Bridgewater Bancshares, Inc. (NASDAQ:BWB) Q2 2023 Earnings Call Transcript

Bridgewater Bancshares, Inc. (NASDAQ:BWB) Q2 2023 Earnings Call Transcript July 28, 2023

Operator: Good morning, and welcome to the Bridgewater Bancshares 2023 Second Quarter Earnings Call. My name is Chuck, and I’ll be your conference operator today. [Operator Instructions] Please note that today’s call is being recorded. And at this time, I would like to introduce Justin Horstman, Director of Investor Relations to begin the conference call. Please go ahead, sir.

Justin Horstman: Thank you, Chuck, and good morning, everyone. Joining me on today’s call are Jerry Baack, Chairman, President and Chief Executive Officer; Joe Chybowski, Chief Financial Officer; Jeff Shellberg, Chief Credit Officer; and Nick Place, Chief Lending Officer. In just a few moments, we will provide an overview of our 2023 second quarter financial results. We will be referencing a slide presentation that is available on the Investor Relations section of Bridgewater’s website, investors.bridgewaterbankmn.com. Following our opening remarks, we will open it up for questions. During today’s presentation, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company.

We caution that such statements are predictions and that actual results may differ materially. Please see the forward-looking statement disclosure in our 2023 second quarter earnings release for more information about risks and uncertainties, which may affect us. The information we will provide today is as of June 30, 2023, and we undertake no duty to update the information. We may also disclose non-GAAP financial measures during this call. We believe certain non-GAAP financial measures, in addition to the related GAAP measures, provide meaningful information to investors to help them understand the company’s operating performance and trends and to facilitate comparisons with the performance of our peers. We caution that these disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP.

Please see our 2023 second quarter earnings release for reconciliations of non-GAAP disclosures to the comparable GAAP measures. I would now like to turn the call over to Bridgewater’s Chairman, President and CEO, Jerry Baack.

Jerry Baack: Thank you, Justin, and thank you, everyone, for joining us today. I’ll start with a quick overview of the second quarter, which is highlighted by some encouraging trends as we continue to work through this challenging banking environment. As we’ve been indicating, the pace of balance sheet growth continues to slow throughout the year, but we were pleased with the improvement of the balance sheet composition. Not only did we see a strong rebound in total deposit growth, which increased nearly 20% on an annualized basis from the first quarter, our core deposit balances increased 7.4%, outpacing loan growth of 5.6%, essentially aligning growth rates on both sides of the balance sheet. Net interest margin pressure continued during the quarter as expected, as funding costs continue to rise across the industry.

On a positive note, we did see the pace of margin compression slow considerably on a month-over-month basis throughout the quarter. Joe will talk more about this in a few minutes. Our expenses remained very well controlled for the second consecutive quarter. This has been intentional and shows that we have the ability to manage expenses as revenue growth slows. Asset quality remained pristine with no net charge-offs, very low levels of nonperforming assets and stable levels of watch and substandard loans. We continue to be very proactive and diligent on this front. We remain pleased with the performance and quality of our loan portfolio. At the end of the day, this all translated to another quarter of tangible book value growth, which is now up over 10% year-over-year.

In fact, we have grown tangible book value every quarter going back to 2016. Before we provide a more detailed look at our results, I want to take a minute to share some thoughts on the business more broadly. We have always believed that staying in front of our clients is priority number one, and we have remained vigilant in this commitment. Be it seasoned clients or potential client opportunities, our lending and treasury teams are prioritizing in-person visits and continue to see record attendance at our networking events. To further expand our reach, we are actively developing a foothold with women decision-makers through unconventional events and social channels. These efforts are paying off as we onboard new clients that appreciate our responsive and knowledgeable service model.

We have also taken steps to refine our branch-light footprint. Just last week, we relocated our Downtown Minneapolis branch to a more premium Sky way location with more space to serve our clients. Minneapolis is an important market, and we remain committed to serving the downtown community. In addition, as we mentioned last quarter, we recently purchased a parcel of land in a higher-growth East Metro area for a future de novo branch, which will help us fill out our footprint down the road. Despite the overall uncertainty in the market today, one thing is for certain, and that is the confidence I have in our team. We know that Bridgewater’s talent pool runs deep. As a top workplace 7 years running, we know that engagement, job satisfaction and productivity rank incredibly high.

We think about the employee experience the same way we think about the client experience, ensuring that Bridgewater is a place people want to develop, grow, build community and ultimately thrive is our goal. If our people are happy, our clients notice the difference. I firmly believe we have the best bankers in the Twin Cities, and I’m grateful for their commitment to driving the success. With that, I’ll turn it over to Joe.

Joe Chybowski: Thank you, Jerry. Turning to Slide 4. The net interest margin declined 32 basis points to $2.40. As we expected, this pace of compression slowed from the prior quarters. While the current interest rate environment continues to put pressure on margins across the industry, the pressure we are experiencing is slowing. Since the fourth quarter of 2022, we had seen relatively consistent month-over-month core margin compression in the mid-teens in terms of basis points. This began slowing meaningfully in April, May and June, down to the mid-single digits as rising funding costs decelerated in conjunction with the Fed’s moderated rate hiking cycle. Keep in mind that this month-over-month view is on a core margin basis to exclude the noise from the loan fees and highlight the peer interest component of the margin.

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On a stand-alone basis, our total net interest margin for the month of June was $2.33 compared to $2.40 for the full quarter. With the additional margin pressure during the quarter as well as a more moderated pace of loan growth, we saw a decline in net interest income. This was also impacted by the continued decline in loan fees as the pace of payoffs remained slow. Slide 5 shows the various components of the margin. Portfolio loan yields moved higher and should continue to do so for the foreseeable future, especially with yields on new originations typically coming on in the 7% to 8% range. Many of which are being structured with strong prepayment penalties, which will help cement these higher yields for longer. The fixed rate nature of our loan portfolio means it will take a little longer for the repricing to occur, especially since we have managed our pace of new originations.

As we look ahead, we have over $500 million of fixed and adjustable rate loans scheduled to reprice over the next year and over $600 million of variable rate loans efficiently floating. While funding costs have continued to move higher, we did see that pace moderate throughout the quarter as our funding mix improved. Funding costs are likely to remain a challenge given the interest rate environment and ongoing competition for deposits, including treasuries and other market alternatives. There remains many variables and uncertainties that will impact the margin from here, including another Fed hike yesterday. However, we are very encouraged giving several positive trends, including core deposit growth, reduced reliance on borrowings and the continued upward repricing of the loan portfolio, which together should firm the outlook as we continue to execute.

Turning to Slide 6. We continue to demonstrate a long track record of revenue and profitability, even as the current environment creates near-term revenue headwinds. As expected, this has resulted in lower revenue over the past few quarters as the vast majority of our revenue is spread based. On the fee side, noninterest income declined from the first quarter, primarily due to nearly $300,000 of FHLB prepayment income last quarter, which didn’t recur, as well as lower letter of credit fees, which tend to bounce around from quarter-to-quarter depending on client activity. Turning to Slide 7. Our expenses remain very well controlled. After declining 6.7% in the first quarter, noninterest expense increased just 1.4% in the second quarter. The increase included higher industry-wide FDIC insurance expense following the revision of the assessment methodology and subsequent replenishing of the deposit insurance fund coming out of 2022.

Over the years, we have done a good job of consistently growing expenses in line with asset growth. While expenses were lower in the first half of 2023, coming in below asset growth, we would expect to see the pace of expense growth pick up in the back half of the year. This incremental expense growth will likely come from investments in our people and technology, as well as areas that are impacting all banks, such as FDIC insurance expense and IntraFi deposit costs. Over time, we anticipate expenses and assets to continue to generally track in line, keeping in mind that assets are growing slower this year than they have in prior years. Even with our expense discipline, our efficiency ratio has increased into the low 50% range due to the ongoing revenue challenges.

We still maintain a highly efficient operating model relative to other banks and expect that to remain the case. With that, I’ll turn it over to Nick Place.

Nick Place: Thanks, Joe. As Jerry mentioned, deposit growth was a highlight of the quarter for us, as you can see on Slide 8. Total deposits increased 19.6% annualized during the quarter, including core deposits, which were up 7.4% annualized. As some of the noise from the first quarter subsided, we were able to return our focus toward bringing in new client relationships and growing existing balances consistent with our strategy over the past few years. In fact, we saw increased balances across all of our deposit categories during the quarter including noninterest-bearing, which increased over 4% annualized. However, the overall deposit mix has continued to shift toward interest-bearing accounts, similar to what other banks are seeing across the industry.

We were encouraged to see core deposit growth exceed loan growth during the quarter, allowing us to lower our loan-to-deposit ratio to 104%, back within our target range of 95% to 105%. Finally, only 22% of our deposits were uninsured at the end of the second quarter, down from 38% at the end of last year as we continue to optimize FDIC insurance coverage and leverage the IntraFi network. Turning to Slide 9. As expected, we saw the pace of loan growth in the second quarter to continue to moderate to 5.6% annualized. On a year-to-date basis, loans have grown at a 9.4% annualized pace, which is in line with what we expected for the year. Although overall loan demand remains lower than what we were seeing a year ago, we are still getting in front of plenty of good opportunities.

These opportunities include expanding existing client relationships and referrals to high-quality new clients. We will continue to manage our growth through selective loan pricing and further use of participation sales. While we expect loan growth to remain below historical levels in the near term, the opportunities are there for us to ramp the growth back up when appropriate as the environment becomes more favorable and as we continue recent momentum on the funding side. On Slide 10, you can see the loan growth during the quarter was driven by our construction and development portfolio. This increase continues to be driven by draws on previously originated construction loans. As these projects complete their construction phase, many of these balances will migrate to other portfolios.

Overall, we remain comfortable with the diversification we have across our loan portfolio. Turning to Slide 11. We continue to see a slower pace of new originations, which totalled $47 million in the second quarter, down 82% year-over-year. Offsetting the reduced originations are slower payoffs and paydowns, which declined 49% year-over-year. However, we are seeing our payoff pipeline pick up as interest rates have started to stabilize. This could create an opportunity to reinvest some of these payoffs back into new originations at higher market rates going forward. As previously mentioned, we have also been managing our loan growth by selling participations on new originations, including $109 million of participations year-to-date. The portfolio participation sold has increased each quarter over the past year, now over $530 million and nearly $670 million, including un-funded commitments.

In addition to helping manage our growth, this servicing provides an added revenue benefit as well. With that, I’ll turn it over to Jeff. Jeff Shellberg Thanks, Nick. Turning to Slide 12. We continue to feel good about our asset quality as nonperforming assets remained at very low levels, making up just 0.02% of total assets at the end of June. We had essentially no net charge-offs for the 10th consecutive quarter. In fact, we have had cumulative net charge-offs of just $376,000 since 2017, and we have no loans 30 to 80, 90 days past due. All of this is largely due to our measured risk selection, consistent underwriting standards, active credit oversight and experienced lending and credit teams. At this point, we are still not seeing any early signs of credit weakness.

We are actively monitoring the portfolio and staying engaged with our clients as we do expect normalization at some point. Finally, we remain well reserved at 1.36% of gross loans. The provision for credit losses on loans was $550,000 which was mostly offset by a $500,000 negative provision for unfunded commitments. On Slide 13, you can see that our watch and substandard loans both declined modestly during the quarter. This included one relationship that was upgraded from substandard to pass. Substandard loans are pretty evenly split between C&I and CRE and now make up less than 1% of total loans and just over 6% of total capital. Overall, we feel good about the risk profile of the portfolio and believe that it is well positioned as we move into the back half of 2023.

Turning to Slide 14, we provide some more information on our CRE and office portfolios. The majority of our nonowner-occupied CRE book is fixed rate, which helps from a repricing risk standpoint. We continue to actively engage with clients that have maturing loans or repricing rates over the next 12 months to identify possible cash flow stream and recommend solutions early in the process, if necessary. The current average loan-to-value of this portfolio was 61%. As of quarter end, we had $196 million of nonowner-occupied CRE office exposure, which is about 5% of total loans. This includes only four loans located in central business districts totaling $35 million. We continue to monitor this portfolio closely, and we feel good about the outlook given the lower average loan amount, diversified client base and primary Midwest suburban office exposure.

Overall, we haven’t noticed any material changes in these portfolios since the last quarter, and they continue to perform well. I’ll now turn it back over to Joe.

Joe Chybowski: Thanks, Jeff. Turning to Slide 15. As you’ll recall, we took several actions in the first quarter to reinforce our already strong liquidity position. We remain in a similarly strong position at the end of the second quarter with nearly $2 billion of on- and off-balance sheet liquidity, a robust 2.5 times the level of our uninsured deposits. We have not utilized any borrowings from the FRB discount window or the new bank term funding program. Slide 16 highlights our tangible book value growth and strong capital ratios. Tangible book value per share increased another 1.7% to $12.15 in the second quarter. We continue to demonstrate an ability to consistently grow tangible book value through various market ups and downs.

From a capital standpoint, we saw an increase in all of our capital ratios during the quarter, including CET1, which increased from 8.48% to 8.72% in tangible common equity, which increased from 7.23% to 7.39%. We are focused on continuing to build these ratios back up over time given our more managed pace of loan growth and continued earnings retention. From a capital priority standpoint, organic growth remains our primary focus. Beyond that, we continue to review and evaluate potential M&A opportunities. We also have a $25 million stock repurchase program that was approved by the Board in 2022. We did evaluate repurchasing shares during the second quarter with where the stock was trading, however, we felt it was prudent to remain conservative with our capital given the persistent uncertainties in the environment.

We’ll continue to evaluate the potential for future share repurchases based on a variety of factors. Overall, we have been very pleased with the recent positive balance sheet trends we have seen, including our growing capital levels, diversified liquidity position and deposit growth and composition, just to name a few. We believe all of these position us well moving forward. Turning to Slide 17. I’ll summarize our thoughts on our near-term expectations. Coming into the year, we expected the pace of loan growth to moderate to the high single-digit to low double-digit level in 2023, which is what we have seen so far year-to-date. Over the back half of the year, we would expect growth to likely be in the high single-digit range as we continue to focus on better aligning loan growth with core deposit growth over time.

Our loan-to-deposit ratio briefly moved above 105 in the first quarter, but we were able to bring it back down in our target range of 95 to 105 in the second quarter. The net interest margin continues to be difficult to predict given the various factors. However, with the recent month-over-month trends we mentioned earlier, we would expect the pace of margin compression to continue slowing over the back half of the year. Depending on the path of interest rates, the shape of the yield curve and the pace of our core deposit growth and loan payoffs. From an expense standpoint, while expenses were very well controlled in the first half of the year, we do expect an incremental pickup in the back half, specifically related to increased investments in our people and technology, as well as FDIC insurance expense and IntraFi deposit costs.

And as I mentioned, from a capital standpoint, we will look to continue to build our tangible common equity and CET1 ratios going forward as loan growth moderates and earnings are retained. I’ll now turn it back over to Jerry.

Jerry Baack: Thanks, Joe. Finishing off on Slide 18. Even though the banking industry has changed dramatically in 2023, the strategic priorities we identified at the beginning of the year are still the areas we are focused on midway through this year, and we have made good progress on each of them. We have managed our balance sheet growth and more recently started to see better alignment between loan growth and core deposit growth. While we typically grow expenses in line with assets, we have been able to manage this expense growth over the past year, well within the pace of asset growth. In addition, our ability to actively manage credit risk has resulted in superb asset quality across the loan portfolio. And finally, we are taking strategic actions to help better position us down the road including enhancing our branch footprint and taking steps to expand our C&I function over time. With that, we will open it up for questions.

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Q&A Session

Operator: [Operator Instructions] And the first question will come from Brendan Nosal with Piper Sandler. Please go ahead.

Brendan Nosal: Good morning, guys.

Jerry Baack: Morning, Brendan.

Brendan Nosal: Just to start off here, maybe trying to put a finer point on the margin outlook. I guess that there are so many moving parts that make it tough to really get a clear sense. But if I just do the simple math exercise of taking the monthly progression of margin pressure from Slide 4 and continuing to moderate it over the next 3 months, I kind of get a third quarter margin somewhere in the range of — Indiscernible — Just kind of curious if that is in the reasonable range of expectations for next quarter.

Joe Chybowski: Hey, Brendan, this is Joe. I think as you said, I mean, the ability to precisely project the trajectory of the margin is certainly difficult, as you acknowledge. I think we’ve been pleased with the continued moderation and slowing of month-over-month compression. I think with the funding remix in the second quarter certainly is beneficial for margin. I think the moderation of the Fed hiking cycle has also benefited that. I think as time continues to pass, and the loan book continues to reprice, that’s obviously beneficial. And so to talk about the precise number is difficult, but I will say we’re pleased with the trends. And I think another thing I’ll add too is we are seeing earlier signs of potential payoff activity in the loan book, which as we’ve talked about in the past, is certainly beneficial to margin twofold.

I think historically, loan fees have contributed about 25 basis points to our loan yield. And so when you think about payoffs, if any of those payoffs have unrecognized deferred fees outstanding, obviously, a payoff will accelerate the recognition of those fees. And so if you think about the second quarter, I mean, loan fees were only 10 basis points of the loan yield. So that certainly is a catalyst. And the other thing I’d say on that is, obviously, most of those potential payoffs are at yields inside of where we’re originating deals today. So that’s certainly margin accretive as well. So if you kind of couple all that together, I think over the long haul, we feel like stabilization is possible. We’re pleased with the continued moderation and slowing.

Brendan Nosal: Got it. All right. Maybe turning to the funding side of the equation. You guys did a really nice job on growing core funding this quarter, which is really nice to see. Maybe for the noncore pieces, though, those higher cost CDs, the broker, the FHLB. Can you just talk about kind of what term you guys are putting that product on sheet at and then how quickly those can reprice lower should rate swap?

Joe Chybowski: Yes, I’d say we’re trying to be really careful about both sides because obviously, we are liability sensitive coming into this rate hiking cycle. And so you don’t want to materially then change that now when you feel like there’s a moderation in the rate hiking cycle and ultimately, the curve. So I don’t think we want to materially change the profile. So we’re definitely being balanced as we always have been. So some of that’s placing that out the curve 3 to 5 years. I think we’ve been really diligent about maintaining the optionality to the extent we can. So in the brokered market, taking advantage of callable options as well as in the FHLB markets. The other thing I’d add, too, which is something we’ve obviously been diligent throughout this cycle is leveraging the derivatives markets, and that has been directly linked to some of these brokered CDs while the term of the brokered CD might be short term, the derivative itself is further out the curve, which more aligns with the asset side of the balance sheet, and that’s obviously boded well for us.