Great Western Bancorp, Inc. (NYSE:GWB) Q2 2020 Earnings Call April 30, 2020 8:30 AM ET
Mark Borrecco - President and Chief Executive Officer
Peter Chapman - Chief Financial Officer
Doug Bass - Chief Operating Officer
Conference Call Participants
Terry McEvoy - Stephens
Ebrahim Poonawala - Bank of America Merrill Lynch
Jeff Rulis - D.A. Davidson
Jon Arfstrom - RBC Capital Markets
Andrew Liesch - Piper Sandler
Damon DelMonte - KBW
Janet Lee - JPMorgan
Good morning and welcome to Great Western Bancorp's Second Quarter Fiscal Year 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator instructions]
Joining us on the call today, we have Mark Borrecco, President And Chief Executive Officer; Doug Bass, Chief Operating Officer; Peter Chapman, Chief Financial Officer; Karlyn Knieriem, Chief Risk Officer; and Seth Artz, Head of Investor Relations.
Before getting started, Great Western would like to remind you that today's presentation may contain forward-looking statements that are subject to certain risks and uncertainty that could cause the company's actual future results to materially differ than those discussed. This is especially true in the current environment with extreme uncertainty stemming from the COVID-19 pandemic.
Please refer to the forward-looking statements disclosure contained in the presentation on the company's website as well as their periodic SEC filings for a full discussion of the company's risk factors.
Additionally, certain non-GAAP financial measures will be discussed on this conference call. References to non-GAAP 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. Reconciliation for such non-GAAP measures are appropriately referenced and included within the presentation. Please note, today's event is being recorded.
I would now like to turn the conference over to Great Western Bancorp's President and Chief Executive Officer, Mr. Mark Borrecco. Mark, please proceed.
Thank you so much, operator. Good morning and thank you all for joining the call. I would like to start by saying that I'm truly honored to have joined the Great Western family. My first few weeks have been exciting, as we manage through the challenges related to the COVID-19 pandemic. While the situation remains fluid, this initial experience has provided me insight into the caliber of our employees. It's been exceptional to watch the team come together to support our customers and communities in their time of need. Thank you to the staff for staying focused on making life great.
Before we discuss our financial performance, I want to focus on our current operating environment. We have more than 750 of our employees working remotely, which is over 85% of our non-retail team. We rewarded our retail and support team members with a one-time bonus for their continued hard work and also included a PTO cast out option for all employees who may need supplemental support.
Because of the aforementioned dedication of our frontline staff, all, but six of our 177 branches remain open using drive ups, with limited access and adjusted hours. We supported our local small businesses with the Paycheck Protection Program. We have completed over 3,800 applications, totaling more than $731 million of loans.
We have worked with our clients regarding loan modifications to the tune of over 450. This will help give those commercial and retail customers short term relief as they manage through this widespread disruption.
We have also expanded our loan monitoring in key segments, like hospitality, to ensure we are staying close to our customers as they navigate these uncertain times, while also allowing us to be proactive in identifying issues and providing solutions.
In short, we have been extremely nimble and focused as we adjust our business model to support our customer base, while also minimizing risk from the pandemic. Today, our organization is running smoothly and we are maintaining a level of safety and soundness that is critical in times like this.
Even with all the challenges, we were able to recruit a new Chief Credit Officer, Steve Yose. Steve is an experienced credit executive with strong knowledge of CRE, C&I and most especially, Ag Lending. This is a huge win for the bank to attract Steve, especially given our current asset quality performance. We look forward to welcoming Steve to GWB on May 11.
Lastly, as our results this quarter shows, we have taken notable steps by increasing our credit provision and impairing our goodwill, which were the right measures to take given current environment and the level of uncertainty.
Now, for insight on our financial results, I would like to turn the call over to our Chief Financial Officer, Pete Chapman. Pete?
Thanks Mark and good morning, everybody. I want to spend a little bit of time discussing two significant items that Mark just referred to, included within our results this quarter in light of recent market conditions. A detailed breakout is in slide three of the earnings release presentation and also within the earnings release itself.
The first item relates to an impairment totaling $742 million for the full balance of goodwill and also other intangible assets. It's worth noting that $622 million of the goodwill was from the previous parent National Australia Bank's purchase of Great Western Bank in 2008 and an additional $118 million relates to subsequent acquisitions. So, in actuality, the balance sheet now is more reflective with the current business, particularly in these market conditions. As you would be aware, goodwill and intangibles were a deduction from capital previously, so this charge does not affect our capital position.
The second item relates to an aggregate $74 million in credit and other related pretax charges. The majority of these charges relates to a 40 -- $59.7 million provision for loan and lease loss expense and a $7.1 million credit mark on our fair value loan portfolio, both of which were driven by a qualitative adjustment in our collective reserve attributable to the significant deterioration in economic condition inputs into these credit calculations.
These items and other less material adjustments have significantly increased our allowance ratio as a percentage of loans to 1.4% and comprehensive credit coverage ratio to 1.68%, up from 0.76% and 0.96% respectively.
In addition, we impaired an OREO hospitality holding by $3.3 million, given the current environment. As a reminder, we adopted CECL effective October 1, 2020, so credit charges and coverage for the quarter do not reflect CECL.
One other key point is we are redacting prior guidance in light of the COVID-19 pandemic and the significant impacts being made on economic and business conditions. We'll be monitoring the landscape and we will provide updated information as it becomes available in subsequent quarters.
Looking to revenue, net interest income was $104 million compared to $107 million in the prior quarter. Interest earning assets increased in the quarter, while adjusted NIM decreased 10 basis points to 3.55%. The emergency rate cuts of 150 basis points in early March contributed to four basis points of NIM decline, with a decline in total loan yields of 17 basis points versus an 11 basis point decline in total deposits for the quarter.
In light of this lower rate environment on slide six we provided a new chart on our loan portfolio, which gives additional detail on rate floors and re-pricing timelines for our loan portfolio. With the recent rate cuts, we now have $2.1 billion of our variable portfolio at floors and yielding 4.68% alongside $4.6 billion of fixed loans yielding 4.57%. We will remain focused on NIM management, reducing deposit pricing through the quarter as we navigate fed rate decisions, PPP lending and funding and changes in customer behavior.
Non-interest income, not including fair value activity and COVID charges, were $14.6 million for the quarter compared to $17.2 million in the prior quarter. Due to the March quarter seasonally being slower for service charge and other fee income combined with a noticeable decline in transaction activity in March for both debit and credit card volumes.
Expenses, excluding the impairment of credit charges noted earlier, were $62.3 million for the quarter compared to $56.9 million in the prior quarter. The increase was driven by $1 million in merit increases that took place in January, $3 million in pre-COVID-19 OREO and legal expenses and a bonus of $0.5 million that was paid to our retail and certain support staff in recognition to their hard work and flexibility in keeping our bank active and open supporting customers.
Our capital position ended the quarter very strong with common equity Tier 1 ratio of 10.6% and a tangible common equity ratio of 9.3%. $40 million of share buybacks were completed earlier in the quarter, and the remaining $35 million of authorization is on hold given the current environment. Tangible book value per share also increased to $20.84 in the quarter.
We declared a dividend of $0.15 per share for the quarter ending March 31, 2020 and reflects the desire to help ensure the balance sheet is as strong as possible through the uncertainty of this COVID pandemic. The Board will monitor the impact of COVID-19 and consider dividends within the context of this in subsequent quarters.
Now for an update on our portfolio and asset quality, I'll hand over to our Chief Operating Officer, Doug Bass. Over to you, Doug.
Thanks, Pete. Loan and deposit growth trended with system growth in the quarter. And for our unfunded commitments perspective, we saw a nominal increase of $72 million in balances. This included planned construction draws as well.
In this environment, we were focused more on portfolio composition and asset quality and it provided additional detail on our loan portfolio. In light of COVID-19 pandemic and the economy and on specific segments such as hotels, restaurants, travel and entertainment and retail, nearly every sector will be impacted by the economic disturbance from COVID-19. We have been actively reviewing these sectors and along with the entire portfolio for early indicators of stress.
For this quarter, we included additional information on hotel, restaurant and entertainment concentrations, given the relative size to the portfolio, including geographic distribution, along with how they have been impacted with sudden and abrupt fall off in business activity.
Looking closer at these segments, we have $114 million in Entertainment, $120 million in Restaurant and Drinking Places, and $1.1 billion in Hotel and Casino Hotels. The Entertainment segment is 1.2% of total loans, with 78% of this portfolio secured by real estate. The Restaurant portfolio is also 1.2% of total loans and is 74% secured by real estate. The Hotel portfolio includes 12% of our total portfolio. We have added two additional slides to profile those in more detail.
To summarize, the Hotel portfolio is 90% in footprint, with the remaining 10% still related to borrowers that reside in footprint. It is a seasoned portfolio with longstanding customer relationships, who own multiple properties and have an average loan to value of 62%.
There are 10 projects in various phases of construction, with $11 million advanced on $82 million in total commitments. These hotels have completion dates scheduled for late 2020 and into 2021. Regular reviews of the hotel portfolio continue to give us good insight into this segment.
Turning our attention to ag, our annual renewal process on the grain sector is nearly 85% complete, with no material deficiencies or downgrades from the process. Planting progress is tracking above average with conditions vastly better than a year ago, when much of the corn belt was underwater.
The COVID pandemic is impacting overall commodity prices with demand disruption in the supply chains and those details are being worked through. We are encouraged that USDA has launched a meaningful aid package that will provide $19 billion of immediate relief to most sectors through direct payments that may potentially offset the decline in commodity prices.
This quarter, we reached a level of stability within our overall asset quality. Watch loans were flat and substandard loans decreased modestly quarter-on-quarter. Net charge-offs were $8.6 million compared to $6.1 million in the prior quarter, bringing our year-to-date ratio to 0.31%. We did move three credits totaling $63 million to non-accrual this quarter, given developments in their workout process, which contributed to an increase to $213 million. Our specialized business service team is diligently working to resolve these credits.
Dairy performance had been strong, but has seen a recent decline in milk prices, driven by volatility from the COVID-19 pandemic. Previously, we had communicated that we would expect to see a number of upgrades to our dairy customers in the June 2020 quarter based on current performance. Should lower milk prices continue, we will delay upgrades from substandard to ensure our customers will be sustainably profitable at prevailing market prices, coupled with support from their marketing and hedging programs.
Last quarter, we mentioned our new loan risk rating system being implemented, with the addition of a special mention rating that resides between the watch and substandard classification. That project is progressing well and we are in the final stages of calibration to run in parallel for the last half of the fiscal year, ahead of external reporting transition to the new fiscal year.
Now back to Mark.
Thanks, Doug. We will continue to monitor our loan portfolio closely, while supporting our customers and communities. After the safety of our employees, my number one priority is improving our asset quality.
As I mentioned previously, having Steve join our team as Chief Credit Officer with his extensive knowledge of Ag Lending will bolster our ability to improve asset quality.
We will now open up the call for questions. Operator?
Thank you. [Operator Instructions]
Our first question today will come from Terry McEvoy of Stephens. Please proceed with your question.
Hi. Thanks. Good morning, everyone.
Hi. Good morning. Maybe just my one question. There is seven hotel related loans over $25 million. Could you just kind of run through those loans? Are they non-accrual watchlist? Any shared national credits? And just given -- give us a little more color given the relative size of those seven loans. Thank you.
No. No, no. No, they are not of the hotel relationships. So, I think, we've only got over $1 million in substandard at the moment, Terry, and that was before the COVID pandemic. So, overall, the portfolio is pretty strong. Nothing in terms of snicks, shared credits or participated credits.
Doug, I don't know if you want to give a bit more detail on those larger ones.
Yeah. The seven, Terry, would be all in footprint with long-term relationships. And as Pete mentioned, there's only one that's adversely risk rated today.
Okay. Thank you.
Thank you. Our next question will come from Ebrahim Poonawala of Bank of America. Please proceed with your question.
Good morning, Ebrahim.
I guess, question for Mark. Mark, congrats on the new role. Just wanted to understand the thought process around reducing the dividend. It -- sooner as you build the reserves significantly despite the lack of CECL adoption, just talk to us in terms of how we should read into the dividend reduction relative to your outlook in terms of the EPS power that the bank expects to generate over the coming quarters?
Yeah. Look, I'll kick-off then hand over to Mark, Ebrahim. Really, part of the decision process was just given the uncertainty at the moment, Ebrahim. As you say, asset quality metrics for the quarter while not where we or Mark would like them to be, have been pretty stable. We have really only, I think, seen one downgrade as a result of the COVID piece.
But just with the uncertainty in the outlook, we just thought it was a prudent decision in a quarter where we've got goodwill coming off. We've got the reserve build as well. We just thought it was appropriate to address the dividend in the same quarter also rather than sort of maybe push it to next quarter as others have talked about was the general thought process. And with earnings, we've always had a strong earnings power, but just given the outlook here at the moment, we just thought we would pause and see how the next 90 days went before we make any more commitments in terms of what that looks like going forward.
Yeah. Thanks, Pete. I would agree with that sentiment. I think also as we -- as I step into the role -- and thank you for the congratulations -- for me, it's also a chance to understand that with the uncertainty of where we are. Right now, getting our arms around the asset quality, making sure that we have the right processes and we have the right elements in place. Again, mentioning that having a new Chief Credit Officer will be a big win for the organization. And so, for us right now, it is really a step around being prudent over the next 90 days. As Pete mentioned, we will have a chance to revisit that dividend. And by that time, have a much better handle as to the impacts and the duration of the COVID pandemic.
Our next question will come from Jeff Rulis of D.A. Davidson. Please proceed with your question.
Thanks. Good morning. Question maybe for Doug, on the newer non-accruals brought in on the quarter. I wanted to see the transition of those. Are those progressions from previously identified credits? Any new problem credits, anything that was tipped over by COVID, just some detail on the new credits in there?
Sure, Jeff. Within that sector, there was one. They were all previously classified in prior quarter and that went in. And of the segments they were in, one was in the hog sector and the other was in primarily healthcare, but all had been on our radar in a classified risk rating previously -- prior quarter end. It was about a 50/50 balance between ag and C&I.
Okay. So, I think you said it was three credits. Are they -- those credits -- that came on?
Yes. Two of them are healthcare related, Jeff, and the third is in the hog sector, but the balances are roughly 50/50 between C&I and healthcare.
Fair enough. Okay. Thank you.
Our next question will come from Jon Arfstrom of RBC Capital Markets. Please proceed with your question.
Thanks. Good morning everyone.
Good morning, Jon.
I guess -- congratulations, Mark, on the new role and also congratulations on getting rid of the goodwill. I know it's a big number, not easy, but I never thought that was a fair accounting. So, it's a fresh start.
But I guess, big picture for you, Mark. There's a lot of stuff you get asked about the numbers, but this is your first call and just 30,000 feet, what do you want to change at Great Western? When you look at it, where do you see the opportunities? What do you want to do differently? We understand near term credit headwinds, but what do you want to change with the company?
Yeah. Thanks. And for me, this whole first eight weeks has been an amazing journey in terms of just getting a chance to see how the organization handles stress. How people step-up and how we've rallied. Historically, Great Western Bank has focused on having a very strong efficiency ratio. And you look at the numbers and you see that through our expense controls. But I think for me, one of the things that we can do to not only make our employees more successful at doing their jobs, but also make it easier for customers to bank with us is make investments in some technologies, whether that's taking our smaller credits and making them far easier to manage, easier to get through the system and easier to monitor going forward.
I want to make sure that we make those technology investments that may have an initial slight uptick in our expense, but ultimately will make this organization far more efficient in terms of reducing the number of manual processes, reducing the amount of risk that we have by not having these systems and technology pieces in place.
So, from a 30,000 foot view -- foot view, I believe strongly that we can make some of those targeted investments. We can actually make the bank more efficient, but not only in terms of efficiency, but actually put the bank in a better position to manage the risk. And so that for me is really, I think, a big opportunity for us.
I also look at our footprint and I look at how we differentiate ourselves in the marketplace. While we make those changes and while we have more standardized processes across the footprint and while we have centralization of some of our key activities, I don't want us to lose that local feel. One of our core values is, empowered locally, but think globally. And I don't want to lose that local feel, because I believe strongly that's what differentiates us in our market and how we can win business from our competition.
And so, I don't want to lose that, but I do want to make those targeted investments. I do want to be able to increase our ability and efficiency around processes, standardizing and making them far better able -- or make us far better able to manage the risk associated with those processes.
Okay. Good. Fair enough. And then maybe if I can squeeze in one more for you, Pete. A lot of moving parts in the income statement. But just another big picture question, how do you want us to think about the pretax, pre-provision trajectory? It seems like fees are a little softer, expenses a little higher. We understand the margin pressure, but anything you want to call out or slide for us in terms of how we should think about pretax, pre-provision from here? Thanks.
So, look, Jon, I think you got the moving parts there. I think around the NIM, I think it will still be a little bit of softness. Obviously, it was exacerbated a little bit this quarter by the emergency cut. And then on the fee income line piece some -- mortgage seasonally will be better next quarter, which is always a positive. Just on the surface charge income, as I said, just with everybody staying at home, there's a bit of uncertainty around the debit and credit card interchange at the moment in terms of how that will flow through and how the PPP will flow through. So, but not, I think, you've got the moving parts, Jon, just given the amount of moving parts for the next quarter, we will just take stock here and see how this plays out before giving a bit more guidance in the subsequent quarter.
Okay. Thanks a lot.
Our next question will come from Andrew Liesch of Piper Sandler. Please proceed with your question.
Just some follow-up questions on the expenses for the quarter. So the uptick in the OREO cost and maybe a few hundred thousand dollars of excess or maybe something like one-time commentation costs. So, if we kind of back some of that out, is the run rate of around $61 million for maybe this quarter, looking okay, recognizing there could be some investments made in the quarters ahead?
Yes. You've got to the underlying, Andrew, sort of in that $61 million to $62 million for the quarter. Yeah. So, that's the good base run rate to move off. And then in subsequent quarters, we will just have to see how we go around anything we need to do around impact to COVID and the like. But yeah, that's a good baseline run rate.
Great. I have got it on my other question. Thanks.
Our next question will come from Damon DelMonte of KBW. Please proceed with your question.
Hey, good morning everyone. Hope everybody's doing well during these challenging times. So, my question, just looking to get a little bit more details on the amount of loan modifications and dollar amounts associated with that, and as well as the PPP activity, what you guys expect to realize on loan fees related to that? Thanks.
Loan mods? Yeah, around loan mods, Damon, it's -- at the moment and it's pretty fluid, as you appreciate. It's running at about 12% of the portfolio. So, it's about 400 -- so around the portfolio, it's around $1 billion -- about $1.1 billion, which runs about 12% of the portfolio based on information a day or so ago.
Great. And then with regards to the PPP activity, I think you said around $600 million in loans, how much in fees are you expecting from that?
Yeah, it's around 3%.
3%? Okay. Thank you very much.
Thank you, Damon.
Our next question will come from Janet Lee of JPMorgan. Please proceed with your question.
Good morning. I see that you provided deferrals to 450 loan customers. And what is that in terms of loan balances? And what percentage of your $1.4 billion of loans that are COVID sensitive those are in deferrals? Thanks.
Yeh. So, we just -- the dollar amount, Janet, it's about $1.1 billion. And of that $1.1 billion, about half of that is in relation to the hotel and service industry portfolio, which as you would expect that's been one of the portfolios that has slowed more significantly. So, that's about half of those requests. After that, there's a pretty wide spread across a number of different industries. So, there's nothing else particularly material that really sticks out there.
Great. Thank you.
Our next question will come as a follow-up from Ebrahim Poonawala with Bank of America. Please proceed with your question.
Thanks. Pete, just following up on the reserve build, like if I have heard this correct like between the reserve built in the quarter and the discount on the fair value mark, your reserve ratio is about 1.68%, 1.7% at the end of the quarter. Just talk to us since -- obviously you're not going to adopt CECL towards the end of the year, but it seems like you had a pretty significant reserve base. So, I am just trying to get a sense of how much more in reserve build we could expect over the coming quarters? If you can just give some color around that, would be helpful.
Yeah. Look, we haven't rerun our CECL numbers based on the updated economic conditions as yet, Ebrahim. From our economic provider, they came in late March. And obviously, there was a lot going on this quarter end. So, the focus was to get the numbers right for sort of March. So, look, at this stage, don't have an updated guidance on the CECL piece.
And just given the uncertainty, Ebrahim, I wouldn't want to give a range at this stage. Given we're a couple of quarters out, but certainly, as signs settle down hopefully for all of us over the next quarter. We might be able to give you a bit more color when we do our results announcement in July, Ebrahim, at this stage. Sorry about that, but just a lot of moving parts that I wouldn't like to quite a range of.
No, that's fine. But ex-CECL, should we see significant reserve base continue, or do we need to start seeing a fair amount of credit? Like if you start seeing credit migration, which I expect you will in the coming months and quarters, will that lead to continued ramp-up even under the incurred model, is that a reasonable assumption?
It's a good question. Look, we feel we've been pretty significant in terms of our stress of the economic factors that go into our portfolio. So, we feel we've taken some pretty strong measures here, Ebrahim. Really, it's just going to be a function of the environment. If we continue to get worse, yes, you may see a reserve build if things maintain or get a little bit better than potentially not, Ebrahim. So.
All right. Thanks.
This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Mark Borrecco and all the speakers for any closing remarks. Please go ahead.
Thank you, operator. Before we leave the call, I want to say thank you to my predecessor and former Chairman, Ken Karels. Ken, I appreciate your support through the transition. I wish you all the best in retirement. We will definitely miss you.
I would also like to reiterate my excitement about joining the Great Western family. It is clear we have a great deal of work ahead of us, but I know I am ready and so is the team. Thank you so much. Stay safe, and have a great day.