Earnings Call Transcript - STEL Q1 2022

Operator, Operator

Thank you all for being here and welcome to the CBTX First Quarter 2022 Earnings Conference Call. Currently, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. I will now pass the call to your speaker today, Mr. Justin Long, General Counsel of Community Bank of Texas. Thank you. Please proceed.

Justin Long, General Counsel

Thank you. Good morning. I'm Justin Long, General Counsel of CBTX, and our management team would like to welcome you to the CBTX Inc. earnings call for the first quarter of 2022. We appreciate you joining us. Yesterday, we issued our earnings press release, 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, our financial performance, 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 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. 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, and CEO; Ted Pigott, our Chief Financial Officer; Joe West, our Chief Credit Officer; and Joseph McMullen, our Controller. At the end of their 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. Welcome to the earnings call for CBTX Inc. for the first quarter of 2022. We are pleased to present our first quarter results for 2022. The first quarter continued the positive momentum generated in the fourth quarter of 2021 as we left our regulatory overhang behind. Our core loan growth continued at a lower rate than the fourth quarter and returned to our more normalized mid to high single-digit growth. Our deposits remained strong in a quarter that has historically seen some runoff after year-end as we approach the tax season. Our local economy continues to gain strength and our pipeline is continuing to build. We are in a rising interest rate environment, and with an asset-sensitive balance sheet, we believe this provides us with opportunity. However, a rising interest rate environment also signals the need to be cautious and maintain discipline. We will continue to monitor the Federal Reserve and its impact on interest rates. Rising interest rates will also mean pressure on cash flows and real estate valuations. But our markets are strong and appear able to withstand the pressures of rising rates as well as other demands at the moment. COVID-19, geopolitical pressures, inflation, and supply chain issues are challenges we feel fully prepared to navigate as we look forward to our new partnership with the great folks at Allegiance Bank. We've been working closely with Allegiance Bank, preparing to integrate our teams while we press forward to gain approval from our regulators and shareholders. Our shareholders meeting to vote is set for May 24th, and we have been encouraged by the shareholder feedback as we move towards our vote. We believe that this merger is one that will build shareholder value for years to come. We are excited as we look to the remainder of 2022. We feel that we are prepared for the economic challenges that may lie ahead and are determined in our efforts for the successful merger of equals with Allegiance Bank. Now, I'll turn the meeting over to Ted Pigott, our Chief Financial Officer.

Ted Pigott, Chief Financial Officer

Thank you, Bob. Certain financial information for the first quarter of 2022 and prior periods begins on slide 6 of our investor presentation. The company reported net income of $10.6 million and diluted per share earnings of $0.43 for the first quarter. For the fourth quarter of 2021, the company reported a net loss of $545,000 or $0.02 per diluted share as earnings were impacted by costs associated with regulatory agency settlements and costs related to the pending merger. Net interest income for the first quarter decreased $460,000 to $32.6 million from the first quarter of 2021 and increased $1.8 million or 5.9% from the fourth quarter of 2021. The interest margin on a tax-equivalent basis increased 15 basis points to 3.22% from 3.07% for the fourth quarter. The yield on earning assets was 3.31% for the first quarter, compared to 3.85% for the first quarter of 2021. The cost of interest-bearing liabilities was 27 basis points for the first quarter and 34 basis points for the first quarter of 2021. Yields on earning assets decreased, and costs of interest-bearing liabilities remained at about the same level, which continued the compression of net interest margin on a tax-equivalent basis to 3.22% for the first quarter of 2022. The provision for credit losses was $435,000 for the first quarter compared to $412,000 for the first quarter of 2021. The provision for credit losses for the first quarter was comprised of a $415,000 provision for credit losses related to unfunded commitments and a $20,000 provision for credit losses for loans. Non-interest income for the first quarter was $5.3 million, an increase of $2.2 million or 71.3% compared to $3.1 million for the first quarter of 2021, and increased $1.2 million or 30% compared to $4.1 million for the fourth quarter of 2021. The interest and non-interest income in the first quarter compared to the first quarter of 2021 was primarily due to payments totaling $1.5 million recognized for early termination of a land lease, alongside other non-interest income which included a gain of $1.2 million for the sale of assets underlying a portion of the company's equity investments, partially offset by a loss of $1.2 million included in net gains on assets for disposals of business buildings and write-offs concerning low leasehold improvements for a land lease that was terminated earlier. Non-interest income for the first quarter increased $1.4 million or 5.9% to $24.7 million compared to the first quarter of 2021. Non-interest income for the first quarter of 2022 decreased $10.2 million from the fourth quarter of 2021, primarily due to regulatory fees which decreased $7.8 million because of penalties totaling $8 million in the settlement of BSA/AML compliance matters paid in the fourth quarter of 2021. Other expenses decreased $864,000 to $2.6 million primarily due to the decrease of $513,000 in expenses associated with the pending merger of Allegiance Bancshares. Income tax expense was $2.3 million for the first quarter and the effective tax rate was 17.69% compared to 19.8% for the first quarter of 2021. Total assets as of March 31, 2022 increased $417 million or 10.4% to $4.45 billion compared to $4.03 billion for March 31, 2021 and decreased $40 million or 0.9% compared to the $4.49 billion total at December 31, 2021. Annual growth in total assets included $258.9 million in securities and $163.3 million in cash and cash equivalents. Loans, excluding those held for sale, decreased $11.8 million or 0.4% down to $2.88 billion compared to $2.89 billion at March 31, 2021, primarily due to PPP loan paydowns. Excluding the PPP loans, the loan portfolio increased $241 million or 0.2% to $2.86 billion over the 12 months. Total deposits as of March 31, 2022 increased by $436.5 million or about 12.9% to $3.82 billion compared to $3.38 billion at March 31, 2021 and decreased $10.1 million or 0.3% compared to $3.83 billion at December 2021. The cost of total deposits was 12 basis points for the first quarter. The capital maintains strong capital ratios as the total risk-based capital ratio was 16.06%. The common equity Tier 1 capital ratio was 14.97%, and the Tier 1 leverage ratio was 11.08%, all at March 31, 2022. Non-performing assets totaled $22.1 million or 0.5% of total assets at March 31, 2022 compared to $23.6 million or 0.59% of total assets at March 31, 2021 and compared to $22.6 million or 0.5% of total assets at December 31, 2021. The allowance for credit losses on loans as a percentage of loans was 1.09% at March 31, 2021, and 1.141% at March 31, 2021, and finally 1.09% at December 31, 2021. Now, I'll turn over the presentation to Joe West.

Joe West, Chief Credit Officer

Thank you, Ted. I'll speak a bit to our loan portfolio, beginning with slide nine from the investor presentation. For the first quarter, our net loans were up at $2.85 billion versus $2.84 billion and then for the first quarter of 2022, there was an increase of approximately $12 million. We funded approximately $178 million in new loans during Q1 and had $125 million in loan payoffs, excluding PPP payoffs. For this quarter, C&I including the effect of PPP payoffs declined by approximately $33 million or 5.3% compared to Q4, and C&I increased $3 million, excluding the PPP payoffs. CRE was up $51 million, 4.46% quarter-over-quarter. Construction and development were up $13 million, or 2.7%, compared to the fourth quarter of 2021 and one to four family declined $14 million, or approximately 5%, and multifamily declined $7 million. Slide 10 sets forth the components of our commercial loans. Our total commercial loans were up slightly for the first quarter to $2.5 billion versus $2.47 billion at the end of the fourth 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 oil and gas loans for the third quarter decreased to $186 million compared to the end of the fourth quarter of 2021. Slide 12 sets forth information about our PPP loans that continue to wind down. During the first quarter, our net PPP loans decreased to $18 million, and we received $36 million related to forgiveness for payments to customers. The table at the bottom of slide 12 sets forth our average yield of our loan portfolio, our average yield on our PPP loans, and the average yield on our loan portfolio when factoring out the PPP loans. Slide 13 provides information about our allowance for credit losses. As Ted noted, our allowance for credit losses to loans was 1.09% at March 31, 2022. Turning to slide 14, our nonperforming assets remained low during the first quarter and our credit quality remains strong. Slide 14 also shows information regarding our nonperforming assets to total assets, which was 0.50% as of March 31, unchanged when compared with the fourth quarter of 2021. As with the fourth quarter, our recoveries during the quarter exceeded our charge-offs, resulting in a net recovery of $77,000. With that, I'll turn it back over to Bob Franklin.

Robert Franklin, Chairman, President, and CEO

Thank you, Joe. With that, operator, we'll open up for questions.

Operator, Operator

Your first question comes from Will Jones from KBW. Your line is open.

Will Jones, Analyst

Hey. Great. Good morning, guys.

Robert Franklin, Chairman, President, and CEO

Good morning, Will.

Will Jones, Analyst

Hey. So just wanted to start an update with the merger. I noticed you set a date for the shareholder vote. I’m just curious where you guys stand regarding approval from the regulators. Are you getting any pushback there, or do you still feel like you're on track for that later second quarter close? And then, could you just remind us who all you're required to get approval from?

Robert Franklin, Chairman, President, and CEO

Well, the approvals are from the state, the FDIC, and then the Fed. And as in everybody's case, I think we're all waiting on the path. But we have no indication that we won't meet. Our expectation was that we would close this transaction somewhere around June 30. And I think we have no indication that we shouldn't be meeting that target at this point.

Will Jones, Analyst

Got you. But then just from the state and FDIC, those are still outstanding as well?

Robert Franklin, Chairman, President, and CEO

They are. But I think typically, you'll see them wait until the Fed comes out to do that, but sometimes they get in front. Typically, they let the Fed lead.

Will Jones, Analyst

Got you. That makes sense. Helpful there. And then, turning on the loan growth, you guys really maintained some nice momentum off of that unprecedented fourth quarter. But more back to that mid to upper single-digit range that you've alluded to, does still feel like a good proxy for what you expect the rest of the year?

Robert Franklin, Chairman, President, and CEO

I think we're seeing a more normalized environment. There are various pressures in the market, but we still have many solid loans. Our markets are performing well, and I see good opportunities to maintain our momentum. However, we are being more cautious about the current situation. We're uncertain about the direction of interest rates, which are generally expected to rise. From an earnings perspective, this should benefit us given our asset-sensitive balance sheet. Still, we plan to approach lending with caution regarding the risks involved. The markets in Dallas, Houston, and Beaumont are strong, with job and population growth, and people are keen to move to Texas. We anticipate being able to take advantage of this moving forward. Nevertheless, we must remain mindful of the warning signs related to increasing interest rates and ongoing supply chain challenges as we make decisions.

Will Jones, Analyst

Okay. Great. I appreciate the commentary there. And I noticed that excluding PPP, your loan yields were up a smidge linked quarter. Just curious was that a function of some better pricing you're seeing on these new loans?

Robert Franklin, Chairman, President, and CEO

No, I don't believe so. This happens every time interest rates begin to change; the same phenomenon occurs whether they rise or fall. There is significant pricing disintermediation, as some are still pricing at previous rates while others are becoming more aggressive. Therefore, the market lacks stability in this aspect. As non-market centers, we are still aligned with market pricing. The pricing hasn't notably increased yet with these initial Fed movements, although I expect that to change over time. We are becoming more attentive to incorporating variable-rate pricing in most of our deals, even if that means establishing floors and ceilings. We are conscious of rising interest rates as we negotiate new agreements.

Will Jones, Analyst

Okay. Again, very helpful there. And if I could just squeak one last one in here. I know we haven't talked about the buybacks a lot in the past few quarters, but just wanted to get your thoughts there. I'm not sure what you guys have authorized today or if a buyback makes sense for you guys right now with the pending deal. But the stock has pulled back along with the broader bank group and is kind of more in line with what you've historically bought back. Just wanted to get your thoughts there?

Robert Franklin, Chairman, President, and CEO

It's challenging for us to be active at this moment due to our regulatory approvals and our merger with Allegiance. However, we see this as a strategy we will implement once we are able to. We strongly believe in this approach. Currently, we feel the market isn't valuing our stock as we would prefer. When we receive the go-ahead, I expect we will actively engage in that segment of the market.

Will Jones, Analyst

Understood. Thanks guys.

Robert Franklin, Chairman, President, and CEO

Thank you, Will.

Operator, Operator

Your next question comes from the line of Brad Milsaps from Piper Sandler. Your line is open.

Brad Milsaps, Analyst

Hey, good morning.

Robert Franklin, Chairman, President, and CEO

Hi, Brad.

Brad Milsaps, Analyst

Hey, Bob just wanted to talk a little bit more about loan repricing. Can you remind us kind of your mix in terms of variable and fixed rate loans and kind of what would you expect to reprice with each move from the Fed, maybe inclusive of any floors that you have to maybe eat through on the way up?

Robert Franklin, Chairman, President, and CEO

Go ahead, Joe.

Joe West, Chief Credit Officer

We're primarily split evenly between variable and fixed rates. We have just under $1.1 billion tied to the prime rate, while around $380 million is based on other indexes like SOFR, LIBOR, or the 11th District cost of funds for mortgages. About $380 million in loans adjusted according to the last Federal Reserve change in March. We anticipate that as the prime rate reaches 4% and 4.5%, we will be able to reprice just over 80% of those prime loans. Overall, we feel confident about our positioning for repricing as interest rates increase on our prime index loans.

Brad Milsaps, Analyst

Thank you. That's very helpful. I understand that you're in a bit of a holding pattern until the two balance sheets are combined. However, I noticed you've made some adjustments in liquidity this quarter. How should we consider that as the two companies merge? Will it be directed towards accelerated loan growth, or do you anticipate being more aggressive in expanding a larger bond portfolio now that rates have increased? I'm interested to hear your thoughts on liquidity, especially since Allegiance is also holding a significant amount. I'm curious about your perspective on this.

Robert Franklin, Chairman, President, and CEO

Yeah. I think because we have discussions around putting the two banks together, we want to make sure we have liquidity to do the kind of things we want to do. But yes, I think to be more aggressive around deploying that in loans is certainly what we're after. We did do some additional deployment into the bond portfolio. I think we'll continue to look at that as rates come up and try to use some of that liquidity there. But we want to be mindful of our partners and ensure that we're doing the right things, so that as we come together we're not crossing each other in whatever we're doing. So, there are a lot of discussions around that. I think, as we come together we'll still probably have some significant liquidity, but I think we're going to have an idea of what we want to do with that, and primarily what we do is make loans. So, that's where we want to put most of it.

Brad Milsaps, Analyst

Got it. And Bob, just final kind of bigger-picture question for me, when you announced the merger, I think you were targeting kind of a $2.65 in earnings per share in 2023 with a steeper curve and a higher Fed funds rate. And at the time, I think people sort of pushed back on that. You've turned out to be right. The expectations for higher rates have probably gotten even higher since then, but we also have more maybe inflationary pressure. Kind of how do you think about that $2.65 number as you sit there today in terms of kind of how things have changed since November? Just curious how maybe any of your assumptions might have improved or, in some cases, maybe worsened? Just kind of curious how you're thinking about that $2.65 number.

Robert Franklin, Chairman, President, and CEO

Projections can be challenging at times. From our perspective, we remain optimistic about our capabilities. There are various factors influencing us, making it difficult to assess the situation accurately. I feel uncertain about whether we will increase supply to meet demand or decrease demand to align with supply. These questions are still open. A lot will depend on our ability to utilize some of this liquidity, along with the ongoing uncertainty about a potential recession in 2023. Overall, we still feel positive about the projections we've shared, and I wouldn't change that stance.

Brad Milsaps, Analyst

Great. Thank you, guys. I appreciate you taking my questions.

Robert Franklin, Chairman, President, and CEO

Thanks, Brad.

Operator, Operator

Your next question comes from the line of Matt Olney from Stephens Inc. Your line is open.

Matt Olney, Analyst

Hey, thanks. Good morning, everybody.

Robert Franklin, Chairman, President, and CEO

Good morning, Matt.

Matt Olney, Analyst

Bob, as you mentioned earlier, the combined company is going to have lots of liquidity. And based on your commentary, it sounds like the big priority is going to be putting this into loans over time. And CBTX has had that kind of long-standing loan growth goal of about 5% to 8%. But I guess across the street, Allegiance has been growing loans for a while in that mid to upper teens and since then it's kind of slowed down. But I guess I'm curious as you put these companies together, if you think you're still going to maintain that mid to high single-digit loan growth over time. I'm not looking for any kind of near-term guidance on 2023. I'm just thinking about a longer-term speed limit for the combined company with respect to loan growth. Thanks.

Robert Franklin, Chairman, President, and CEO

I believe that's a great question. As we integrate the companies, I see both growth trajectories aligning. A lot of this is contingent on various factors, and historically, we target an average growth rate of 5% to 8%. There have been periods when the economy performed exceptionally well, allowing us to exceed that range. At this moment, it's difficult to pinpoint our exact position in the economic cycle, which adds complexity to our projections. However, it looks like Allegiance is following its growth path and we are seeing positive developments on our end as well. If the market conditions remain favorable, I believe we could achieve results at the higher end of our range over the next year. Allegiance seems to be experiencing a similar situation, having had a strong quarter. During their call, they will detail their progress. We are optimistic about the prospects for both banks, and the teams involved seem enthusiastic about our collaboration. Each bank brings unique strengths to the partnership, making it a promising combination. Our employees have been working diligently to ensure the success of this merger, and the momentum remains strong on both sides. We will see how this unfolds throughout the year.

Matt Olney, Analyst

Okay. That's helpful, Bob. Thank you for the color there. And I guess going back to interest rate sensitivity. You guys gave us some good disclosures a few minutes ago on the loan side. I'm curious about the deposit side. Have you adjusted any kind of deposit rates since that mid-March Fed meeting? I'm curious just about the near-term expectations of trying to manage deposit costs on the first part of the rate cycle. Thanks.

Robert Franklin, Chairman, President, and CEO

We feel good about it. I mean, we have 47% of our deposits in demand deposits. We do think pressure on interest rates is going to be up. We haven't seen in the marketplace a huge move. We have not moved our rates much, other than maybe a few specific things. But for the most part, we haven't moved our rates yet, but I do think there will be pressure to move those rates as we move through the next couple of quarters if that stays true to a 50-basis point move or maybe a couple. But we know, directionally, pressure is to the upside. I don't think it's going to be to any great degree. Typically, what we're watching, we don't play in the CD market that much. So most of ours is around money market. We tend to really watch, not only the locals that are playing in our market but also where brokerage firms go because, typically, our customers' alternative is not to another bank but to what I'm getting in my brokerage account. And so we also are sensitive to that. We just haven't seen much movement there.

Matt Olney, Analyst

Okay. Very helpful. And just lastly on the energy front, I don't know if this is for Bob or Joe, but we've seen a little bit of volatility in some of your disclosures around energy loan balances and specifically on the energy services line. I think it was up in the fourth quarter, now down quite a bit in 1Q. Anything worth calling out there? Is this normal seasonality of some customers, or are you losing customers and adding customers? Just anything worth mentioning there. Thanks.

Joe West, Chief Credit Officer

That was sort of a combination of a new loan that was booked in Q4 to a service company, and then we had two customers. One, they sold their property which was a real estate loan and the service business. They sold their property and paid us off and the other one in Q1 was an inventory dependent loan that refinanced out to another lender. We were frank about it; we were disappointed to see it go. So we're at $185 million. That's kind of where we've been hanging around for the last few quarters. If you go back, we were like at $170 million, high $170 million. It's a pretty straight line. We just had that bump in Q4 and it came back down in Q1.

Robert Franklin, Chairman, President, and CEO

We're not a significant oil and gas lender, Matt, but we definitely will take our opportunities when we see them. We're really sponsor-driven. When we have strong sponsors behind something, that's when we tend to react in the oil and gas business. We can have strong sponsors, no matter what industry we're in. We like people that do it well, and that's where we tend to allocate our resources. But we don't shy away necessarily from the oil and gas business for any specific reason. It can be volatile, and we understand that, but when we have strong sponsors in that area, then we tend to want to invest there.

Matt Olney, Analyst

Thanks, guys.

Robert Franklin, Chairman, President, and CEO

Thank you.

Operator, Operator

There are no more questions at this time. Turning the call back over to Mr. Bob Franklin.

Robert Franklin, Chairman, President, and CEO

Thank you. I appreciate the opportunity to discuss our first quarter earnings and your interest in being on our call.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.