Business Context and Reporting Period
Equity Bancshares, Inc. is a Wichita, Kansas-based bank holding company whose wholly owned subsidiary, Equity Bank, provides commercial, retail, mortgage, wealth-management and related banking services through 52 branches in Arkansas, Kansas, Missouri and Oklahoma. This Form 10-K covers the fiscal year ended December 31, 2019, with unaudited fourth-quarter information also presented.
At year-end, the Company reported $3.95 billion of assets, $3.06 billion of deposits, $2.54 billion of loans net of allowance and $478.1 million of stockholders’ equity. The Company completed its acquisition of three MidFirst Bank branches in February 2019, adding approximately $98.5 million of deposits and $6.5 million of loans at closing.
Financial Performance and Key Metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Interest and dividend income | $175.5 million | $161.6 million | Up $13.9 million |
| Net interest income | $125.9 million | $124.8 million | Up $1.1 million |
| Provision for loan losses | $18.4 million | $4.0 million | Up $14.4 million |
| Non-interest income | $25.0 million | $19.7 million | Up $5.3 million |
| Non-interest expense | $99.6 million | $94.4 million | Up $5.2 million |
| Net income | $25.6 million | $35.8 million | Down 28.6% |
| Diluted earnings per share | $1.61 | $2.28 | Down 29.4% |
| Net interest margin | 3.48% | 3.81% | Down 33 basis points |
| Return on average assets | 0.64% | 1.00% | Down 36 basis points |
| Return on average equity | 5.52% | 8.52% | Down 300 basis points |
Interest income benefited from higher average loan balances, while funding costs increased materially. The average cost of interest-bearing liabilities rose to 1.65% from 1.34%, and the cost of interest-bearing deposits rose to 1.53% from 1.15%. The efficiency ratio increased to 65.45% from 60.14%.
Non-interest income growth was led by debit card income of $8.2 million, service charges and fees of $8.7 million, and mortgage banking income of $2.5 million. Salaries and employee benefits were $52.1 million, data processing expense was $10.1 million and merger expense was $0.9 million.
Operating cash flow was $48.5 million. Investing activities provided $96.1 million, primarily because of $85.4 million of net cash received in the MidFirst acquisition and an $8.5 million reduction in loans. Financing activities used $248.1 million, including deposit reductions, debt repayments and $10.9 million of treasury stock purchases. Cash and cash equivalents declined to $89.3 million from $192.8 million.
Financial Condition, Debt and Liquidity
- Total assets declined 2.8% to $3.95 billion, primarily due to lower cash, loans and investment securities.
- Gross loans held for investment declined 0.7% to $2.56 billion. Commercial real estate loans declined $201.3 million, while construction loans increased $107.3 million and residential real estate loans increased $58.9 million.
- Real estate loans represented 70.5% of gross loans, including $1.16 billion of commercial real estate loans. Commercial and industrial loans were $592.1 million.
- Total deposits declined 1.9% to $3.06 billion. Savings and money-market balances increased, while time deposits declined 17.3% to $833.2 million.
- Borrowings included $324.4 million of Federal Home Loan Bank advances, $35.7 million of repurchase agreements, $9.0 million under a bank stock loan and $14.6 million of subordinated debentures.
- The Company reported $448.1 million of commitments consisting of $441.9 million of commitments to extend credit and $6.2 million of standby and performance letters of credit.
- Equity Bank remained well capitalized. Its year-end total risk-based capital ratio was 12.47%, common equity Tier 1 ratio was 12.03% and Tier 1 leverage ratio was 8.92%.
Material Changes Versus the Prior Comparable Period
- Profitability weakened principally because the provision for loan losses increased by $14.4 million. Management attributed the increase largely to one credit relationship, for which it recorded a $14.5 million provision and subsequently charged off a net $15.2 million.
- Net charge-offs increased to $17.6 million from $1.0 million, and the allowance for loan losses increased to $12.2 million, or 0.48% of loans, from $11.5 million, or 0.44%.
- Nonperforming assets increased to $46.9 million, or 1.19% of assets, from $39.6 million, or 0.98%. Nonaccrual loans increased to $38.4 million from $33.2 million.
- Potential problem loans declined to $27.2 million from $52.9 million, and classified loans declined to $65.6 million from $86.1 million.
- Book value per common share increased 7.2% to $30.95, while tangible book value per common share increased 8.8% to $20.75. Stockholders’ equity increased 4.9% to $478.1 million despite $10.9 million of share repurchases.
- Net interest margin compressed as deposit and other funding costs rose faster than asset yields.
- Non-interest income increased 26.7%, while merger expense decreased substantially from $7.5 million to $0.9 million.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management continues to describe a strategy focused on organic commercial loan growth, stable community-market deposits, selective community-bank acquisitions and disciplined integration. The filing does not provide specific quantitative earnings, revenue or loan-growth guidance.
- Credit event: Two related borrowers filed for Chapter 11 bankruptcy after year-end 2018. The relationship was placed on nonaccrual during the first quarter of 2019, and the bankruptcy reorganization was approved in the fourth quarter. The Company’s year-end exposure to the borrowers was $14.3 million, plus a $4.4 million loan secured by a principal’s residential real estate. Actual future disposition values may differ from management’s estimates.
- Internal controls: Management concluded that disclosure controls and internal control over financial reporting were not effective at December 31, 2019 because of a material weakness involving untimely and incorrect reconciliations of certain corporate accounts to the general ledger. The Company completed the reconciliations and implemented new supervision and review procedures, but remediation remains an important verification item.
- Accounting changes: CECL became effective for the Company on January 1, 2020. Management expected an increase in the allowance for credit losses but had not determined the magnitude of the adjustment. The standard could increase earnings and capital volatility.
- Interest-rate risk: The filing’s model indicates that an immediate 300-basis-point increase in rates would reduce projected 12-month net interest income by 12.3%, while a 100-basis-point decrease would increase it by 1.9%. Model results depend on assumptions regarding deposits, prepayments and repricing.
- Liquidity and concentration risk: The ten largest non-brokered depositors represented approximately 11.5% of deposits, and the ten largest loan relationships represented approximately 8.4% of total loans. A substantial portion of lending is secured by real estate and concentrated in four Midwestern states.
- Debt collateral: The Company pledged all Equity Bank stock as collateral for the $9.0 million bank stock loan, which had a maximum borrowing facility of $40.0 million. A default could expose the Company to loss of its principal operating subsidiary.
- Legal matters: The Company expects to pay a $1.474 million judgment in the CitiMortgage matter, subject to reassignment of loans with existing collateral. A putative securities class action related to the disclosed credit relationship remained pending, and the Company stated that its outcome could not reasonably be estimated.
- Subsequent event: The Company submitted notice in January 2020 regarding the proposed closure of three branches and plans to transfer their loans, deposits and other property to continuing branches.
- Other risks: Key risks include local economic and real-estate conditions, interest-rate movements, deposit competition, acquisition integration, cybersecurity and third-party systems, regulatory changes, LIBOR transition, FDIC assessment increases and the possibility that the allowance for credit losses will prove inadequate.
Important Facts for Investors to Verify
- Read the credit-quality disclosures and subsequent updates concerning the large bankrupt borrower relationship, collateral values and any additional charge-offs.
- Confirm remediation and testing of the material weakness in account reconciliations and whether management later concluded that internal controls became effective.
- Assess the actual CECL adoption adjustment and its effect on the allowance, retained earnings, capital ratios and future provisions.
- Monitor deposit trends, time-deposit maturities, funding costs and available borrowing capacity, including Federal Home Loan Bank collateral requirements.
- Evaluate exposure to commercial real estate, construction lending, local economic conditions and the ten largest loan relationships.
- Review the status and potential financial impact of the securities class action, CitiMortgage judgment and any mortgage repurchase or indemnification claims.
- Verify the effect of the three proposed branch closures and whether the Company continues to pursue acquisitions.
- Reconcile non-GAAP measures such as tangible book value, return on tangible common equity and the efficiency ratio to GAAP results.