expansion is going incredibly well. As I think you all know, last year, during 2019, our – we – our fully expensed expansion into Minnesota and to St. Cloud, Mankato and Owatonna and joined by our existing presence in Rochester, Minnesota is going very well. And we have purchased land and have completed the design process for our building in the St. Cloud area, actually it’s in Sartell, Minnesota, which is adjacent to St. Cloud, and construction is underway on that new facility. So with that, I’d like to turn the call over to Brad Winterbottom, our Bank President.

Good morning, everyone. My comments will be brief. I’m going to talk a little bit about our sales activities. Absent PPP, we’re up about 4.5% through the first nine months of this year. The pipeline is – I won’t say it’s robust, but we still have a fair amount in our pipeline that we’re working on. We have a couple of headwinds that will hit us in the fourth quarter. We have a couple of long-term customers that have sold their business. And I would anticipate some pay down there, some significant pay down, maybe to the tune of $20 million. On the other side of that coin, though, is we have construction projects that are going in all areas that we do business in. And I would say that we have between now and probably a year from now, another $100 million of construction loans that will be advanced on projects. Our bankers are not only working on the PPP forgiveness, but the business development people are doing just that. It’s a little harder. People are cautious in terms of letting our folks have face-to-face. But we are working on that. And, again, we’ve added about 4.5% of new loans, and that has really come from all markets, but especially up into our three new markets that we entered into last year. Those would be my comments. I’m going to pass this over to Mr. Harlee Olafson.

Yes. Good morning, and, again, thank you for your interest in our company. I’m going to talk about our credit quality, watch list, COVID modifications and then some specifics in regard to individual communities and how – what the environment is there. On our watch list, our total watch list right now, which include watch credits, non-accrual credits and everything in that category totals $47 million. And although our level is up, that still is less than 2% of total loans, which is historically low when you look at watch lists in general. Of those loans that are in our watch list, we really look at one of the credits as having the ability to possibly have some loss potential in it. We don’t see it as of today. The collateral on it appears to be adequate to cover the principal balance on the loan. But if things don’t work out correctly, we could have some small level of loss in that loan as it kind of liquidates. When we look at also the level of additions to our allowance through the course of the year, we’ve put in $8 million, and we fully believe that that exceeds our loss potential in anything in the watch list. So anyway, moving on from the watch list; COVID modifications. We have a fairly robust commercial real estate portfolio. It includes apartments, warehouse, office, mixed-use hotel, medical office, senior living centers; all of those different types of categories. As with most areas, the entertainment and hospitality areas of business have been affected the most by COVID-related issues. Just for example, in our hotel portfolio, and looking at occupancy percentages over the last six months, April and May were very close to zero in June, the occupancy percentage in our hotel portfolio, on average, moved up to 36%. In July, it moved to 40%. August, it moved to 57%, and then it fell off in September, back down to 50% and although that isn’t great. It’s still – it not catastrophic either. In looking at the COVID modifications on our hotel properties. The average loan-to-value on the properties we provided or have modifications on currently is 62% loan-to-value. And pre modification cash flows on those properties exceeded 1.5 to 1. So these are good properties that under normal circumstances will bounce back. Total modifications at quarter end were fairly high still because they were still in process. As we hit November, our total modifications declined to something under 7%. And then we have modifications that begin payments in December and January that would drop us down into under 4%. In looking at other types of things that are going on, we have looked at our stress tests on our major types of commercial real estate and what the debt service coverage’s are right now. And besides the hotel portfolio, debt service coverage’s on the average are well above 120 and seem to be moving along in a good manner. We are requesting and receiving more interim financial results from our borrowers, so we can stay on top of what’s happening with them. And believe that in most cases our portfolio, because of the strength of our customer base, is still very strong. One of the things that’s interesting in our portfolio is just the level of liquidity our customers are holding. This year, our business DDA accounts are 50% higher than they were the previous year. Last year, we were about $400 million in non-interest-bearing deposits. And this year, we’re over $600 million. A lot of that, I think, is due to the conservative nature of our customer base holding cash out of concern of what’s happening with the economy as a whole. Moving on to individual markets and what’s happening in them. Our Rochester to market, we were concerned a little bit in the Rochester market because Mayo – Mayo Clinic, which is a big employer and driver of the economy there had decreased the a level of non-critical activities they we’re doing. They are back to 100% of their pre-COVID activity. In fact, they had gone through a process of decreasing salaries by 10%. They not only gave the money back to their employees, they also gave them some bonus on top of that. So Rochester right now, I think, is doing very well. It is driven a lot by Mayo. In Eastern Iowa, the University of Iowa enrollment is down about 4%. There is really no new major construction going on. The problem for their world over there is there’s no events really happening that draw people to the town. There’s a very active community with university. And with that, like in most places, there’s no concerts, no ballgames, no things that really draw people to the city from a tourist perspective. Housing is strong. In the area they sell fast on anything under $400,000. University Iowa hospitals are back up at full speed right now and they are drawing people to the town. Apartments is a big deal in Iowa City and Coralville, average occupancies there have always been very strong. They are down from about 97% to 93% currently. In our new Minnesota markets, we continue to grow really good franchise customers, loans and deposit balances in that – in those markets. We have about $230 million in loans in the new markets and $107 million of deposits, which is – the deposits, what we’ve learned while opening new business is something that lags a little bit. Currently, we don’t have traditional bank buildings in any of those communities at this time, but that will change in the future. As is the case in all markets, new projects in regard to construction and those type of things is quite limited at the current time. I’ll leave it with that right now, and we’ll entertain questions later if there are any. And I’ll hand it back to Doug.

Okay. Actually, at this time, we would entertain any questions that may be out there.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Brendan Nosal of Piper Sandler. Please go ahead.

Good morning, everybody, hope you all doing well. Thank you for all the prepared commentary, definitely very helpful. Just starting off on the growth outlook, definitely appreciate that there are some larger payoffs coming in the fourth quarter. I just want to get a sense of looking past the payoff activity, growth was quite strong this quarter. So what is your outlook for kind of net loan growth over the next couple of quarters?

I would say we have a pipeline that will replace the payoffs before the end of the year, absent anything that we don’t know that’s going to pay off between now and then. So I don’t see us dipping below the 4.5% by the end of the year. In fact, I would anticipate that may be up just a little bit.

Perfect. That’s helpful. Then moving on to the margin, you guys have done a really, really nice shot of lowering deposit costs, pretty much as fast as you can in response to what the fed has done. But just given that costs have come down so much, I’m guessing there’s probably not a ton more room to run on the liability side. So I’m just trying to understand how you’re thinking about the margin outlook for the year. I’d imagine perhaps a little bit of pressure, but just curious how I’m thinking about it?

Well, you’re correct. We really don’t have much more opportunity to lower deposit costs. And then what will impact the margin going forward in this environment will be existing investments and loans that mature, and we have to reinvest those dollars. So most – I think we could say what’s near certainty that the reinvestment dollars will be at a lower yield than the existing dollars. To the extent of that, it’s a little hard to tell.

Yes. I would just add that some of the loans that are getting re-priced because we’ve booked those maybe five years ago would probably be in the low to mid-4% range, and we’re not getting those kinds of rates on new assets that are getting booked. But all of those usually come with some sort of a prepayment penalty as well.

Okay. Great. Understood. Moving on to the credit side of things. You mentioned in your prepared remarks that there was one credit, you might see some loss on potentially. I was just hoping for a little more detail on that relationship, what sector it is? What does collateral look like things like that?

Yes. The sector is in, it’s a large non-profit that I wouldn’t want to mention the name specifically, but the large non-profit has multiple facilities that have been appraised recently that would have appraised values and some have letters of intent on properties, they’re looking at doing some sale and leaseback to certain areas. They have some donors and friendly sponsors that are willing to do some of that. They also have some cities and different areas that are interested in similar properties that they would have properties that have appraised values of over $30 million. And our portion of the credit is $16 million, but the total credit is about 26%. So there is – depending on how things go, that credit could have a small loss here or there, but that isn’t – they’re still on operating entities. So there are other options that are also – it’s just – it’s the one that we look at the most critically.

Yes. That’s perfect. That’s helpful color. Wanted to just ask quickly about the $16 million movie theater credit that you pointed out in 10-Q. I mean it seems like hotels occupancy has been generally trending in the right direction since the worst of the early days of COVID. But it kind of feels like movie theaters have just been almost doors shut ever since the beginning. So just any color on whether there is any operations ongoing and any cash flow coming in or if it’s relatively shut down right now? And just how do you feel overall about the relationship?

They do have some of their theaters open. And what they’re running in there is kind of classics and those type of things. Just to add some more color in regard to the strength of their hands, They’ve injected somewhere in the neighborhood of $7 million into the business and also a very strong, very strong individual or partial owner has also increased their personal guarantee to support the business, along with – and that individual order has exceptional levels of liquidity so that’s what’s happening. They’re certainly, like everybody else, they have – they’re dependent on the product coming out to be able to put out viable entertainment. If they’re not putting out new movies, it’s not going to work. But they have strong hands and that’s the – and they have strength and liquidity to support their business.

Good. And then moving on to deferrals. You guys pointed out both in your release and in your prepared remarks that you have line of sight to deferrals moving down to a much, much lower number. Is it fair to say that most of what would remain, that chunk rolled off through the end of the year in hotel?

Yes, it is. I just – when I look at the total on that, we’re looking at about $80 million of basically, these are Marriott Hilton products that are in deferral through March and April. Loan to values are in good shape. And again, pre pandemic, these are awfully strong operating entities, and personal guarantee. They do have – they are guaranteed personally by – some of them have multiple owners that have other sources of liquidity and income. We do have a group of hotels that really their main business is just the hotel business. And their source of other cash is not as ready, but their loan to values are very, very low in the 50s. So while they don’t have the income coming in, they have the ability to survive this and come back once we have something a little closer to normal.

Okay. And then turning to the increase in non-accrual, I appreciate that it’s – off a very low base in the overall figure. It is still quite low, but up regardless. So I was just hoping you could offer a little more color on the two credits that your OV [ph] increased this quarter. And then also curious if those are the same relationships that drove the uptick in substandard bonds.

Correct. The one we already talked about was the non-profit that takes up $16 million of the $18 million, I think. The other one that’s of any substance is a shared national credit. It’s really the only one we have. That’s $1.4 million. We – it had – that’s a tradable asset. We could trade that right now for at par, a little over $100,000 to par. But in everything that we can see it’s going to come back to par, and then we’re going to trade out of that credit at that point.

Okay. Good. That’s certainly helpful. And then last one for me for before I let you guys go. You spent a good part of this year taking strong pre-provision earnings and building the reserve. So I’m just curious where would your coverage sit today? Is that a level that you think is – is it at a place to absorb any potential issues down the road, or would you prefer to be more cautious over the next couple of quarters and continue to add just given the environment?

Well, sitting here today, I mean, certainly, at the end of September, we thought the allowance was adequate. As we move forward, it’s just going to depend upon the environment, the information that’s available. Brendan, if we had to guess right at the moment, the fourth quarter provision may be similar to the second and third quarter. But that’s probably as close as we can get to a guess right now.

Yes, totally understood. No one has the crystal ball on that, but just curious how you’re thinking about things. All right, fantastic. That is it for me. Thank you so much for taking the questions.

Yes, thank you.

[Operator Instructions] The next question comes from Kevin McLaughlin of McLaughlin Investments. Please go ahead.

Good morning, everyone. First of all, congratulations on another great quarter under very difficult circumstances. My question for Doug, I don’t understand what the implications would be in the forgiveness process relating to these PPP loans, is that going to accelerate the recognition of the fees for the bank? Or how does that work?

Yes, Kevin, you’re correct. The fees that were collected upfront are deferred and amortized over the life of these loans, which is two years. And then as the loans pay off, any unamortized fee that still exists at the time that the loan pays off, will be recognized into income at that time. And so we’re starting to see a few payoffs. I mean, as of yesterday – at the end of September, we had not had any payoffs or forgiveness payments. As of yesterday, we have received $750,000 in payments. So it’s just beginning, just starting to trickle in. But –

On the basis of how much Doug?

$220 million – $224 million. So I mean, it’s just a – but so look, so Kevin, it’s a little hard to project or predict the dollar amounts and when they’re going to come in. At this point in time, I think we would say that most of these loans will not be forgiven until 2021.

Okay. And then my other – and I don’t know, this isn’t so much a question. Thank you, Doug. But I wanted to ask Dave, if you wanted to get kind of chesty over the announcement by Wells Fargo and their business banking operations in Rochester when I was up there visiting your branch office?

Well, they’ve essentially got rid of all their bankers quite simply. So that is rather, I guess, over the past – the history of the past 30 years, that’s an outcome that I don’t think many would have been able to predict.

And that’s the point that I wanted everyone on the call to understand. When you enter a market and normally, it takes three to five years to breakeven and you breakeven in just nine months. So within a handful of years later, one of your biggest competitors drops their business banking services because so many clients have moved. I think that, that’s something that everyone on the call should recognize and appreciate because that’s an extraordinary performance. I’ll leave it to you to close, but I just want to say congratulations. And I’m hopeful that – I think that there are implications in these other new markets, and I’m excited about what you’re accomplishing there as well.

Thank you, Kevin.

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

I would just like to again thank everyone for joining us, and we appreciate your interest in our company. Thanks.