Good day. Thank you for standing by. Welcome to the Equity Bancshares Q3 2021 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to hand the conference over to your host, Mr. Chris Navratil, with Equity Bancshares. Mr. Navratil, you may now begin.
Good morning. Thank you for joining Equity Bancshares Conference Call, which will include discussion and presentation of our third quarter 2021 results. Presentation slides to accompany our call are available via PDF for download at investor.equitybank.com by clicking the Presentation tab. You may also click the event icon for today's call posted at investor.equitybank.com to view the webcast player. If you are viewing this call on our webcast player, please note that slides will not automatically advance. Please reference slide one, including important information regarding forward-looking statements. From time to time, we may make forward-looking statements within today's call. Actual results may vary. Following the presentation, we will allow time for questions and further discussion. Thank you all for joining us. With that, I'd like to turn it over to our Chairman and CEO, Brad Elliott.
Thank you, Chris, and good morning. Thank you for joining our call and your interest in Equity Bancshares. Joining me is Eric Newell, our CFO, Greg Kossover, our Chief Operating Officer, and our President, Craig Anderson. We've had a busy quarter working on many different objectives and staying focused on attracting new customers and retaining our current customers. This effort has translated into our financial performance. We closed the American State Bank & Trust merger on October 1st, as we anticipated. Not only that, we also successfully completed our data conversion on the same weekend. I view our ability to announce a merger and close and convert a core competency of Equity Bank. We could not do it without the dedication of countless members on our team.
While most of our shared service teams worked throughout the weekend to ensure our customers had limited interruptions, I wanted to especially recognize the efforts of Jesse Nienke and Jim Brunzell. Both led our technology and system teams throughout the entire summer and the closing weekend with a dedication and commitment to excellence. They have been involved in most of the M&A transactions we have completed to date and are highly competent. Obviously, they could not have done it without their entire teams and the leadership of Julie Huber, Jeremy Allen, Mary Potter, and 20-plus other leaders who met constantly throughout the planning process to make this transaction go smoothly. With the data conversion behind us, we can quickly start to realize the savings we modeled and expect most of it to be achieved this quarter.
We continue to experience non-PPP loan growth in the quarter, growing 7.3% on an annualized basis, thanks in part to the leadership of Mark Parman's metro market group and Brad Daniels and his Ozark Mountain Region teams. I anticipate the new ASB&T markets will present us opportunities for organic loan growth in addition to our legacy markets growth. Eric, take everyone through the numbers for the quarter, please.
Thank you, Brad, and good morning. Last night, we reported net income of $11.8 million, or $0.80 per diluted share. We calculate core earnings at $0.96 per diluted share, beating Street consensus. Core results this quarter were driven by the recognition of origination fee income from PPP loan forgiveness and improvement in fee-based drivers across many of our categories. Non-merger related expenses slightly increased linked quarter. Salaries and benefits were impacted by lower deferred expenses in the period. There are several items to call out that will help reconcile our GAAP number to core earnings. First, we had $10 million of previously non-accrual loans from our Almena State Bank transaction with the FDIC that moved to accrual during the quarter, resulting in $1.35 million of interest income recognition.
We recognized a $486,000 BOLI death benefit, reduced other income due to our adding of $770,000 to repurchase obligations related to Almena SBA loans, recognized a $381,000 gain on securities transaction and an associated $372,000 loss on extinguishment of debt. Finally, merger expenses of $4 million associated with the October 1 closing of the American State Bank & Trust merger. Our GAAP net income includes a provision for the allowance for credit losses totaling $1 million. There are many factors influencing the provision this quarter. First, another successful quarter of mitigating losses led to a reduction in the historical loss ratio within our calculation. Next, as we continue to move away from the peak of the pandemic without noted loss experience, the economic and qualitative components of the calculation have improved.
That said, with the Delta variant, supply chain concerns, and the as-of-yet unknown long-term impacts of stimulus efforts, management has maintained a reserve of approximately 120 basis points on generally reserved for loans. Finally, specific reserves increased $4.8 million in the quarter, which Greg will discuss more in a moment. The September 30th coverage of ACL to non-PPP loans is 2.04%, unchanged from the previous quarter. Net interest income totaled $39 million in the third quarter, increasing from $34.6 million in the last quarter, representing a $4.3 million increase. During the third quarter, the weighted coupon in the portfolio, excluding PPP, increased approximately 13 basis points. Origination fees recognized from forgiven PPP loans increased notably again in the third quarter. We recognized $7.7 million of fee income and $456,000 of interest income related to PPP loans in the third quarter.
Comparing to the second quarter, total PPP fee income and interest income totaled $5.8 million and $984,000 respectively. At September 30th, we had $3 million of net unrecognized fee income associated with PPP loans, which totaled $95.7 million. Removing PPP fees and interest income from net interest income in both the third and second quarters results in a pro forma net interest income of $30.8 million and $27.9 million respectively. Loan yield, earning asset yield, and net interest margin in the quarter ending September 30th is 4.33%, 3.55%, and 3.19% respectively. This compares to the quarter ending June 30th of 4.41%, 3.55%, and 3.13% respectively. I would note that the $1.35 million of interest income recognized from the previously non-accrual loans during the quarter is having a beneficial impact on NIM. If excluded, NIM during the third quarter was 3.05%, which was within the range of our outlook. Craig?
Thanks, Eric. Organic loan growth totaled $46.5 million, representing an annualized 7% growth during the quarter. PPP loans declined $176 million through the forgiveness our customers are experiencing from the SBA. Year-to-date, we've recognized $16.6 million of fee income from this forgiveness activity and have had $546 million forgiven. At the end of the quarter, we had only 320 loans remaining to submit to the SBA, all of our 2020 PPP loans have been submitted and forgiven. Organic originated loans totaled $217.6 million in the third quarter, down slightly from the $261 million originated in the second quarter. Of the total originations in the third quarter, 80% were in commercial, CRE, and agricultural loans. Our pipeline remains strong and is consistent with what we have been reporting over the last several quarters.
With the addition of ASB&T and their seasoned bankers, I expect that we will continue to show a growing pipeline. Our sales teams continue to successfully grow our fee-based businesses. Our service charges are benefiting from the product realignment put in place in the first quarter of this year, better allowing us to charge fees for services offered to customers in those account types. We also continue to experience increases in fee income from merchant services, commercial credit card, and treasury management products offered to our commercial customers. Eric?
Before I turn it over to Greg, I want to highlight the continued pressure excess liquidity is placing on our NIM. Securities and cash totaled 31% of average earning assets in our third quarter, up from 28% in the second quarter. While we continue to be awash in deposits, we are seeing customers use some of their excess liquidity. In looking at our most popular consumer account, which makes up 60% of the total number of transaction accounts, the average balance continues to be $1,240 higher than pre-COVID levels. The peak average balance occurred around March 31 of this year. When compared to that peak, average balances have declined $678. We don't expect average balances to go down to pre-COVID levels anytime soon, but for context, at 125% of pre-COVID levels, we anticipate another $45 million decline in overall balances in this account type.
Positively, we've grown our number of checking accounts in this type by over 17% through the pandemic, a testament of our operational approach during this time by always being open for our customers' financial needs. Greg, why don't you take everyone through your thoughts on credit?
Thanks, Eric. During the third quarter, we continued our work to successfully position our customers and the bank for successful outcomes. First, we had some movement of Almena assets out of non-accrual during the quarter, which Eric briefly mentioned. Last year, we took a conservative approach on certain Almena loans due to the pandemic. As we close in on the first year of watching the performance of these loans and gathering information that was not readily available to us when we closed on the transaction. We've been able to develop cash flow expectations and assess performance against those expectations. The result was moving 37 loans totaling $9.7 million back to accrual. In addition, our hotel portfolio has continued to show improved operating performance, as has our ag credits. Neither of these portfolios has emerged with the weakness the industry feared one year ago.
Loans with deferred payments in 2020 have performed well in 2021, as the environments we operate in have stabilized and returned to a degree of normalcy. Net charge-offs were again at just $129,000 during the quarter, and pay-downs on legacy non-accruals were approximately $4 million during the quarter. OREO continues to trend flat to down and without any significant net losses as asset values remain stable. We were notified in the last week of the quarter, a shared national credit going through the review process was moved to substandard. The tenets of this credit remain positive, including a positive EBITDA, no missed payments, adequate collateral coverage, as well as being in a recovering industry.
We have discussed in recent quarters an aircraft parts manufacturer we have been banking for over 10 years and a credit we originated with them in 2017 and have carried in our special mention category for several quarters. This borrower has struggled to keep its customer base intact following the 737 MAX issues and continued on through COVID, and we are in discussions with all parties to determine the best course of action. In early October, the borrower missed its payment for the first time, and as such, we have moved the relationship to substandard non-accrual status and have placed a credit mark on it. The collateral, which is highly desirable machines designed for the aircraft industry, remains in high demand, and we are in discussions with several interested potential buyers. We look to resolve this credit in the next two quarters.
We are also closely monitoring and in discussions with leadership of a credit in the magazine and health monitoring subscription businesses. That ownership and management team continues to be very cooperative and pay down principal through normal course debt reductions and with the sale of other assets. We are discussing with their management team a plan to continue retiring principal as they adjust the operations of their business. That credit remains on non-accrual status, has a credit mark on it, and we will continue to work to a resolution in the next few quarters. Eric?
Thanks, Greg. Before turning the call over to Brad, I wanted to turn your attention to the forecast slide on the earnings deck. Here you can see our thoughts on the forecast for the fourth quarter and preliminary 2022. We are in the middle of our budgeting process for next year, as well as integrating the American State Bank & Trust balance sheet into that process. Our long-term goals remain unchanged. Improving our revenue mix, increasing fee contribution to that mix, drive positive operational leverage off of our expense base, and building our loan-to-deposit ratio to levels we saw pre-COVID. This last goal is dependent in part to economic factors in the markets we serve. Supply chain, labor market, and inflation each add a level of uncertainty to our customers and in turn, to loan demand.
Successfully shifting excess liquidity to the loan portfolio from cash and investments is critical to improving our pre-tax, pre-provision return on assets. Barring any new stimulus programs, we do not expect PPP income to influence our 2022 results. Brad?
Thanks, Eric. We continue to anticipate a December close with Security Bank on their sale of branches in St. Joe, Missouri. Our teams are working diligently on another successful integration into Equity Bank's products and services. We expect the branches to add $78 million of deposits in a market that we believe we can grow under Josh Means and Greg Duran's leadership. Last week, Equity Banc shares paid its first common stock dividend to shareholders. As I've said previously, the dividend will broaden our institutional and retail investor base and be a tool for capital management when the stock repurchase program does not meet our earn back needs. The Equity Bank team continues to work every day to help our customers achieve their goals and dreams by helping them access our products and services.
Our shared service teams continue to find ways to make it easier for our customers to engage with Equity Bank. Being a trusted and valued partner to our customers is our value proposition. In turn, we build shareholder value. With that, we are happy to take your questions.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes on the line of Jeff Rulis with D.A. Davidson. Your line is now open.
Thanks. Good morning.
Morning, Jeff.
Well, I just wanted to clarify on slide 26, those 4Q and full year 2022 projections, those include both American State and the Missouri branch acquisition. Is that correct, in the 4Q numbers?
Yes to American State, no to Security.
Correct.
Okay. Well, I guess the only real impact would be the deposits and maybe some moderate expense. Is that how you'd adjust if you were to roll that in?
Correct.
Okay.
It would have a very de minimis impact to Q4.
Got it. Okay. I guess based on those assumptions, looking at the fee income growth, strong in the third quarter and your expectations for 10%-20% growth in 2022, I guess that leads it to kind of a high $30 million for the full year on fee income. The biggest source of that growth, is that going to be balanced on the service charges and debit card? Is there some other areas? I think you've talked about the product realignment on service charges, but just wanted to get into the meat of that growth for those expectations.
Yeah. To me, I think, service charges is certainly one factor, given that we're going to have a higher level of DDA number of accounts when you bring in the American State balance sheet. That will give us some opportunity to earn service fee income off of those accounts, inclusive of overdraft charges. There is an expectation that we'll probably have a more normalized year on overdraft compared to this year. That's a factor of growth. As well as on the debit card interchange, Jeff, as you mentioned, that you're going to have a higher level of interchange from the American State customers as well. That's definitely a focus point of ours, is to increase our share of customers using an Equity debit card. There's going to be some marketing campaigns behind that.
Just the other initiatives that we've previously talked about, continuing a focus on trust and wealth management, our treasury management products for our commercial customers, including commercial credit cards and purchasing cards. Those things, products and services, have been trending positively throughout this year, and we can think that momentum will continue into next year.
Thanks, Eric. Maybe one for Brad. Just that you mentioned late the sort of the dividends impact, and I assume that's sort of more of a flexibility capital tool. And I guess the question is more on the buyback and your appetite given the dividend sort of initiated here and looking at post the American State transaction. Just trying to get a sense for the buyback appetite and/or what you remain on that authorization. Thanks.
Yeah. As you know, we put out a K on we re-up the authorization 900,000 shares?
$1 million.
1 million shares. Last quarter, in September, the board authorized an additional 1 million shares. I would tell you, Jeff, we are as active as we've always been, as long as it meets our criteria for the buyback. We'll continue to buy back shares as actively as we can. The dividend will have no effect on that.
Got it. Brad, I guess it's related. Just the last thing is while we're talking about capital, just additional, I guess, deal appetite. You've closed this transaction and you've got the branch deal upcoming, but our conversations and thoughts on 2022 of getting an additional deal done?
Yeah. We've got several active conversations going on today with companies of size. Not meaning mergers of equal, but similar to what we have just completed with American State. I think we've got a really good possibility of getting something across the finish line in 2022 for sure. It's still very active in the deal space, and we still have lots of partners that are talking with us about the opportunity of partnering up. I think they're good franchises that fit well with what we do. We fit well with what they do. I think we've got a good opportunity to continue to move forward with those opportunities.
Got it. Thank you.
Thank you. Our next question comes from the line of Terry McEvoy with Stephens.
Hey, guys. Good morning.
Good morning, Terry.
Maybe a question for Eric. When you look at your margin guidance for the fourth quarter or really into 2022, what type of assumptions are you making in terms of the reallocation from cash and securities into loans? Maybe more importantly, are you assuming any higher short-term interest rates or steeper yield curve to help the margin maintain that level?
Sure. The second part of that question I'll answer first. We do not model any change in the shape of the yield curve or the level of interest rates. The way our balance sheet is positioned at the moment, a higher level of interest rates would be moderately beneficial to us. We do really try to attempt to have a kind of no significant asset or liability sensitive. I don't like to make a bet with a balance sheet in terms of that, but the shape of the curve, steepness would absolutely help us. That is not modeled in. On the first part of that question, Terry, if you look at our cash and our securities as a percentage of earning assets right now, we're over 30%, which is probably almost more than double where we'd like to be.
I would say that there is a very small transition out of the investment portfolio into loans. We didn't want to make too much of a bet there. I'd love it. That's an area of opportunity for us in terms of margin in 2022 if we could get more of the portfolio into loans and just reposition that mix. It's not a material factor in what we consider for 2022.
Thanks for that, Eric. I guess any comments on the inflow of special mention credits last quarter? I ask because a couple of the loans Greg talked about earlier came out of that category.
The only special mention credit that came on, Terry, of any size in Q3 was a shared national credit that the governing bodies classified as special mention.
Was it special or substandard?
We had one in special mention and one in substandard.
Okay.
Thanks for that. Maybe just last question. You mentioned the pipeline on the lending side was strong. Over the next couple of quarters, where do you see the best growth opportunities in terms of markets or specific areas across the bank? Thanks.
Terry, I'll take that one. This is Craig. We continue to see very strong pipeline activity and sales deals in our metro markets of Tulsa, Wichita, and Kansas City. Those economies are all doing really well. We're starting to see some deals that we have not seen over the last couple of three years. We built a new regional headquarters in Kansas City. I think that's really elevated our presence there and seeing more deal opportunities in that space. I would say in our community markets, Western Missouri kind of leads our growth there. We're also seeing due to some transition in leadership, some very nice opportunities in our Arkansas market.
Thanks, Craig. Thanks, everyone.
Hey, Terry, before we get off your questions, I want to point out that the movement of the Almena assets, they were substandard. They moved to special mention, which might be more to your question. The shared national credit's actually pretty small, but we'll park the Almena assets as special mention till we gain some more experience about improving them even further.
They were actually moving up, not down, Terry.
Right.
Perfect. Thanks again.
Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Our next question comes from the line of Andrew Liesch with Piper Sandler. Your line is now open.
Hey, good morning, everyone. How are you?
Morning, Andrew.
Hi. I just kind of want to stick with the margin here. I guess I would have expected a little bit more optimism for next year. Does this include any discount accretion that might flow through in this forecast?
No.
Okay.
Keep in mind-
I mean, Yeah.
Keep in mind that will flow through. A lot of that will flow through ACL.
Oh, right. Okay. Got it. All right. I guess I'm just curious, is there room on the funding side to get the margin back above this level? I'm just kind of curious, I was a little surprised to see it at this level. What could you guys do to get it up further?
On the funding side, I do think there is some opportunity there. We're looking at the quarter to date, 9/30 cost of savings, and now you see it 16 basis points. We do have a fairly sizable public funds portfolio in that number, and that cost is higher, I think at this point. We've been taking actions while we can because a lot of that is driven by contractual periods. Every single time we see something come into our pricing committee, we take the opportunity to reprice that down. I think that will continue. We do take actions to kind of piecemeal into reducing the cost of funds on our money market accounts as well, and we've done that throughout the year. There's probably a little bit more room there. I do think that there are some opportunities on the funding side, Andrew.
On the asset side, I think a lot of it comes down to the mix. 30% of earning assets sits in cash and the investment portfolio. We don't need to grow that denominator at all, but if we can move some of those funds out of those two categories into loans, that is just very significant improvement to our NIM.
Got it. I'm sorry if I missed this earlier. The new loan coupons, what was added in the third quarter?
If you take our loan yield without PPP, which is 4.33%, so I'm just taking out the effects of PPP. Looking at the originations in the quarter, we're about 25%-30% are basis points below that.
Got it. Okay.
Just from a little more context, the biggest categories that we originate, kind of our core categories, C&I, CRE, those both had a four handle, in terms of originations in the quarter also year to date. AG, we're probably, again, at the high four handle year to date on originations there. Close to five. In terms of origination trend on yield, we're actually a little bit better now than we were earlier this year. I think to answer your question, it really comes down to mix of earning assets.
Got you. Makes sense. Great. Thanks, guys. I will step back.
Thank you. Our next question comes from the line of Damon DelMonte from KBW. Your line is now open.
Hey, good morning, guys. Hope everybody's doing well today. Just wanted to follow up on the credit side of things with your outlook for the provision. I think, Eric, you noted you had 120 basis points of kind of COVID-related reserve that's still embedded in there. This quarter, you did take a $1 million provision kind of tied to the credit that moved into non-performing. How do we think about provision in the fourth quarter, and as we look into 2022? Do you think it's a near-term event to release some of that COVID-related allocation, or do you think you need to keep providing for this loan growth you're having? Just any color would be great.
Yeah. Damon, I think it doesn't feel right to me just yet to have releases on our COVID provision or ACL, just given one of the things I really look at or the management team is focused on, not just me, is the stimulus that is in the economy and is impacting our customers positively, and that's great. I think we want to kind of see how our customers perform without that stimulus in the economy. That's one thing that we're very focused on. It just doesn't feel right to release. In terms of providing for loan growth, I don't think you're going to see a meaningful provision in the fourth quarter. Going into 2021, I had told everyone on these calls that we were budgeting about 20 basis points of provision on average loans.
Looking at what we know today for 2022, I don't think that that's the right number. It's going to be lower than that. That's one of the reasons why. Actually, I don't know if we provide No, we don't provide specifics on our key business drivers, but we're not thinking that the provision for 2022 is 20 basis points at all. It's probably half that.
Okay. Got it. That's helpful. It's good color. Yeah, that's all that I had. As I said, a lot of other good questions, so thanks a lot. Appreciate it.
Ladies and gentlemen, I'm showing no further questions. Thank you for joining our Equity Bancshares Conference Call, and have a great day.