Earnings Call Transcript - STEL Q2 2021

Operator, Operator

Good day and thank you for being here. Welcome to the CBTX Q2 2021 Earnings Conference Call. All participant lines are currently set to listen-only mode. Following the speaker's presentation, we will have a question-and-answer session. I would now like to turn the conference over to your speaker today, Justin Long. Please proceed.

Justin Long, General Counsel

Thank you. Good morning. I’m Justin Long, the General Counsel of CBTX and our management team would like to welcome you to the CBTX earnings call for the second quarter of 2021. We appreciate you joining us. We issued our earnings press release yesterday afternoon, a copy of which is available on our website, along with the slide presentation that we will refer to during this presentation. We also filed our quarterly report on Form 10-Q for the second quarter yesterday afternoon. Before we begin, I’d like to remind you that during this presentation, we may make forward-looking statements regarding future events, our financial performance or our business prospects. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Additional information concerning factors that could cause actual results to differ is available in our earnings release and in the Risk Factors section of our annual report on Form 10-K, our quarterly report on Form 10-Q for the second quarter, and our other filings with the SEC, which can all be accessed on our Investor Relations website at ir.cdtxinc.com. Any forward-looking statements are made only as of the date of this call and we assume no obligation to update any such statements. You should also be aware that during this call, we will reference certain non-GAAP financial information. A reconciliation of these financial measures to the most directly comparable GAAP financial measures is included in our earnings release and investor presentation. I’m joined this morning by Robert R. Franklin Jr., our Chairman, President...

Robert Franklin, Chairman, President

Thank you. Well, we got cut off, so I am not sure where I was in my brilliance. But let me… Our PPP portfolio continues to decline as the pace of borrower forgiveness picked up during the second quarter. Our officers are increasing their pace of in-person meetings and we are seeing our pipeline build as we continue into the third quarter. Our expectations are that we will continue to see new loan activity coming from existing relationships and newly acquired customers, as our calling efforts continue to increase into the third and fourth quarters. We have been provided significant liquidity by our customer base. Our job is to stay focused and disciplined on our credit culture, as we put these funds to work. We face stiff competition and the rate environment is challenging, but we have dealt with these issues since the beginning as community bankers. The challenges do not make mistakes as we are not being paid a rate risk premium in this interest rate environment. I also want to thank our entire team that has worked very hard on our Bank Secrecy Act program to meet regulatory expectations, including the formal agreement with the OCC. It has been a bank-wide effort and we continued our efforts during the second quarter, including the work with some consultants and outside counsel. We have continued to communicate with the OCC regarding our program and the formal agreement. We believe that we have taken the necessary actions to comply with each of the articles of a formal agreement with the OCC. Based on discussions with the OCC we expect to hear from them regarding the status of the formal agreement in the coming weeks. We do not anticipate our spending on consultants to continue into the third quarter and fourth quarter. We are pleased to be in a more robust economy and expect to capitalize on that growth to continue to build CBTX for the future. We remain focused on creating shareholder value. We have a great team, excellent customers and operate in growing markets. We have a strong balance sheet exhibiting a strong capital position. Our relationship model provides us with low-cost deposits and strong sticky customer relationships. Our focus will remain on driving long-term value for our shareholders.

Ted Pigott, CFO

Thank you, Bob. Certain financial information for the second quarter and prior periods begins on slide four of our investor presentation. The company reported net income of $11.7 million or $0.48 per diluted share for the quarter ended June 30, 2021, compared to $10 million or $0.41 per diluted share for the quarter ended March 31, 2021, and $2.3 million or $0.09 per diluted share for the quarter ended June 30, 2020. Our net interest income for the second quarter 2021 was $31 million, a decrease of $2.1 million from the first quarter. The net interest margin on a tax equivalent basis was 3.29% for the second quarter, a decrease of 42 basis points from the first quarter 2021. The loan yield decreased 28 basis points to 4.36% for the second quarter 2021, compared to the first quarter of 2021. The cost of interest-bearing liabilities was 0.32% for the second quarter, compared to 0.34% for the first quarter of 2021. Our provision for credit losses was a recapture of $5.1 million for the second quarter 2021, compared to a provision for credit losses of $412,000, primarily due to continued improvements in the national economy, economic forecast, loan quality and the size of the loan portfolio. Non-interest income for the second quarter increased by $380,000 from the first quarter to $3.5 million, primarily due to increases in gains, sales of assets and also card interchange fees. Non-interest expense for the second quarter of 2021 was $25.2 million, an increase of $1.9 million from the first quarter. The increase from the first quarter 2021 primarily resulted from increases in professional and director fees of $738,000, salaries and employment benefits of $546,000, and advertising, marketing and business development of $225,000 from the first quarter. Total assets at June 30, 2021 increased by $37.9 million to a total of $4.1 billion compared to March 31, 2021. This growth was driven by net deposit inflows of $32 million. Loans excluding loans held for sale at June 30 decreased by $162 million to a total of $2.7 billion compared to March 31, 2021. PPP loans, net of deferred fees and unearned discounts, were $179 million at June 30, 2021, compared to $268.8 million at end of March 31, 2021. Compared to June 30, 2020, our loans excluding PPP loans decreased 3.8% on an annualized basis. Deposits at June 30, 2021 increased by $32 million to $3.4 billion compared to March 31. Compared to June 30, 2020, deposits increased 5% on an annualized basis. The company maintains strong capital ratios as the total risk-based capital ratio increased to 17.72%. The common equity Tier 1 capital ratio increased to 16.46% and the Tier 1 leverage ratio was 11.63% as of June 30, 2021. Non-performing assets totaled $21 million or 0.52% of total assets at June 30, 2021, compared to $23.6 million or 0.59% of total assets at March 31, 2021. The allowance for credit losses for loans was $37.2 million or 1.36% of total loans at June 30, 2021, compared to $40.9 million or 1.41% of total loans at March 31, 2021. The ACL decreased during the second quarter, primarily due to a recapture of $4.2 million and $893,000 in the ACL for loans and unfunded commitments. Due to improvements in the national economy and economic forecasts, reduction in loan portfolio and an improvement in loan quality. Net recoveries were $499,000 for the second quarter compared to net charge-offs of $49,000 for the first quarter 2021. Now I will turn it over to Joe West.

Joe West, Loan Portfolio Manager

Thank you, Ted. I’ll speak to our loan portfolio beginning with slide seven from the investor presentation. For the second quarter, our net loans were down slightly at $2.69 billion versus $2.85 billion at the end of the first quarter of 2021, a decrease of approximately $160 million, due primarily to pay downs during the second quarter of 2021 of approximately $64 million on commercial loans. We also had a decrease of approximately $90 million in our PPP loans. Our loan deferrals relating to COVID continue to decrease and we had nine loans totaling $20.5 million in loan deferral at the end of the second quarter. For the quarter, C&I was down by approximately $98 million or 12.9%, again with $90 million in PPP payoffs compared with Q1. CRE was down 1.5% quarter-over-quarter. Construction and development was down 8.2% compared with the first quarter. 1-4 family was down 6% and multifamily was down 2.4%. Slide eight sets forth the components of our commercial loans, and our gross commercial loans were down slightly for the second quarter from $2.56 billion versus $2.41 billion at the end of the second quarter. As you turn to slide nine, you will see our construction and development loan components and our construction development loans were down approximately $38.1 million when compared to March 31, 2021, due to payoffs, as well as some existing C&D loans reaching completion and moving to permanent loan classification. Slide nine sets forth our oil and gas exposure, including how we quantify our direct and indirect exposure. Our direct and indirect oil and gas flows for the second quarter increased slightly to $171.6 million compared with the end of the first quarter. Slide 10 sets forth information about our PPP loans. During the second quarter we saw the pace of approved forgiveness applications increase and our net PPP loans decreased $39.6 million from the end of the first quarter. During the second quarter we originated $20.3 million in new PPP loans and we received payments totaling $110.4 million related to forgiveness or payments from customers. We continue to work with our borrowers on forgiveness applications. The table at the bottom of slide 10 sets forth our average yield on our loan portfolio. Our average yield on our PPP loans and the average yield on our loan portfolio, while taking out the PPP loans. Slide 11 sets forth information about our allowance for credit losses. As Ted noted, our allowance for credit losses was 1.36% at June 30, 2021. Turning to slide 12, our non-performing assets decreased again slightly during the first quarter, and our credit quality remains strong. Slide 12 shows information regarding our non-performing assets to our total assets, which was 0.52% as of June 30, 2021, compared to 0.59% as of March 30, 2021. Our recoveries during the second quarter exceeded our charge-offs, resulting in a net recovery of $499,000. With that, I’ll turn it back to Bob Franklin.

Robert Franklin, Chairman, President

Thanks, Joe. With that, we’ll open it up to questions.

Operator, Operator

And your first question is from Graham Dick with Piper Sandler.

Graham Dick, Analyst

Hey. Good morning, guys.

Robert Franklin, Chairman, President

Good morning.

Graham Dick, Analyst

So I just kind of wanted to start off on the pay down front. I know it’s tough to gauge. But given what you guys are seeing in the market today, do you think it will accelerate or decelerate in the back of the year? And then also how does that impact what you expect on the loan growth front excluding PPP loans?

Robert Franklin, Chairman, President

Yeah. Graham, we somewhat expected to see the second quarter have somewhat of a dip as we started to push into more face-to-face meetings. We did get some unexpected pay downs in the form of several projects that were sold. The pricing on some of this stuff kind of surprised us with retail centers, which we thought were fairly stressed over the COVID period but recovered quickly, and there’s a lot of capital chasing these projects. So a little unexpected to see and I think Joe has numbers for us, if you want to talk about that, Joe, I don’t know.

Joe West, Loan Portfolio Manager

In the first half of the year, we observed a decrease in our outstanding retail commercial real estate by approximately $48 million. Previously, we noted our exposure to commercial real estate in the retail sector was just below $300 million, and now it has dropped to nearly $250 million. Notably, these changes were not due to write-downs or refinancing, but rather from the sale of properties to other investors. We monitored the selling prices and found they exceeded the appraised values, which indicates some strength in that market. Additionally, we experienced a reduction in our outstanding loans in convenience stores, largely due to refinancing and sales, totaling about $20 million in the first half of the year. There was also a slight contraction in the 1-4 family portfolio, as homeowners opted for lower rates through other lenders. The significant declines were primarily in retail and convenience stores, which slightly de-risked the balance sheet. However, we were pleased to see that property prices remain stable.

Robert Franklin, Chairman, President

What we have observed is that our pipeline has significantly improved compared to the beginning of the first quarter and the first part of the second quarter. We're beginning to secure new opportunities and book those loans as we start the third quarter, and we anticipate this will only increase throughout the year. We feel optimistic about our trajectory, and it didn't surprise us that we experienced a slight downturn in the second quarter while we continued our face-to-face meetings. I expect payoffs to maintain a pace similar to what we usually see in a cycle, but we will see how that unfolds. Most people are likely to experience something similar, and the positive aspect is that our pipeline is strong, and we are confident about our direction.

Graham Dick, Analyst

Okay. Great. Thanks. And on liquidity looks like the average for liquidity balances in the quarter was about $670 million. I just kind of wanted to get a sense of what your plan is on deploying that cash into higher yielding assets. So do you think you’ll buy more bonds maybe at a similar magnitude to what we saw this quarter or are you thinking that you might just reserve the majority of it for loan growth, assuming a lot of it runs out of the bank that may have been temporary or stimulus-driven, I guess, that came in over the last couple of months?

Robert Franklin, Chairman, President

We recognize the situation and appreciate your perspective, Graham. We typically invest our funds in areas where we see potential and are willing to take risks. While we have slightly expanded our bond portfolio, the current market conditions are not ideal for a significant increase. We're cautious in a low interest rate environment because mistakes made now can have long-term consequences. Therefore, we aim to remain flexible. The swift influx of liquidity presents challenges for us to deploy it at the same quick pace, so we need to be careful in our approach. We believe we can maintain a solid growth rate through the end of this year, and if the economy continues to perform well into next year, we expect 2022 to present better opportunities to address our liquidity situation. This is a unique challenge for us as we haven’t faced this kind of liquidity gap in a long time, and it will take time to navigate and comprehend the situation. I believe some of this liquidity will be temporary, and I don’t think people will maintain elevated cash balances indefinitely in a low-interest rate environment. We anticipate that some of that liquidity will eventually be utilized for more productive purposes than what we are currently earning, which is minimal. Our funding costs remain very low, and we're actively seeking opportunities to put this liquidity to good use.

Graham Dick, Analyst

Okay. Awesome. That’s it for me, guys. Congrats on the quarter.

Robert Franklin, Chairman, President

Thank you very much.

Will Jones, Analyst

Hey. Great. Good morning. How’s everybody?

Robert Franklin, Chairman, President

Good morning, Will.

Will Jones, Analyst

Hey, I have great news regarding the BSA. It seems you have gained a lot more visibility on that front. Bob, do you think it’s fair to say that the second quarter is really the last significant amount of BSA expense? I understand it can be quite challenging to look ahead and map that out, but I'm curious if you believe the second quarter might represent the peak BSA expense from here. Additionally, if we focus on the core expense base, excluding the BSA impact, expenses have increased slightly quarter-over-quarter, approaching the $24 million mark, partly due to compensation-related factors. Was there anything one-time in that compensation line, or is it primarily a reflection of the hiring efforts you have made? Is the $24 million a solid core run rate for the expense base going forward? Thank you.

Robert Franklin, Chairman, President

We believe we are nearing the conclusion of our consultation process for the BSA. We are pleased with our current position and have met all necessary compliance requirements. We expect to receive communication from the OCC soon. Regarding increased salary expenses, we have brought on some new BSA personnel, which has contributed to this. We are also in the process of hiring more lenders, having held many discussions with potential candidates to effectively utilize our liquidity. Overall, we are encouraged by the growth in our pipeline and the new lending opportunities available to us. Although we are concerned about the direction of interest rates set by some of our competitors, the current challenging rate environment drives us to work harder for lower returns. Despite this, our cost structure allows us to allocate funds effectively in this environment. With minimal risk premiums available, we are being cautious about the risks we take in our portfolio. We have observed promising opportunities recently, particularly in Houston and East Texas where we have invested significantly.

Will Jones, Analyst

It's great to hear all that positive information. I want to shift focus to capital; it seems you were not active with buybacks this quarter. Can you confirm that? As we look ahead to the second half of the year, I’m interested in your appetite for buybacks. Your capital position is strong, the stock prices have decreased a bit, which seems like a good opportunity to be more active in buybacks. Could you provide some insight on that?

Robert Franklin, Chairman, President

I think we probably share your views on the buyback situation. We see opportunities there and are eager to explore them further. We are feeling more confident about our M&A discussions, considering our current position from a regulatory perspective, so we will keep pursuing that avenue. We are engaging in several related conversations and will see where that leads us. Additionally, we are reviewing our dividend and its financial implications. We are examining various factors comprehensively. I believe there is potential for purchasing our stock, and we plan to continue that strategy. We were somewhat less active in the last quarter, but you might see us becoming more active in the next quarter based on pricing trends.

Will Jones, Analyst

No. That’s great. And then, maybe, Bob, just expanding on the M&A conversation a little bit, where ideally would you like to see your franchise grow? Would it really be in that East Texas market?

Robert Franklin, Chairman, President

Well, I think primarily Houston or Dallas. So, we are looking to expand our presence in Dallas a bit and always would be happy to do something in the Houston market also, because that’s our primary market. But we want to bolster our efforts in Dallas. We have a very small presence there now. But it’s such a great economy up there, and we really feel like we should be a participant there. We’ve been looking for some additional people and possibly some M&A activity up there. So there are some possibilities there and we’re going to continue to pursue that. So we’re looking on all fronts, and I think that’s to keep our eyes and ears open, that’s the best thing for us, along with doing the things that we do every day, which is loans and deposits.

Will Jones, Analyst

Great. Well, that’s it for me. Thanks, guys.

Robert Franklin, Chairman, President

Thank you very much, Will.

Thomas Wendler, Analyst

Hey. Good morning, guys.

Robert Franklin, Chairman, President

Good morning, Thomas.

Thomas Wendler, Analyst

Most of my questions have been asked, but I have one more for you. It seems that your interest-bearing deposit costs have remained steady at 35 basis points. Can you provide some insight into whether you can reduce that further and what your expectations are for it going forward?

Robert Franklin, Chairman, President

Well, I think we find it pretty low as it is. But, no, I don’t think it’s going to go much lower. I mean, we’ve got certain customers that we’ve had to do some things for. But for the most part, we’re paying very little, if not nothing, for deposits and our overall cost of funds is so low at this point. It’s not something we spend a lot of time on anymore. It’s more about how we get this money out, and that’s our real focus.

Thomas Wendler, Analyst

All right. Thanks for answering my question. Have a good day, guys.

Robert Franklin, Chairman, President

Okay, Tom. Thank you.

Operator, Operator

And there are no further questions at this time. I would like to turn the call back over to Robert Franklin.

Robert Franklin, Chairman, President

Thank you very much. We appreciate everyone’s interest in CBTX and look forward to speaking with you next quarter. Thank you.

Operator, Operator

Thank you. This concludes today’s conference call. We thank you for participating and ask that you now disconnect.