Equity Bancshares, Inc. — Form 10-Q Summary
Business context and reporting period
Equity Bancshares, Inc. is a Wichita, Kansas-based bank holding company whose subsidiary, Equity Bank, operated 49 full-service branches across Arkansas, Kansas, Missouri and Oklahoma as of September 30, 2018. The filing covers the three and nine months ended September 30, 2018, with comparable 2017 periods. The interim financial statements are unaudited.
Results include the acquisitions of Kansas Bank Corporation and Adams Dairy Bancshares beginning May 5, 2018, and City Bank and Trust beginning August 24, 2018. These transactions materially affected period-over-period growth and expenses.
Key financial metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Interest and dividend income | $43.0 million, up 75.0% | $116.0 million, up 59.1% |
| Net interest income | $32.8 million, up 61.2% | $91.5 million, up 48.9% |
| Provision for loan losses | $1.3 million | $3.2 million |
| Non-interest income | $5.4 million, up 34.6% | $14.3 million, up 25.9% |
| Non-interest expense | $23.6 million, up 44.3% | $69.2 million, up 48.1% |
| Net income | $10.3 million, up 100.2% | $25.9 million, up 58.2% |
| Diluted EPS | $0.64, versus $0.41 | $1.66, versus $1.33 |
| Net interest margin | 3.76%, versus 3.68% | 3.86%, versus 3.85% |
| Return on average assets | 1.08%, versus 0.85% | Not separately stated for the nine-month period in the selected data |
Reported net interest income plus non-interest income was approximately $38.2 million in the third quarter. The reported efficiency ratio, excluding merger expenses and securities transaction gains or losses, was 59.9%, compared with 63.5% in the prior-year quarter; the nine-month ratio was 59.3%, compared with 61.6%.
Interest income growth was driven primarily by higher average loan and securities balances from acquisitions and loan growth. The average loan yield increased to 5.73% in the third quarter from 5.30% in the prior-year quarter. Funding costs also increased: the average rate on interest-bearing liabilities rose to 1.41% from 0.92%, and total cost of funds increased to 1.23% for the nine-month period from 0.84%.
Financial condition, debt and liquidity
| Balance-sheet metric | September 30, 2018 | December 31, 2017 | Change |
|---|---|---|---|
| Total assets | $3.93 billion | $3.17 billion | Up 24.0% |
| Gross loans held for investment | $2.56 billion | $2.10 billion | Up 21.6% |
| Deposits | $2.82 billion | $2.38 billion | Up 18.4% |
| Borrowings | $652.8 million | $401.7 million | Up $251.1 million |
| Stockholders’ equity | $443.2 million | $374.1 million | Up 18.5% |
| Cash and cash equivalents | $61.4 million | $52.2 million | Up $9.2 million |
Borrowings included $570.9 million of Federal Home Loan Bank advances, $43.3 million of federal funds purchased and retail repurchase agreements, $24.4 million of bank stock loans and $14.2 million of subordinated debentures. The company reported $355.9 million of additional FHLB borrowing capacity based on qualifying collateral and FHLB stock. The $24.4 million bank stock loan facility matures March 11, 2019 and is subject to capital and other covenants; management stated that the company was in compliance.
Cash flow from operating activities was $1.9 million for the first nine months, compared with $16.7 million in 2017. Investing activities used $151.9 million, primarily due to loan growth and securities purchases, while financing activities provided $159.2 million, principally from FHLB borrowings. The net increase in cash was $9.2 million.
Equity Bank was categorized as well capitalized. At September 30, 2018, its total risk-based capital ratio was 11.82%, Tier 1 risk-based capital ratio was 11.44%, common equity Tier 1 ratio was 11.44% and Tier 1 leverage ratio was 8.88%.
Material changes versus prior comparable periods
- Third-quarter net income doubled to $10.3 million, while nine-month net income increased 58.2% to $25.9 million.
- Loan growth and acquired balances increased interest income, but interest expense rose faster in percentage terms because of higher deposits, FHLB advances and market rates.
- Non-interest expense increased substantially because of acquired branch operating costs, employee additions, data-processing costs, amortization of core deposit intangibles and merger expenses.
- Merger expenses were $757 thousand in the third quarter and $6.5 million year to date, compared with $1.0 million and $2.1 million, respectively, in the comparable 2017 periods.
- Classified loans increased to $83.6 million from $61.4 million at December 31, 2017. Nonaccrual loans increased to $43.3 million from $40.3 million, while total nonperforming assets increased to $50.3 million from $48.2 million.
- The allowance for loan losses increased to $11.0 million from $8.5 million, while annualized nine-month net charge-offs declined to 0.04% of average loans from 0.08%.
- Accumulated other comprehensive loss increased to $7.1 million from $3.1 million, primarily reflecting unrealized losses on securities as interest rates increased.
Guidance, outlook, commentary and risks
The filing does not provide quantitative earnings or revenue guidance. Management described liquidity as adequate to meet anticipated funding needs through operating cash flow, loan and securities maturities, core deposits, FHLB advances and other borrowing relationships. Management also stated that the allowance for loan losses was adequate for probable incurred losses, while cautioning that future losses could be substantial relative to the allowance.
The principal risks are sensitivity to interest rates, credit deterioration, real estate collateral values, economic conditions in the company’s markets, deposit outflows, funding costs, competition, regulatory capital requirements, acquisition integration and technology or cybersecurity disruptions. The portfolio is concentrated in commercial and real estate lending; real estate loans represented 72.1% of loans held for investment at September 30, 2018.
Interest-rate simulations indicated that an immediate 300-basis-point increase could reduce projected twelve-month net interest income by 13.1% and economic value of equity by 18.3%. A 100-basis-point decrease was modeled to increase net interest income by 2.4% and economic value of equity by 1.3%.
Equity Bank was a defendant in a CitiMortgage lawsuit involving alleged loan repurchase obligations and claimed damages of $2.7 million plus interest. A $477 thousand loss contingency had been recorded at December 31, 2017; the company stated that it continued to contest the matter. Potential future repurchase or indemnification demands from other investors were described as possible, but the amount and outcome were uncertain.
The company agreed to acquire three branches from MidFirst Bank, with expected closing in the first quarter of 2019 subject to customary conditions and regulatory approval. Estimated transferred deposits were $96.7 million and loans were $7.2 million as of September 30, 2018.
The company adopted ASC 606, ASU 2016-01 and ASU 2016-15 in 2018. It was evaluating the future effects of the current expected credit loss standard, which was expected to result in earlier loss recognition; the filing stated that the impact was not yet known.
Most important facts for investors to verify
- Whether loan growth from acquisitions can be sustained organically without a disproportionate increase in funding costs or credit losses.
- Trends in classified, nonaccrual, potential problem and purchased credit-impaired loans, particularly within commercial real estate and other real estate-related portfolios.
- The adequacy of the $11.0 million allowance as the company transitions to the current expected credit loss model.
- Whether deposit growth and FHLB borrowing capacity remain sufficient to fund loan growth, including the maturity and refinancing of the bank stock loan facility.
- The recurring level of operating expenses after merger-related costs decline, including staffing, data processing and core deposit intangible amortization.
- Completion, accounting treatment and integration performance of the MidFirst branch transaction and other acquisitions.
- The status and potential exposure from the CitiMortgage litigation and any additional mortgage repurchase or indemnification claims.
- The effect of rising interest rates on net interest margin, deposit pricing, securities values, capital and projected earnings.