MainStreet Bancshares, Inc. (MNSB) Earnings Call Transcript & Summary

Well, good afternoon, everyone, and thank you for joining our virtual earnings discussion. My name is Jeff Dick, and I'm the Chairman and CEO of MainStreet Bancshares, Inc. and MainStreet Bank. I'm joined here today with Tom Chmelik, who is the CFO and Senior Executive Vice President of the company and the bank. This presentation will take about 7 minutes and will be followed by a short video about Avenu. We'll open questions for the remainder of the hour. Before we get started, I'll remind everyone that you'll be muted during the call. After our presentation, you can digitally raise your hand. We'd be remiss if we didn't point you to our safe harbor page that describes the context of forward-looking statements. Finally, we use certain non-GAAP measures, which are identified as such within the presentation materials. 2022 arrived on the heels of a low, long, flat interest rate environment, but inflation numbers started to rise, and starting on St. Patrick's Day, the Fed began a pretty aggressive stance against inflation over the course of the year, raising the targeted Fed funds rate 7x from 0.25% to 4.5%. What you will see in our presentation reflects solid balance sheet management. Let's get started. We trade on the NASDAQ capital markets exchange under the symbol MNSB for our common shares and MNSBP for our preferred shares. We're in a great market. The Washington D.C. metropolitan area is among the most demographically appealing areas in the country. As home to the federal government and more than 10% of federal employees, we have 15 Fortune 500 companies, including Amazon, Boeing and Raytheon. We also have 70 data centers that are responsible for 70% of the country's Internet traffic. We have had historically strong employment in our market. MainStreet opened our doors in 2004 in Northern Virginia, and we've grown organically to $1.9 billion with 6 locations. We serve small businesses and professionals and have always been a technology-forward company. Our tagline is put our bank in your office. We provide customized commercial lending solutions and high-touch business banking. We do the same for our consumers and professionals. We also provide banking as a service and embedded banking for deposits and related services. In the current environment, it is equally important to say what we don't do. We aren't engaged in cryptocurrencies or any related crypto lending activities. We don't engage in consumer algorithmic lending and we don't support Maverick Neo banking. We are focused on serving communities with products and services that we believe in and that we know execute well. As we look at 2022 in short, it was our best year ever. Performance metrics are on an excellent path. We are projecting earnings per share of $3.25 and achieved $3.26. Our efficiency ratio is 52.2% even as we are staffing up to support Avenu's Software-as-a-Service solution. Gross loans increased 18% and our loan losses were nil. As we plan for 2023, we plan to continue our path of organic growth. This will now include opportunities generated through our Avenu embedded banking solution. We plan to start amortizing our avenue capital expenditure in March at about $100,000 per month over 10 years. We're also focused on reducing our asset sensitivity over the next 12 to 18 months. Finally, as we build internal resources to fully manage our Avenu solution, we anticipate that the run rate will increase 5% to 6% per month starting in March through October. Focusing on 2022, our enhanced performance is a story of loan yields with 52% of the portfolio -- excuse me, 52% of the portfolio floating, we saw an 85 basis point improvement in our net interest margin, ending the year at 4.19%. As we look at Avenu's results for our internal purposes, we include income from deposits to show Avenu's relative value. We use the effective Fed funds rate as a conservative bogey to show that Avenu is largely carrying itself at this point. Avenu, the new solution has one client in the sandbox that is anxious to get to production. The team is working diligently with that client to meet those expectations. Turning to the balance sheet. Loan portfolio dynamics are consistent with our growth. We ended the year with a legal lending limit of nearly $43 million and an average loan size of $3.3 million. Loan performance metrics remained solid with 18% growth, which consists of $600 million of new production countered by $361 million of repayments. We ended the year with 0 nonperforming loans. So the loan portfolio remains of high quality. The chart on the right side of this slide shows lifetime performance for our investor CRE, other commercial loans and consumer loans. Lifetime originations of $6.9 billion of loans had 10 basis points of accumulated loss. And of course, commercial real estate continues with 0 losses. A significant portion of the consumer losses occurred within the Lending Club loans that we purchased in 2014 through 2016. We consider this our lesson learned on the merits of algorithmic lending. This next slide about construction lending is new. We think it's important to show that the total volume of projects within our construction lending portfolio is very manageable. For practical purposes, we show that units are deliverable when the loan matures. While this isn't always the case, it works well for this exercise. With a total of 285 units, this slide demonstrates that we aren't undertaking large track lending opportunities. As we've always said, we focus on a 20-mile radius from D.C., funding teardowns, new builds, and conversions. The overall inventory in our market remains actually tight. Buyers are seeing a slight shift as they can now make offers without waiving inspections and appraisals and the like. The market is still strong and reports show that the number of new listings is actually down slightly from 1 year ago. All that is good for us. Turning to the deposit mix. Our deposit mix is sturdy with a growth of 7% and year-end core deposits at 76%. 38% of our deposits are not interest-bearing, with Avenu contributing 12% to that number. The deposit beta picked up during the fourth quarter, ending the second half of the year at 57% of the effective Fed funds rate. During that period, the effective Fed funds rate increased 275 basis points. We anticipate the deposit beta to remain similar through the first quarter of 2023. Now as we look at the company's capital stack, we feel that it is its own success story. The mix is powerful and allows us to maximize our investor return on total common equity which we show at 14.99% after isolating subordinated debt and preferred stock. Finally, we continued to outperform the relative market indices. Now at this point, we're going to go to a freshly recorded 6.5-minute video recap of developments at Avenue, after which I'll come back and we'll open for questions. [Presentation]

So I hope you found the video informative. We thought it'd be giving you a little bit of a history about it as we continue to go forward, we're in -- the production has been -- it's in place, and they're working towards getting into that space now with our first customer, which is a digital wallet type of a customer. And so at this point in time, we'll go ahead and ask if anybody's got questions. Just digitally raise your hand, we'll unmute you and you may need to unmute yourself as well. I'm not sure how this works all the time in the Zoom world, but let's give it a try.

We have Chris Marinac up first.

Chris, can you hear me?

Yes. Jeff, hope you're doing well today. Thank you for hosting us.

Absolutely.

Great. I want to start out with just the increase of the loan-to-deposit ratio and a little bit of increase of your use of wholesale funds. And where do you see that going? And can you remind us on sort of the liquidity that you've not tapped and kind of what's still working in terms of new loan collateral that you've created as the portfolio has expanded?

Yes. So we'll start that the loan-to-deposit ratio and honestly, that's a function of good while trying to maximize the liquidity management. We do have an abundance of wholesale funding available to us. We haven't tapped really our -- any of our lines secured or unsecured. So it's really just a function of trying to maximize the balance sheet and maximize earnings, excuse me, out of the balance sheet. We -- our core deposit ratio is staying about the same. But as you completely understand is the wholesale funds that kill you the most when they come due and they start to reprice. And so we've had a little bit of that happen, which is -- puts pressure on the deposit beta. I think we're going to continue to see a little bit of that until we can really start to see Avenu bringing in some lower cost deposits, Tom, do you have anything?

Yes. And the other thing in the fourth quarter, obviously, with the extensive loan growth we had, I mean that far outstrips the deposit growth that we saw in the fourth quarter. So we're trying to manage that as best we can without, as Jeff said, bring in wholesale funding as fast as we need to.

Got you. Okay. Great. That's helpful. And I guess just a follow-up and then I'll yield the floor. When you think about the cost of Avenu, it starts, if I heard you right, in March, so that $100,000 or $300,000 a quarter, do you see a revenue offset to that this year? Or is that just part of your expense spend and then the revenue piece will continue to just really be late this year and into '24?

Yes. Yes. It really depends upon the partners that we bring on and how quickly they grow. And so then that revenue would be a function of 2 things, either fee income that we're generating off of the relationship or just the putting deposits out there, like I said, internally, where we put them in at the effective Fed funds rate and use that as a counter. But yes, we're very hopeful with the fintechs or the partners that we're looking at so far as they get closer and closer to sign up and join in the sandbox and then production.

We now have a question for Matt Breese.

Matt from Stephens. How are you doing?

I'm sorry about that, Jeff. I had a whole conversation with myself apparently. I'm doing great, thanks. I hope you're doing well. In the past, you've disclosed how many clients are in the pipeline for Avenu beyond just kind of the one client in the sandbox. I was curious how many are in that today? And then if we were to flash forward a year from now, and you were to give the bank an A-grade or B-grade or C-grade on Avenu. What does that deposit base look like?

Well, and that's honestly the hardest part of this. And these next few months, once the first client goes live and really starts to build up production. I would say success to us would be, if each client had about $20 million or so of deposits a year from now, more clearly is better. But just -- and then if we had a half a dozen clients filling that need. Like I said, I think that would be a success. And of course, there's fee income on top of that as well that we haven't really taken into the equation thus far.

Great. And maybe discuss the margin, the margin outlook. You discussed in the release, maybe dampening some of that asset sensitivity. Maybe give us some frame of reference for what the tools you're using to dampen it. And then what does that margin management look like in terms of range of outcomes? And then where do you want to lock it in, if that's the end goal?

Yes. Tom had his crystal ball out yesterday, no but -- so the easiest way for us to start to manage that. We've used interest rate swaps in the past. And we've done some pricing as we've looked at some of our relationships that are in the construction period for 18 months and then they want to convert to a fixed rate after that. And so we've looked at the forward rate swaps market. And we're pretty confident that based upon that market and there's a lot of knowledgeable people playing in that pond that their outlook longer term, and I mean 2 years, is rates are going to really start to hold steady and even come down slightly. So rather than really looking to the swaps market for a solution there, we would go ahead and for a price lock in a forward rate and just try to do that internally. Now the benefit to the customer is our prepayment penalties aren't quite as harsh as the market prepayment penalties, although we'll extract a reasonable rate of for them. But so if you look at everything that's tied to LIBOR, as we go forward, eventually, like I said, we'll be taking that in-house. And I think about 15% of the book is tied to LIBOR or SOFR right now. So that's one way. We can even look at some of the construction projects. Everything has got floors on it. So that adds some protection if prices start to come back down. We're redoubling our efforts on owner occupied at this point in time as well. So I guess it's something that we're going to continue to work on. I think the general consensus is the Fed is going to go up a quarter at its next meeting. And who knows, I think it's going to slow down after that and wait for to kind of digest what's going to happen in the market. But you know more about that than I do. So the biggest, I guess, influence is really going to be start to be the deposit side. And that's why we're pushing so hard to get Avenu up and running as quickly as we can and get people into that solution.

So maybe just to wrap that up, what do you think the margin can do in 2023 relative to ending the year on a high note at 4.70%.

I think we're going to start to see some compression, but I think we're going to be able to stay in the 4s.

I would agree with that statement. So we'll certainly still be in the 4s. But as we show in the slide deck, where the deposit betas have gone we've been very fortunate to hold those deposit betas down for most of the year. But obviously, we realize there is pressure there at this point in time to see rising rates on the deposit side.

It's also a function of loan demand and everything. So if we see low demand start to taper, we can manage that a little bit better. So it's a function of opportunity as well as everything else. So we're going to continue to try and manage it as best as we can.

Yes. I guess that's my last question, right? I mean as we look on a quarter-to-quarter basis, loan growth, 2022 was a bit lumpy, right? And in the year, balances were up 9%, from the first quarter the second quarter was up 0.3%. Overall, a very strong year on the loan growth front. I am curious at the end of the year, how the pipeline was and whether or not you think you can continue this kind of double-digit pace of loan growth in '23.

Yes. So managing the commercial real estate, the investor commercial real estate and construction bucket is we're trying to stay within 375% of capital on that. And so I think a lot of the banks that are in our market, at least a few of the banks in our market have seemed to have tightened up in that area, which gives us good opportunity, but we need to find some loan participation partners to help so that we can continue to put those types of assets on the book. We are seeing some other owner-occupied opportunities, even the bigger size, our lending limit is higher. And I'm not sure if that's a reflection of what the mid-tier banks are doing right now or not. But we've seen some nice opportunities with some larger loans and by larger, I'd say, $25 million and up variety. And we generally will find a partner to help participate on those so that we can manage the overall risk to our profile. But I think things are a tiny bit slower here in January, but that's not out of the ordinary. We did get a lot of stuff closed out before the end of the year. So the lenders are kind of regrouping and finding new opportunities.

I'll stop there. I'll hop back in the queue.

All right. Thanks, Matt. Any other questions out there. I'll take a moment to say that we're actually exploring a new software solution for hosting these meetings, and I think the next meeting will be probably a bit more easier all the way around. This has been an effective solution for us. But I think there's something better that we'll be able to focus on. But do we have anything else? Or is there Matt or Chris, do you guys have any others?

Jeff. It's Chris. I have one more, if it's okay. If we move back to Slide 16 and the sort of increase of deposit cost in the month of December, does that include DDAs in that number? Or is that 2.44% just an interest-bearing only number, Tom or Jeff?

No, that is an interest-bearing only number. If you look at the deposits on the DDA side, it held pretty steady at the 36% to 37% range as total deposits. So that mix has stayed pretty constant. Most of the deposits you see in the DDA are operating accounts for these businesses that we have as customers. So they're not out there looking to place this into the treasury market or anything like they need it for their operating cash for what they're doing. So if they were doing anything, they may move a little bit into a money market account temporarily, but it's not going out of the bank. And that's traditionally what we have seen, especially with the government contractors that we bank. So a lot of those obviously have to keep cash reserves as they are doing their business.

Yes. Well, a mistake on our part. We should have showed the whole number. I noticed both Janney, Fig and Stephens came out with much better deposit betas than what we reflect on this, and that's just a function of how it was calculated.

Sure. No, that's fine. I mean it seems that if the Fed were to raise 50 basis points more from here that you may have another 30 basis points rise from that year-end cost in December. So that puts you kind of, I think, all things being equal, maybe like 180, 175 basis points change from here.

Yes. Anything else?

I just had a question, Matt, probably had the same question, just about kind of credit quality below the surface, anything moving in terms of just classified and criticized, just in terms of trends, I know we'll see that data in future filings.

Not really. Actually, it's interesting. I would say, if anything, the trend has been positive. The hotel portfolio keeps getting better and any of those that we had in our sort of COVID watch category pretty much all but cleaned up. And we've gotten -- we had a couple of smaller investor CRE properties are just sold. We got fully paid out of. So it's really more of a positive trend. We're not seeing anything negative yet.

And maybe Jeff, can you hear me?

Yes. I can hear you, Matt.

Just a follow up on that, be a bit more specific. Can you talk about how cap rates are holding up across your various commercial real estate asset classes versus where they were at their lows 4, 5 years ago. And I'm really curious how the push-pull dynamics between cap rates and NOIs are holding up across these various categories. And if there's really any sort of valuation issues arising on those resets.

And I would say that the cap rates in our market really a year ago got as low as I had ever seen them. We have them reviewed. The reviewers are good with them, but we put an internal cap of like 6% when we're looking at something. So when they get down to 5%, we kind of start to calculate that risk ourselves at 6% and say this is what the loan-to-value needs to be. But it's also a function of the type of products that we're doing. We're not doing any sort of A or B office space. So it's more of a C quality generally speaking. And they've got good tenants, and we really take a look at those things. But yes, I think we're going to start to see cap rates come up a little bit, but I doubt if they're going to get back to 8%. The market here is still pretty good. There's been a few more office buildings in our market, sizable office buildings that are kind of starting that process of converting into rental apartments, where they're doing a lot of core drills and everything and converting them to apartments. I think that's going to continue to happen in our market. We've seen that happen a couple of times. We financed 1 project, and it's very desirable. So yes, I guess, I can't speak to the A or B office space, that's its own animal, and I think that's probably the most vulnerable at this point.

We have Chuck Greece.

Chuck from Blue Lion. How are you, sir?

So just a couple of follow-up questions from Chris and Matt. One, on Slide 14, you show a time line on the construction side. And over half of the units are going to be finished in the first quarter. So should we expect a meaningful decline in the construction book?

They generally replace with new product. I think we might see a slight decline in construction lending. I've heard from a couple of the couple of our builders, where they're -- I think they're waiting for the price of real estate inventory to come down a little bit. So we may see a slight decline, but I think we'll see other opportunities, and that's...

So you're confident you could replace those if they turn out away from you or get -- the units get sold.

Yes. At this point, I haven't heard anything from the lenders that would give me a real concern about not having new construction loan opportunities. Tom, I don't know...

Yes. And there's been -- there were stuff that was approved actually in the month of December that obviously it's going to take a while for it to loan up. So those things are happening as we speak, but they're going to be slow. A lot of the things, I think most of the slowdown was or will probably be as the infill people where they do the teardown and rebuild. And as Jeff said, they're kind of waiting for some of the what I would call wholesale prices or whatever that tear down costs for them to buy. And it has started. We've seen some declines in that area. So but they're being very patient. Our infill people actually do have a lot of cash right now. And they -- as I said, they're going to be patient, they're going to watch this market for a little while to make sure that it doesn't go too far sideways on them.

And then a follow-up question on the loan-to-deposit ratio. It's increased a fair amount here getting your loan growth and an challenging funding market. Could you guys bracket for us kind of the high side of where you think that could go? And then to the extent you start getting some real traction or additional traction from Avenu, the lower bound that loan-deposit ratio?

I mean, I think the business bankers are out there all the time finding new opportunities. Obviously, they're not coming in at the same pace that the loan opportunities came in, in the fourth quarter. But they are bringing in new opportunities. I don't think that the first quarter is going to be as robust as the fourth quarter for new loans. And so I think we're probably through the first quarter that deposit beta, if rates go up another quarter, we'll probably see our prices go up half of that, but our deposit rates, I should say, not prices. But in the second quarter, I think there are some wholesale CDs that will be coming due. And so that's going to put some pressure on our pricing if we can't find it internally. So I'm not sure what the entirety of that is right now, but we're certainly looking at it and trying to come up with a good solution. It's not a great answer to your question, but I don't really have the details in front of me to do that or Tom, I don't know if you...

Yes. And I would just -- obviously, the increase in the fourth quarter was more functional loans. And obviously, we always have that same thing that happens in December on the deposits where taxes are being paid. So there was an outflow because of tax payments. And that typically happens, people got to make their quarterly estimates and that money flows out of the bank for a period of time until they continue to start building it back up in the first quarter. Just given the environment, if you guys -- I know you're assuming some loan growth, can you give us a sense as to in high-single digits, mid-single digit anything would be helpful?

Helpful. Yes. I think as we start this year, we're looking at mid-single digits for growth. And we'll reassess, I think at the end of the first quarter, I think a lot of it depends on what the Fed continues to do. If they start to relax a little bit, I mean at the end of the day, I know mortgage rates, the 30-year fixed is up a bit, but if people can play in the ARM market. So those opportunities are still going to be for housing, that take-up will still go. So we will see opportunities in the construction market. We'll see opportunities in the owner-occupied and investor CRE as well. But we're also looking at it from the standpoint of we want to make sure that we don't -- the clients that we bring on and the opportunities that we're looking at are steadfast. So we don't have any issues there either. But yes, I think kind of at 5%, 6% that we thought we were going to see in 2022, and it ended up better than that. But I think that's a good place to focus on right now.

I was going to say the other thing, as Jeff said when he was going through his presentation, our runoff was over $300 million and budgeting similar numbers like that because traditionally, we're back to where we were before the pandemic happened where that slowed down, I think, to 12%. So if we continue at that pace, obviously, we should, as Jeff said, we're somewhere in the single digits in the first quarter.

And then the last question I have is Slide 9 on the Avenu. The income statement information is that -- that's for the full year?

Yes. Yes. We took just the average Fed funds rate and the average balances outstanding. The fee income is all real. So the only sort of funds transfer pricing is the interest income number.

And currently, with Fed funds, where it is now, Avenu, even with funds transfer price is not a drag, okay?

What was the average for the year.

So right. I'm saying today. With Fed funds where they are today, you'd probably be in the black here.

Right. No, that's exactly right.

Okay. That was it for me.

Thank you, Chuck. All right. It looks like there's no other questions at this point in time. So I think it's exciting time for us with Avenu getting closer and closer to getting into live production with our first customer, and there's a few more kind of teed up behind that. We are getting a bit more sort of critical of ourselves as putting out too much information on that side because now we've got the legal agreements and everything else. We like to get those signed before we start to talk about the next and then the next after that. So we're definitely focused on that solution because as was raised by a few of you today, funding costs, otherwise, unless we can get it from our business bankers is going to put a good amount of pressure on that net interest margin. So we're focused on it, and we're going to continue to do the best we can to manage the opportunities that we have, but really focusing more on what income can be produced rather than growth for growth's sake. So thank you, everybody. This will be put up on the website when it's done. And I look forward to hearing anything from you that you may have remarks wise on the Avenu video. Thank you.