Earnings Call Transcript - STEL Q2 2022

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 our earnings call for the second quarter of 2022. 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. Before we begin, I'd like to remind you that during this presentation, we may make forward-looking statements regarding future events, or financial performance or 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 Reports on Form 10-Q, and our other filings with the SEC, which can all be accessed on our Investor Relations website at ir.cbtxinc.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. 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 Bob Franklin, our Chairman, President and CEO, Ted Pigott, our Chief Financial Officer; Joe West, our Chief Credit Officer; and Joseph McMullen, our Controller. At the end of the remarks, we will open the call to questions. With that, I'll turn it over to our Chairman, President and CEO, Bob Franklin.

Robert Franklin, Chairman, President and CEO

Thank you, Justin and welcome to the earnings call for CBTX Inc. We are pleased to present our second quarter results for 2022. During the second quarter, we have continued to see a fairly strong economy and consequently a nice growth in our loan portfolio. We've also seen some of the benefits of our low-priced deposit base which provides us even while beginning to experience some pressure on pricing. During the quarter, we did see some net interest margin expansion and we expect that trend to continue as the Federal Reserve pursues higher interest rates. We are very proud of our team that continues to produce. While we work hard towards our merger with Allegiance Bank. Mergers can be distracting but our team has continued to serve our customers, while also doing the hard work it takes to make sure that we have a successful merger. During the second quarter shareholders of Allegiance and CBTX approved the agreement for the merger and we received approval from both the FDIC and the Texas Department of Banking. While we wait patiently for the approval of the Federal Reserve, we continue to work diligently with our counterparts at Allegiance to provide for a smooth transition for our customers, employees, shareholders and communities which we serve. Despite these positives, we must remain vigilant for the changes to the economy. The Fed has told us that it intends to slow the economy through a series of interest rate hikes to try and get a handle on inflation. We know that higher interest rates can lead to strains on the economy and certain asset repricing. However, we must continue to adjust our underwriting to accommodate a slowing economy. We do benefit from operating in the state of Texas where we continue to see both job and population growth. But we are not immune to what is happening in the rest of the nation and the world. We think that our timing of bringing together two well-positioned Texas banks is a good one. We continue to work to be more efficient as one organization with a strong low-cost deposit base and a granular well-priced loan portfolio. Although we are cautious about the next several months as the economy adjusts to inflation and higher interest rates, we are very optimistic about the long-term future of our bank. Now, I will turn the meeting over to Ted Pigott, our Chief Financial Officer.

Ted Pigott, Chief Financial Officer

Thank you, Bob. Certain financial information for the quarter ended June 30, 2022, begins on Slide 6 of our investor presentation. The company has reported net income of $11.7 million or $0.48 per diluted share for the second quarter of 2022. Compared to net income of $10.6 million or $0.43 per diluted share in the first quarter of 2022 and net income of $11.7 million or $0.48 per diluted share for the second quarter of 2021. Net interest income for the second quarter of 2022 was $34.9 million and increased $2.2 million with $1.3 million attributable to rate variance primarily related to interest-bearing deposits in other financial institutions in the first quarter of 2022. Net interest margin adjusted on a tax-equivalent basis increased 27 basis points to 3.49% from the first quarter this year. Yield on interest-earning assets was 3.56% for the second quarter compared to 3.41% for the second quarter of 2021. The cost of interest-bearing liabilities was 0.25% for the second quarter of 2022 and 0.32% for the second quarter of 2021. The provision for credit losses was $126,000 for the second quarter of 2022 compared to provision in the first quarter of this year of $435,000 and a recapture of $5.1 million for the second quarter of 2021, which primarily resulted from the improvements in the local economy during that period. Non-interest income decreased $1.8 million for the second quarter of 2022 as compared to the first quarter. Non-interest income for the second quarter was down compared to the first quarter this year and included payments totaling $1.5 million recognized in connection with the early termination of the land lease, and included other non-interest income and a gain of $1.2 million for sales of assets underlying a portion of the company's equity investments, partially offset by a $1.2 million loss, including net gain on sale of assets for the disposal of the building and improvements to the land lease that was terminated earlier. Non-interest expense was $23.8 million for the second quarter compared to $24.7 million for the first quarter of 2022 and $25.2 million for the second quarter of 2021. The decrease in non-interest expense of $894,000 for the second quarter, compared to the first quarter of 2022 was primarily due to a $556,000 decrease in salaries and employee benefits, primarily due to higher insurance in the first quarter and a decrease of $305,000 in data processing and software expense. The decrease in non-interest income of $1.4 million for the second quarter of 2022 compared to the second quarter of 2021 was primarily due to a $1.3 million decrease in professional and director fees primarily related to BSA/AML compliance matters and legal fees, partially offset by $1 million costs related to the pending merger with Allegiance Bancshares. Our efficiency ratio for the second quarter of 2022 was down to 61.84%. Our assets are $4.32 billion at June 30, 2022, a decrease of $123 million from March 31, 2022. Securities increased $2.1 million from March 31, 2022, and increased $240.9 million compared to the second quarter of 2021. Loans excluding loans held for sale were $3.03 billion at June 30, 2022, an increase of $153 million or 5.3% from March 31, 2022, an increase of $4.34 million or 11.1% from June 30, 2021. Loans excluding loans held for sale and PPP loans increased $473.6 million or 18.6% to $3.2 billion from June 30, 2021. Our average return on assets for the second quarter was 1.08%. Total deposits at June 30, 2022 decreased $64.6 million to $3.76 billion compared to March 31, 2022. The cost of total deposits was 12 basis points for the second quarter of 2022. The company maintains strong capital ratios as the total risk-based capital ratio was 15.53%, CET1 capital ratio was 14.49% and the tier one leverage ratio was 11.48% at June 30, 2022. Non-performing assets totaled $28.3 million or 6.65% of total assets at June 30, 2022, compared to $22.1 million or 0.5% of total assets at March 31. The allowance for loan losses as a percentage of total loans was 1.06 percent at June 30, 2022. It was 1.09% at March 31, 2022, and 1.36% at June 30, 2021. I will now turn it over to Joe West.

Joe West, Chief Credit Officer

Thank you, Ted. I'll speak a bit to our loan portfolio beginning with Slide 9 from the investor presentation. For the second quarter, our net loans were up at $3 billion versus $2.9 billion at the end of the first quarter of 2022, an increase of approximately $153 million. We funded approximately $178 million in new loans during Q2 and had $126 million in pay downs or payoffs, excluding PPP loans. For the quarter C&I, including the effects of the PPP payoffs declined by approximately $19.5 million or 3.3% compared to Q1 and C&I decreased $10.7 million, excluding PPP payoffs. CRE was up $39 million or 3.4%, quarter-over-quarter, C&D was up $87.6 million or 18.5% compared to the first quarter, and one to four families were stable quarter-over-quarter while multifamily increased $21.5 million or 7.7%. Slide 10 sets forth the components of our commercial loans, and our total commercial loans were up slightly in the second quarter to $2.6 billion versus $2.5 billion at the end of the first quarter, including our PPP loans. Slide 11 also 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 decreased to $183 million compared to $186 million at the end of the first quarter. Slide 12 sets forth information about our PPP loans that continue to wind down. During the second quarter our net PPP loans decreased $8.9 million, and we received $8.8 million related to forgiveness for payments from customers. The table at the bottom of Slide 12 sets forth our average yield on our loan portfolio. Our average yield on our PPP loans and the average yield on our portfolio will take half of PPP loans. Slide 13 sets forth information about our allowance for credit losses. As Ted noted, our allowance for credit losses to loans was 1.06% at June 30, 2022. Turning to Slide 14, our non-performing assets remain low during the second quarter, and our credit quality remains strong. Slide 14 also shows information regarding our non-performing assets to our total assets, which was 0.65% as of June 30, 2022, compared to 0.50% at March 31, 2022. As with the first quarter, our recovery during the first quarter exceeded our charge-offs, resulting in a net recovery of $166,000. With that, I'll turn it back over to Bob Franklin.

Robert Franklin, Chairman, President and CEO

Thank you, Joe. With that, we'll open it up to questions.

Brady Gailey, Analyst

Hey, thanks. Good morning, guys. I just wanted to start with the lack of set approval for the merger. I mean, we're coming up on nine months since the transaction was announced. Is there anything that they're focused on? Or do you guys have any sense as far as what the holdup could be on the Fed side?

Robert Franklin, Chairman, President and CEO

I'll provide some insight. Unfortunately, I can't offer much clarity as I lack information. However, I can share that we announced in November and completed the necessary paperwork with the Fed in January. From January onward, we are still within a typical timeframe for them, but communication from the Fed is limited. We don't have any reason to believe this deal won't be approved. Our main regulators and shareholders have already approved it, and we're not aware of anything delaying the process. While we wish we could offer more specifics, we understand we are in line; we just don't know our position in that line. There are currently about 20 to 25 other deals pending ahead of ours. This situation is frustrating for us, as well as for our employees and stakeholders, because we are ready to move forward, but we are waiting on the Fed.

Brady Gailey, Analyst

And you guys on a standalone basis have excess capital, even the pro forma bank will have excess capital, are buybacks a possibility as we wait for the Fed? Or is that something that you think you just need to wait until this deal closes? And then think about buybacks after the fact?

Robert Franklin, Chairman, President and CEO

It has been quite challenging for us to engage in buybacks due to the restrictions in place. We purchased just over 93,000 shares since the last quarter, indicating that we are somewhat active in the market. We intend to resume buybacks once we navigate these obstacles. While I believe both banks are keen on repurchasing shares, I won’t speak on their behalf today. From our perspective, we view buybacks as a favorable strategic option as we move forward.

Brady Gailey, Analyst

Okay. And then finally for me, I know you guys have talked about kind of a 5% to 8% loan growth rate. You clearly did a lot more than that this quarter. What's the update on how you're thinking about core organic loan growth going forward?

Robert Franklin, Chairman, President and CEO

I still think over the long term, if you average us out, that's kind of where we would be on a consistent basis. But there are times when we feel like there are opportunities for us. The Texas economy, as I'm sure we've heard on other calls, still appears to be fairly strong, although we're starting to see some weakening, and we have to be prepared for that. But we're taking opportunities, we're tightening our underwriting a bit, we're able to get a lot more in the way of equity on the front end. And we're making sure that we have people that have the liquidity and ability to service the debt if they have to hold it for a little longer than they initially thought they would. So it's still a good economy for us. I think we will see loan growth start to wane a bit, just because that seems to be what the Fed and everybody else wants to happen. But we're going to continue to seize opportunities where we can. So I don't think we're going to maintain this type of loan growth for the next several quarters, but I do think it will come off a bit.

Brady Gailey, Analyst

Okay, great. Thanks for the color, Bob.

Robert Franklin, Chairman, President and CEO

Thank you.

Brad Milsaps, Analyst

Maybe, Bob, I wanted to start with the net interest margin. I think in the deck, you disclosed about half the loans are variable rate, but about three quarters have floors. I wonder if after this week, are we pretty much through the floors? Just wanted to kind of get a sense of how you guys are thinking about further margin expansion from here. Pre-COVID, you were much higher, and the balance sheet is a little bit different. But what would you say is kind of your opportunity to improve the net interest margin from here?

Joe West, Chief Credit Officer

Yes, we believe we're past the floors. The initial adjustments were the quarter point increase on March 17 and the half-point increase on May 5, which aligned with the floors in June. As a result, we didn't see much benefit from those in Q2. Now, we are in a strong position to take full advantage of the recent moves in our portfolio. So yes, for the most part, we've caught up to the floors, and this should help us slightly increase the margin.

Brad Milsaps, Analyst

Okay, great. Thank you. And then, maybe switching gears to expenses. You guys are kind of excluding some of the noise, kind of flat year-over-year. It looks like headcount is down about 40 people. Just kind of curious, I know you outlined a 15% expense savings when you announced the deal, are some of those savings maybe already in the run rate? Just kind of curious how to think about the expense opportunity. Have you identified any changes regarding that?

Robert Franklin, Chairman, President and CEO

I believe the answer to your question is yes, regarding all those points. As we work on integrating the two banks, we are identifying individuals who will move forward and those who will not, and this is happening right now. Some of the staff reductions are linked to this combination, which I think is somewhat positive. It does put pressure on some of our teams because it leaves us a bit short in certain areas. However, overall, we're prepared, and I am confident that if we receive approval from the Federal Reserve, we will be ready to proceed. Both banks have been preparing for this for a significant time, and we have a solid plan for moving forward once we clear the final obstacle. We are just navigating one last challenge, and we are unsure of the placement of that challenge.

Brad Milsaps, Analyst

Okay. Thanks, Bob. And maybe just final one for me, do you think you guys will provide sort of an update on, maybe at closing, kind of where you're thinking about the marks? A lot has changed since November, not only the rates but just curious if you guys had any plans just to maybe kind of level set expectations there in terms of how we should think about the two companies coming together, given all the things that have happened.

Robert Franklin, Chairman, President and CEO

Yes, I think there will be some opportunities to do that. I don't think we're really prepared to do that today. But I think we can, we'll be looking to do that as we get closer and try to understand what the timing of this is, to give people a better understanding of what that might look like. So I would say, stay tuned on that front.

Brad Milsaps, Analyst

Got it, but still feel comfortable with sort of, I mean, given what's happened, sort of the net numbers that you guys put out there, back in November, in terms of kind of what you thought that companies could earn, it would seem to me that that would have only improved, given how rates have moved?

Robert Franklin, Chairman, President and CEO

Yes, I have some concerns about making broad generalizations. However, overall, I believe we are performing better in nearly all aspects compared to our projections. Our production and pricing have both shown improvement. The factors influencing our ongoing operations are also better than expected. While it's possible someone might identify some areas of underperformance, I prefer not to generalize too much. Overall, I can confidently say that we appear to have improved from our original projections.

Brad Milsaps, Analyst

Great, thanks, Bob.

Robert Franklin, Chairman, President and CEO

Thank you.

Matt Olney, Analyst

Hey, good morning, everybody. Going back to Brad's question around cost savings and the timeline. Just curious, since you're still waiting on final deal approvals? Did you have to push back the original systems conversion date? Or is that date still in the future? And we could still hit this if we get an approval soon?

Robert Franklin, Chairman, President and CEO

That's a good question, Matt. We're getting really close. We've identified a couple of dates. We’re a bit pressed for the first one, but I believe we can still meet the second date, which is later. We're still aiming for a conversion this year. If it takes too long, we might need to move that conversion to next year. I do think we can get approval within the next few weeks, and we still have a conversion date we can hit in 2022.

Matt Olney, Analyst

Okay, appreciate that, Bob. And then, on the loan growth front, it looks like a lot of that growth this quarter was driven by construction which led to hear more about this. It looks like it was diversified based on your disclosures from commercial to multifamily land. I think you disclosed that the construction balances are now over the 100% guidelines, would love to appreciate this is short-term in nature or anything else you can disclose around the construction pace?

Robert Franklin, Chairman, President and CEO

In a normalized operating environment, firstly, there have been sort of two larger components of the C&D component, and one of those is just our normal C&D business which is fairly diversified and what it is, and actually geographically too because we're doing some things in Dallas, we're doing some things in Austin, and we're doing various parts of the state that are really having some pretty good economies. The other is our low-income housing piece and that depends on where we are project-wise with those guys that drives that C&D piece up. We probably, it depends on the volume that we do, but it'll be 6 to 10 projects a year. And those tend to be fairly sizeable in certain circumstances. It's something that the regulators really like to see us do for one. And so, when they look at our C&D book, we're able to separate that out. Not ignore it because it is a part of construction development, but it has a different credit mix. And we've seen this as we've watched it go through cycles; it's a very strong piece of credit for us. And I think it's something that the regulators like to see. So when they look at us, if you eliminate that piece out, it drops down to the mid-80s. The same applies when you look at CRE, and where we are in CRE versus 300. So we get the benefits of that, and the regulators appreciate it. We've been doing that basically since we came together with Community Bank in 2013. So if that helps.

Matt Olney, Analyst

Yes. That's great color, Bob. I appreciate that. That's helpful. And then, I guess shifting over towards deposit cost. Seems like most banks we've spoken with didn't really move their deposit pricing higher until we got into that May and then June timeframe, and then we've moved a few times. Since then, we'd love to hear more about the banks deposit pricing and how it kind of changed during 2Q if at all and kind of any recent pricing adjustments. Since the Fed announcement this week. Thanks.

Robert Franklin, Chairman, President and CEO

We've seen some movement in specific categories, as there are banks in our market that are more aggressive with deposit pricing than others. However, following our recent adjustments, we anticipate making slight movements across the board. We will recover some of what we've been offering elsewhere. The majority of the market has maintained a disciplined approach to pricing, though there are some that are being more competitive. We've managed to keep deposit costs down until now, and I expect that trend to continue. Our primary focus is on maintaining a strong demand deposit base, which has remained stable. Additionally, we're attentive to money market accounts, as they play a vital role in our relationships tied to demand deposits. We are particularly mindful of competitive actions from Schwab, Fidelity, and other brokerage firms, since most of our clients choose us for the relationships we build. They may not switch immediately, but they will if they notice those firms making changes while we don't. We need to avoid that scenario. While we may not be the highest-priced deposit option in our area, we are committed to remaining competitive. We will align our strategy with market conditions, which currently seem stable.

Matt Olney, Analyst

Okay. That's all for me. Thanks, guys. Congrats for the quarter.

Robert Franklin, Chairman, President and CEO

Thank you. And I'm not showing any further questions at this time. I’d like to turn the call back over to Bob for any closing remarks. Well, thank you very much. Thanks to everyone that participated in the call today. I want to reiterate that we are very proud of our staff. Our people are working very hard to continue to grow our bank, take care of our customers, and they're really doing two jobs, getting ready for a merger that I believe will really benefit this organization in the future. So, thank you for participating in our call today.

Operator, Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.