Spirit of Texas Bancshares, Inc. (STXB) Q1 2021 Earnings Conference Call April 22, 2021 10:00 AM ET

Company Participants

Jerry Golemon – Chief Operating Officer
Dean Bass – Chairman and Chief Executive Officer
David McGuire – President and Chief Lending Officer
Allison Johnson – Chief Financial Officer

Conference Call Participants

Matt Olney – Stephens
Brad Milsaps – Piper Sandler
Woody Lay – KBW

Operator

Greetings, and welcome to the Spirit of Texas Bancshares First Quarter 2021 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions]

It is now my pleasure to introduce your host Mr. Jerry Golemon, Chief Operating Officer. Thank you, sir. You may begin.

Jerry Golemon

Thank you, operator, and good morning, everyone. We appreciate you joining us for the Spirit of Texas Bancshares conference call and webcast to review 2021 first quarter results. With me today is Mr. Dean Bass, Chairman and Chief Executive Officer; Mr. David McGuire, President and Chief Lending Officer; and Ms. Allison Johnson, Chief Financial Officer. Following my opening remarks, we will provide a high-level review and commentary on the financial details of the first quarter before opening the call for Q&A.

I’d now like to cover a few housekeeping items. There will be a replay of today’s call and it will be available via webcast on our website at www.sotb.com. There will also be a telephonic replay available until April 29, 2021, and more information on how to access these replay features was included in yesterday’s release. Please note that the information reported on this call speaks only as of today, April 22, 2021, and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening or transcript reading.

In addition, the comments made by management during the conference call may contain certain forward-looking statements within the meaning of the United States Federal Securities Laws. These forward-looking statements reflect the current views of management. However, various risks, uncertainties and contingencies could cause actual results, performance or achievements to differ materially from those expressed in the statements made by management. The listener or reader is encouraged to read the company’s Annual Report, Form 10-K, filed with the SEC for the year ended December 31, 2020, to understand certain of those risks, uncertainties and contingencies.

The comments today will also include certain non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures are included in yesterday’s earnings release, which can be found on the Spirit of Texas website.

Now, I’d like to turn the call over to our Chairman and CEO, Mr. Dean Bass. Dean?

Dean Bass

Thank you, Jerry, and good morning, everyone. Welcome. We are pleased to announce another solid quarter performance. Texas is open for business, and the economy is picking up steam. During the quarter we have seen a significant number of Texans received the vaccine and into the mandatory mask requirement in businesses across the state allowed to operate at full capacity. As a result, we have seen an increase in economic activity across the state. And we anticipate a quicker recovery in many parts of the country.

During the quarter, we reported strong net income of over $10 million with fully diluted EPS of $0.58, and return on average assets of 1.32% annualized. Our provision expense has returned to pre-pandemic levels consistent with the improvement and all economic indicators within Texas. The current allowance balance appears adequate based on our insight experience, and assessment model. Credit quality has improved and loans and active deferral periods are not significant in either number or balance.

The net interest margin has been adjusted in response to the global pandemic and has stabilized with our measures taken to deploy excess liquidity and remove inefficient leverage. We are pleased to now turn our gaze to future growth both organically and through strategic partnerships.

The first quarter has always been a slower quarter with respect to loan growth. And as we review our pipeline and funding projections for the remainder of the year, we’re confident in our quarterly and annual loan growth projections. We will never chase loan growth at the expense of our underwriting guidelines, but we are excited about the opportunities that are currently expected to materialize in the next few quarters. As always, we’re diligently looking for strategic partners who can assist us with growing the bank with meaningful impact.

Now, I’ll turn the call over to David to discuss the loan portfolio and asset quality. David?

David McGuire

Thank you, Dean. I would like to add some more detail around our results that I know the entire Spirit team has proud to have achieved. The unpaid principal balance of loans and active deferment periods has declined from $91.3 million at December 31, 2020 to $11.6 million as of March 31, 2021. 97% of loans requesting at deferment during 2020 have resumed scheduled payments and when the last loan excess deferment in the middle of May, we expect that more than 99% of loans requesting deferment will resume scheduled payments. These statistics would not be possible without our lending team and credit administration team who have worked tirelessly the past year understanding borrower needs and providing guidance as well as assistance.

While we did experience some loan growth during the quarter when excluding PPP loans, we sold approximately $45.2 million participations from the commercial real estate portfolio in an effort to improve concentrations and assist our loan mix with respect to policy limits. As Dean mentioned, the first quarter has historically been a period for slower loan growth and demand typically increasing late in the second quarter through the end of the year. As we look at our current pipeline, we are still projecting year-over-year loan growth, excluding PPP loans in the high single-digits.

The yield on loans in the fourth quarter of 2020 was 5.09%, which decreased 33 basis points from Q4 2020. The decrease in yield was expected given newly originated PPP loans, which yield 1% and a slower pace of PPP forgiveness than we experienced in the fourth quarter of 2020. Excluding the impact of PPP loans, the loan yield was 5.29% compared to 5.3% at December 31, 2020. The yield on loans excluding PPP has stabilized.

Asset quality remains strong during the first quarter. We have seen improvement in past due in loans and overall risk ratings, non-performing loans increased to $9.9 million at March 31, 2021 from $8.6 million at December 31, 2020. Non-performing loans to outstanding loans increased to 41 basis points from 36 basis points during the quarter primarily related to working through remaining pandemic related credit accounts. We did not expect overall non-performing assets to increase meaningfully during 2021.

The provision for loan losses for the first quarter was $1.1 million, which was consistent with the first quarter of 2020. At quarter end the coverage ratio on the organic portfolio was 92 basis points, excluding PPP loans. Annualized net charge-offs were 14 basis points for the first quarter of 2021.

With that, I’ll turn the call back over to Jerry to provide a review of the funding side of the company. Jerry?

Jerry Golemon

Thank you, David. Total deposits at the end of Q1 were $2.6 million, an increase of $138 million or 5.6% from Q4 2020, and an increase of $520 million or 25% over Q1 2020. Of the $138 million sequential increase from Q4 2020, $59 million was related to newly originating PPP loans and $45 million was due to the seasonality of public funds.

Noninterest-bearing deposits increased $72.7 million or 10% from Q4, again with deposits related to PPP loans representing the bulk of the increase. Noninterest-bearing deposits now make up 30.8% of total deposits up from 23.4% at the end of Q1 2020. This improved shift in deposit mix along with aggressive repricing of deposits resulted in a 0.38% cost of deposits a decrease of eight basis points from Q4 2020. The bank has no broker deposits.

The reported loan-to-deposit ratio at the end of Q1 was 93.6%. Excluding PPP activities, the loan-to-deposit ratio drops to 79.7% down from 85.9% at the end of Q4, due to the previously mentioned loan participations sold during the quarter. Borrowings decreased by $61 million during the first quarter to $191.7 million due to payoff a PPP LF borrowing after obtaining PPP forgiveness on the loans pledged against it, as well as the maturity of FHLB short term borrowings.

Borrowings totaled 6% of assets at the end of Q1. The company has significant sources of available liquidity, including $50 million in a holding company line of credit, Fed funds land totaling $118 million, and the Federal Home Loan Bank availability of $668.8 million.

I would now like to turn the call over to Allison to provide a financial overview in the first quarter. Alison?

Allison Johnson

Thanks, Jerry, and good morning, everyone. We provided detailed financial tables in yesterday’s earnings release. Consolidated net income for the three months ended March 31, 2021 was $10.1 million with fully diluted EPS to $0.58, compared to earnings of $4.1 million and fully diluted EPS of $0.22 in the first quarter of 2020.

Net income and earnings per share were primarily driven by the recognition of $1.8 million of net PPP origination fees and $2.2 million of deferred costs associated with the origination of the latest round of PPP. We anticipate the remaining $1.9 million of net origination fees on PPP loans generated during 2020 to be recognized during Q2 2021. In the latest round of PPP, we funded a $144.3 million in loans with net PPP origination fees of $4.7 million, which we should recognize over the life [ph] of loans.

Non-interest income was $2.6 million for the first quarter of 2021, compared to $8.8 million in the fourth quarter of 2020, a decrease of $6.2 million linked quarter. The decline from Q4 2020 was primarily driven by the one-time fee recognition from the gain on the sale Main Street Lending Program loans of $3.7 million and a reduction in swap product income of $1.9 million. We expect non-interest income to increase in the coming quarters, as treasury management offerings and swap products remain a strategic initiative for 2021.

Non-interest expense, which totaled $16.6 million for the first quarter of 2021, compared to $18.4 million in the fourth quarter of 2020. Decrease due to the deferral of $2.2 million in costs associated with the origination of the latest round of PPP loans. Given our ongoing efforts to diligently reduce expenses, branch optimization will continue to be a focus in 2021.

The tax equivalent margin in the first quarter of 2021 was 3.98%, compared to fourth quarter 2020 tax equivalent margin of 4.44%, representing a 46 basis point decrease sequentially. Excluding the impact of PPP loans are tax equivalent net interest margin for the first quarter of 2021 was 4.02% compared to 4.21% for the fourth quarter of 2020. During the quarter, we moved approximately $200 million of cash into higher yielding securities, which should help to improve the margin in the second quarter, and ensure that our tax equivalent net interest margin remains above our target of 4%.

The provision for loan losses for the fourth quarter was $1.1 million, which increased the allowance to $16.3 million or 67 basis points of our total loans outstanding or 79 basis points excluding the 100% government guaranteed PPP loans. The provision expense for the quarter related primarily to the increase in specific reserves on impaired loans. The coverage ratio on the organic portfolio was 92 basis points on the $1.51 billion in organic loans outstanding, excluding PPP loans at quarter end. Additionally, we have $4.1 million unamortized discounts on the acquired loan portfolio at March 31, 2021.

We would not expect elevated provision expense for the remainder of 2021 beyond those amounts needed to fund net charge-offs and loan growth. As of March 31 2021, we continue to enjoy strong capital ratios with a Tier 1 leverage ratio at the bank of 10.38% and 9.98% of the company on a consolidated basis maintaining a strong capital position as the current priority so that we can focus on organic growth and strategic partnerships that may arise in the coming quarters.

I’d like to turn the call back over to Dean for closing remarks. Dean?

Dean Bass

Thank you, Allison. I’m very pleased with the first quarter results, and truly excited for what is in store for Spirit of Texas Bank. We can now return our focus to the growth trajectory we’re on at the beginning of 2020. With some level of visibility returning to the capital markets, we’re seeing merger activity increase as banks seek to combine strengths and mitigate weaknesses exiting the pandemic.

Spirit of Texas has a strong capital position, and an experienced management team with expertise in finding the right strategic partners. Without a doubt, the future of our bank will be a story of growth, stability, and quality as it has since inception.

This concludes our prepared remarks. I’d like to ask the operator to open up the line for any questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Matt Olney with Stephens. You may proceed with your question.

Matt Olney

Good morning. Thank you.

Dean Bass

Good morning, Matt.

Jerry Golemon

Good morning, Matt.

Matt Olney

I want to start on the PPP side. And it sounds like the forgiveness process was slower than expected in 1Q and that’s definitely been the sentiment from some of your peers as well. But you’re expecting I think the remaining fees from the first round of PPP to be recognized in 2Q I believe. So does that mean you’re already seeing the process of forgiveness start to improve in recent weeks?

Allison Johnson

Sorry, David, I’ll take this first. And you can intervene. We did in the second half of March that actually picked up and forgiveness and we actually ended up recognizing another $1 million of additional fee income remaining half of the first two rounds of PPP loan fees we have $1.9 million yet to be recognized, which we expect to recognize in the second quarter of this year.

David McGuire

Yes. Matt, just a little color there too to add as we saw acceleration right before the end of the quarter in the SBA forgiving loans, and that’s continued on for up through today as a matter of fact. So, we’re plowing through those first two rounds and think that those will be satisfied here pretty quickly this quarter, as Allison said, and then we’ll wait out the round three and start processing those loans for forgiveness later in the year, late third quarter, early fourth.

Matt Olney

Got it. Okay, perfect. And just on fees in the first quarter a little bit slower, I think than you expected with respect to both swaps and SBA gains love to hear more about what you saw in the first quarter and your expectations on these overall, but those two in particular, from here?

Allison Johnson

Sure. So last quarter, we implemented this new swap product. So, we scrubbed the existing loan portfolio, and any eligible loans that we bought should take advantage of that product, we went ahead and implemented that swap product for those customers. So that an increased fee income kind of about $1.9 million, which was kind of an anomaly for Q4, the seasonality of that, though, I would think, with Q1, typically being a slower loan growth quarter. We expect that swap fee income to pick up in future quarters to we’re estimating about probably about a $1 million a quarter here going forward. And additionally, I’ll let David talk about the seasonality associated with the SBA portfolio and a gain on sale generated from those.

David McGuire

The SBA is, last year was a very difficult year for generating a new SBA loans due to the pandemic. But if you look at it today, we’re starting to see activity that we had pre-pandemic in the SBA department. So the expectation is that we’ll probably because of the timeline on closing and fully funding SBA loans we expected to see a much better second half the year in the SBA world, and will probably be more reliant upon swap and other product income, fee income during the second and third quarters on through the end of the year.

Matt Olney

Okay, got it. That’s helpful. And then on the loan side, loan growth side, I think you mentioned sold some participations around $45 million, just love to hear more about strategy behind this. I think you’ve mentioned reducing concentrations. I’m curious whether any fees associated with selling these to other institutions? And would you look to continue to do this in the future? Thanks.

David McGuire

Well, if you remember, Matt, we did this last year at this exact same time as we’re going into the acquisition of the Simmons branch is trying to balance out where our internal policies were, versus regulatory targets. Again, this year, we did the same as we build up our CRE portfolios, we’re able to their high quality loans, were able to find partners that want to take on a piece of the loan, so we can rebalance. And we now have the capacity to refill those buckets going into the rest of the year. So and there’s – we are, when we do sell those loans, we take a 25 basis points servicing fee on those loans, no fee – no other fees associated with that. And our expectation is, is that as we move along and looking at our growth projections for the rest of the year, we may bring some of those back like we did last year.

Dean Bass

And Matt just remember, like last year, we did the same thing, to lessen the – to bring about more liquidity in lessen, some pressure points. And then this year, it’s for a different reason. But we have the same capacity to bring those back in.

Matt Olney

Okay, that’s helpful. Thank you. I’ll back in the queue.

Operator

[Operator Instructions] Our next question comes from the line of Brad Milsaps with Piper Sandler. You may proceed with your question.

Brad Milsaps

Hi, good morning.

Dean Bass

Good morning, Brad.

David McGuire

Good morning, Brad.

Brad Milsaps

I wanted to maybe follow-up on the margin and kind of loan yield discussion, I was impressed that you’re able to hold the kind of the core loan yield flat on a linked quarter basis, essentially. Just kind of curious, do you expect, any additional pressure there? Do any of those servicing fees from the commercial real estate participation is that run through interest income opposed to fee income that might be supporting that just, I want to get a sense of, how much more stability you think, is there kind of given, kind of where that rate is versus, maybe what we’re seeing from other of your peers in the market?

Allison Johnson

Yes. So, Brad, again, I think loan yields have stabilized for us going forward. The way those participation works is that would run through the yield there. But I really don’t think that, that had a material impact on the loan yield. The cost of funds side, we’re continuing to see, we’re continuing to see cost of funds decrease, we would expect that trend to continue in the following quarters, we’ve got 22% of our CD portfolio is going to reprice next quarter, and 78% is going to reprice over the next 12 months. So, we’ll see some relief there.

We did move some money around from cash and deploy that into our securities portfolio during the quarter. So, we expect to see some pickup there in Q2 as well. But I think like most things, we’re just – we have an influx of deposits right now. I mean that’s mainly driven by the quantitative easing that’s going on. And we don’t necessarily see that faucet turning off anytime and in the short term. So with that, we’re constantly monitoring our liquidity position and our asset mix or earning asset mix and seeing how we can deploy that cash versus what we can keep in cash to use for future loan growth.

Brad Milsaps

Just on the funding side of things, Allison, yes I think you had about $190 million of borrowings and long term debt at the end of the quarter. I think roughly $37 million of that is the remainder essentially the funding for PPP loans and that should come down as those loans pay-off?

Allison Johnson

That’s correct.

Brad Milsaps

Okay, great. And then on the expense side of things you mentioned, kind of ongoing branch rationalization, just kind of wanted to get a sense of run rate expenses, I assume that, you will see that the $2.2 million of FAS 91 related deferred costs come back in the run rate, but any other offsets there on, kind of the branch rationalization side that, that could push the run rate lower?

Allison Johnson

Yes. Again, we expect to see, maybe some branch rationalization occur in the second half of the year. One of the things we did last year was we turned off, again given COVID, there wasn’t a lot of loan growth, so we shut off the incentive compensation for our lenders. Given that we’re expecting growth this year, we turn that initiative back on. So that’s being factored in. So from a run rate perspective, we expect to maintain that about $18.5 million per quarter going forward with the potential of getting some branch closures in there in the second half of the year.

Brad Milsaps

Great. And just final question from me, for Dean, I think you guys, at the end of the year, we’re pushing about, 365% CRE to total capital, obviously, you had the loan participation this quarter. How much is that going to impact your ability to grow? I mean, is it, it’s kind of 400? The number is you sort of view as an upper bound. Are you trying to push overtime, back below the 300 threshold, just kind of curious, kind of how to think about that, that number, and what kind of governor that might, was represent towards growth going forward?

Dean Bass

We think we’re in a very good position. And if you remember back last year, some of your questions last year was, what are you going to do with the CRE from the Simmons? It’s a large dollar amount, it’s puts a little pressure there that was going to payoff, what’s the quality of those? And now, this year, we’re in an excellent position, let David explain what, transpired and what position does in a great spot right now. Good question.

David McGuire

Yes. Brad, we – internally, we’ve adopted policies, probably about a decade ago now to exceed regulatory targets with going up to 150% of our Tier 2 capital for construction loans, and then we went to 350%, on total CRE. So, when we bumped across that number that that immediately gets our attention, and we want to manage back down to below that we’ve done that we’re in the low-320s right now. And given that with earnings, and in other measures, we’re going – we’re building capacity right now. So, that we have the availability to service the needs of our existing customer base and new customers going forward.

Dean Bass

Also consider when we did the sub debt last year was to for M&A, and organic growth. And so keep in mind, we still have additional funds to drop down if we thought it was needed and could stimulate our progress and income.

Brad Milsaps

Great. Thank you, guys. I’ll hop back in queue.

Dean Bass

Thank you, Brad.

Operator

Our next question comes from the line of Woody Lay with KBW. You may proceed with your question.

Woody Lay

Hey, good morning, guys.

Dean Bass

Good morning.

David McGuire

Good morning, Woody.

Woody Lay

Yes. So, I was hoping to get a quick update on the hotel portfolio. It was nice to see deferrals fall to such a low level, but I was just curious how occupancy rates are trending to this point?

Dean Bass

Yes, Woody, we’re – we predicted by the summer that all of our hotel portfolio would be back on its feet. And what we’re seeing is actually they’re approaching that faster and so then just the beginning of the summer. Right now, we’re we have the loans that are continued to be deferred. We have three hotels. Things are – revenues are improving, RevPARs are improving, Occupancies are improving. And so we think that those by the middle to the end of the summer, we’ll be back in where they need to be, and the rest of the hotel portfolio is performing as expected. And all payments being made as agreed. All contractual payments and amortizations are back in place. So overall, we feel very good about that. We’re not quite ready to entertain doing new hotel loans at this point. But, if things become better for the industry, particularly here in the state of Texas, that’s where we focus on. We think that you know that portfolio will remain healthy, and look to grow it probably later in the year or into 2022.

Woody Lay

That’s great to hear. Next question is, what the industry is flush with excess liquidity at the moment, I would imagine that pricing competition on the loan side is pretty intense. But you sound pretty optimistic with your Ford loan yields from here. It’s just curious how you’re seeing the price and competition on Ford and where you’re onboarding new average loan yields at this point?

Dean Bass

We have a target of maintaining a margin above 4%. And so depending on the deal, we’re going to get it particularly if it’s a loan, it’s going to be a three to five year maturity, and they’re looking for a fixed rate, right, now we’re being really careful with that. We’re pricing that in. We want to be north of 5%, on a three to five year fixed rate deal. If it’s a floating rate deal, then you’re going to see pricing in the in the low-to-mid 4s. And as far as competition, I can’t really speak to what everybody else is doing other than looking at what their margins are, but based on our local peers, they’re doing the same to same things we are. So the expectation is, if we’re running into competition, that the pricing will be pretty much the same, it’s just going to be down to our underwriting guidelines versus theirs.

David McGuire

Also we might add, our pipeline, going into the pandemic last year, was around $1 billion. And that’s what we had on ready to come through the bank in the following quarters. And so now we’re seeing that pipeline back to those ranges, close to those ranges, where they were pre-pandemic, which is very encouraging.

Woody Lay

Got it. And then last for me, the pipeline, does sound strong at this point in time, are there any segments in particular, that will be driving the growth? Or will it sort of a broad base as we go forward?

David McGuire

Yes, one of the benefits of being basically having a statewide footprint is, is that we see a lot of different opportunities that our lenders are able to take advantage of. So, if you look at the pipeline, and when we do – we actually segment it out. We’re not seeing any one segment growing any faster than the other. So, we expect that our – the granularity that we’re trying to go after, as a company, for safety reasons, is going to remain there, and not looking to add huge loans on to move the needle, we’ll do it one-by-one, like we’ve always done it. And it will be and in many different segments that you might expect that in a company like ours is a community bank. We’re going to be probably more real estate related as collateral, but could be for lots of different purposes.

Dean Bass

And David makes a good point. We have a very geography in our team. We have some strong professionals that have been, and been doing their job for many, many years in different markets. And so that gives us a little bit of an advantage in just territory and where they’re looking for loans. So that’s the strength we feel like.

Woody Lay

Got it. That’s all for me. Thanks, guys.

Dean Bass

Thanks, Woody.

Operator

Our next question comes from the line of Matt Olney with Stephens. You may proceed with your question.

Matt Olney

Thanks. Just a follow-up on the investment securities purchase in the quarter, I think you mentioned about $200 million. Love to hear more details behind that in terms of products and yields and duration? Thanks.

Allison Johnson

Sure, yes. So, we have a really low risk profile in general. The majority of that was put into cash flowing agency mortgage-backed. The average yield on that portfolio is 1.5. And the duration is a little over five years.

Matt Olney

Perfect. Thank you. And then I guess more for Dean around M&A. We’d love to hear your thoughts about the M&A chatter in Texas more broadly, and love to hear kind of what types of transactions make the most sense for the bank this year? Thanks.

Dean Bass

I’d be disappointed if you didn’t ask me that question. So, I – we have always been in that $300 to $500 million range has been a target. But as we’ve talked about before, there are different bank groups, outstanding bank groups at different levels, the $5 billion to $1 billion to $1 billion to $2 billion and are there any other merger potentials that are out there that makes sense for the company. We’ve been open to try to figure out what’s in the best interest of our company. And I agree with you, I think it’s that there is a strong interest now in a lot of different sectors. We had a good run the first two years in M&A and we had a pretty active board that was going to continue pre-COVID and now that has picked back up where there’s more strong company good companies on the board right now, whether it’s on the fringes or in the metros, but it’s a little harder waiving into the metro markets. So our fringe, and edges has been successful to us. And we think that’s a good way to continue.

Matt Olney

Okay, thanks of commentary.

Dean Bass

Thank you.

Operator

There are no further questions at this time. I would like to turn the floor back over to you, Mr. Dean Bass for closing comments.

Dean Bass

Thank you, everyone, for being on the call. We appreciate your interest and listen up. We think there are a lot of exciting things in the quarters. And we have certainly enjoyed being on this call and look forward to talking to you in the future. Thank you.

Operator

Ladies and gentlemen, thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time. And have a wonderful rest of your day.