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Spirit of Texas Bancshares (NASDAQ:STXB)
Q3 2019 Earnings Call
Oct 23, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings, and welcome to the Spirit of Texas Bancshares third-quarter earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my lovepleasure to introduce your host, Jerry Golemon, chief operating officer. Thank you, sir, you may begin.

Jerry Golemon -- Chief Operating Officer

Thank you, operator, and good morning, everyone. We appreciate you joining us for the Spirit of Texas Bancshares conference call and webcast to review 2019 third-quarter results. With me today is Mr. Dean Bass, chairman and chief executive officer; Mr.

David McGuire, president and chief lending officer; and Mr. Jeff Powell, our chief financial officer. Following my opening remarks, we will provide a high-level review and commentary on the financial details of the third 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 by webcast on our website at www.sotb.com. There will also be a telephonic replay available until October 30, 2019, 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, October 23rd, 2019, 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, 2019, 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 -- Chairman and Chief Executive Officer

Thank you, Jerry, and good morning, everyone. I'm extremely pleased to report another solid quarter. We had adjusted non-GAAP income for the quarter worth 6.2 million or $0.40 in non-GAAP EPS. Significant organic loan growth of $69.4 million, or 19.4% annualized over the second quarter.

Total deposits at the end of Q3 were $1.59 billion. Excluding the cyclical public fund deposit, deposit growth was 3.6% over Q2 or an annualized growth rate of 14%. The Citizens State Bank transaction we announced last quarter is on track to close in the fourth quarter of 2019 subject to satisfaction of customary closing conditions, including regulatory approval. Once closed, the Citizens transaction represents an exciting strategic financial opportunity for us to expand our footprint in the East Texas region and reach a total of 36 well-placed locations throughout Texas.

We believe that Citizens State Bank, a strong community bank with assured commitment to providing exceptional customer service, will be a great partner to the Spirit franchise. Together, we will be better positioned to take advantage of organic growth and acquisition opportunities that will enable us to better serve our customers and further enhance shareholder value. I'd also like to take a moment and recognize the outstanding list out bankers that we have been fortunate to employ. Now I'd like to turn the call over to Mr.

David McGuire, our president, chief lending officer, to discuss some of our quarterly credit metrics. David?

David McGuire -- President and Chief Lending Officer

Thank you, Dean. During the third quarter of 2019, the loan portfolio grew to $1.49 billion, an annualized increase of 19.4% over June 30th, 2019. And an increase of 54.9% over Q3 2018. The yield on loans in the third quarter of 2019 was 6.27%, which remained in line with Q2 2019 and increased 43 basis points from Q3 2018.

Interest in fees and loans increased by $9.2 million or 65.9% over Q3 2018 representing the growth in the loan portfolio, as well as improved yields. The provision for loan losses for the third quarter of 2019 was $900,000, which increased allowance to $6.6 million or 44 basis points of our loans outstanding. Nonperforming loans to outstanding loans increased slightly to 61 basis points at the end of Q3 compared to 40 basis points at the end of Q2 2019 and 39 basis points at the end of Q3 2018. Annualized net charge-offs were 17 basis points for the third quarter of 2019.

Asset quality remains a key emphasis for our lending culture. While the economics in all of our markets remain strong, we keep a close watch on our portfolio for any signs of deterioration through a very thorough and conservative loan underwriting process and a very comprehensive third-party loan review. With that, I'll turn the call back over to Jerry Golemon to provide a review of the funding side of the company. Jerry?

Jerry Golemon -- Chief Operating Officer

Thank you, David. Total deposits at the end of Q3 were $1.59 billion up slightly from the $1.57 billion at June 30, 2019 and an increase of 81.7% over Q3 2018. Excluding the cyclical public fund deposits, deposit growth was 3.6% over Q2 or an annualized growth rate of 14%. Non-interest bearing deposits represent 23.1% of total deposits.

The average cost to deposits were 103 basis points in Q3 2019 representing a 2-basis-point increase from Q2 2019 and a 1 basis point increase from Q3 2018, while the tax equivalent net interest margin decreased 1 basis point from Q2 2019 and was down 2 basis points from Q3 2018. Borrowings, including FHLB decreased to $74.2 million or 3.8% of assets compared to 4.7% at Q2 2019 and 7.4% at the end of Q3 2018. The loan-to-deposit ratio ended the quarter at 93.8% as compared to 90.3% at the end of Q2 2019 and 110% at the end of Q3 2018, illustrating the impacts of the Comanche and Beeville mergers. I would now like to turn the call over to our chief financial officer, Jeff Powell, to provide a financial overview of the third quarter.

Jeff?

Jeff Powell -- Chief Financial Officer

Thanks, Jerry, and good morning, everyone. We provide a detailed financial tables in yesterday's earnings release. Highlighting some operational results, we ended the third quarter with approximately $2 billion in assets. In July, we announced our partnership with Citizens State Bank.

A few facts about the bank. It's a community bank established in 1967 and headquartered in Tyler, Texas. There are seven branches located throughout Tyler in the surrounding markets. Tyler serves as the hub for East Texas with four major hospitals, three colleges and a metropolitan area population of over 225,000.

Non-interest bearing deposits to total deposits are over 36% with total cost of deposits approximately 86 basis points. Attractive profitability, year-to-date return on average assets over 1.7%, strong capital levels role-diversified loan portfolio. This is a financially attractive transaction. Approximately 10% EPS accretion in the first full year of combined operations, excluding the recent common equity rates.

Well capitalized pro forma excluding the common equity raise, acceptable tangible book value dilution of 5.6% and an earn-back period of 3.7 years excluding the common equity raise. It's accretive to tangible book value and capital ratios inclusive of the common equity raise. Once the Citizens State Bank transaction closes in November, our asset size will increase to approximately 2.3 billion with approximately 1.7 billion in loans. We also raised capital in late July.

We issued 2.3 million shares at $21.50 a share. This raised approximately 47 million after the 5% underwriter's discount. We used the net proceeds of this offering to pay off 21 million outstanding on line of credit with a third-party lender and we used 19.2 million to pay the cash portion of the consideration for our upcoming merger with Chandler Bancorp. This capital raise increased our average common shares outstanding since last quarter by approximately 1.5 million diluted shares to 15.7 average diluted shares outstanding.

In late August, the Beeville systems were seamlessly converted to the bank's core processor. We will start seeing the 2.4 million of cost savings in the fourth quarter as we stop using the system and processes previously paid by Beeville. Since we converted late in the third quarter, we estimate that 25% of the cost savings will accrue this year and we will see 100% in 2020. Moving on to our 2019 third-quarter results for the period ended September 30th, 2019.

Third-quarter 2019 GAAP net income, which includes $901,000 of non-GAAP after-tax, merger-related expense increased to 5.3 million with fully diluted GAAP EPS of $0.34 compared to GAAP earnings of 5.8 million and fully diluted GAAP EPS of $0.41 in the second quarter of 2019. Excluding the $901,000 of non-GAAP after-tax, merger-related expense, non-GAAP income for the quarter was 6.2 million or $0.40 in non-GAAP EPS. The higher number of shares outstanding from the capital raise was also a driver of lower EPS quarter over quarter. Our tax equivalent margin in the third quarter came in at 4.63% against second-quarter margin of 4.64% for a 1-basis-point decrease.

The key contributors to decline in tax equivalent margin is primarily due to declines in the yield on securities and interest-bearing deposits in other banks as a result of the impact of a decrease in interest rate by the Federal Open Market Committee during the quarter. Loan yields held up well from last quarter, and the quarter-over-quarter net rate on deposits combined with borrowings also remained steady. Our balance sheet continues to be asset sensitive. We anticipate that our cost of deposits and borrowings will continue to decline as we can immediately decrease rates and now an interest-bearing demand as rates decline.

Loan yields will probably decline with another rate decrease, but we believe our margin will continue to remain one of the highest in the state as our cost of funds will decline in line with the yield on loans. GAAP ROA was 110% compared to 78 basis points in the fourth quarter of 2018. Adjusted ROA taking out one-time items would be 1.29%. The reported GAAP efficiency ratio was 67.17% when compared to 72.11% in the third quarter of 2018 and 80.4% in the fourth quarter of 2018.

Adjusted efficiency ratio excluding one-time items was 62.4% in 3Q 2019 compared to the adjusted 62% in the same period last year and 71.8% in the fourth quarter of 2018. Book value continues to improve reaching $18.41 a share compared to $16.42 per share at December 31, 2018. Tangible book value at the end of the third quarter was $15.01 per share compared to the $14.12 at December 31, 2018. You will notice that we grow our tangible book value every quarter that doesn't have a merger occurring.

I'd now like to turn the call back over to Mr. Bass for wrap-up. Dean?

Dean Bass -- Chairman and Chief Executive Officer

Thank you, Jeff. To conclude, we are extremely pleased with our performance during the third quarter, and believe we are well positioned to take advantage of opportunities in our markets, while serving our strong and growing customer base. I'd like to thank everyone involved with Spirit of Texas Bancshares' success, especially the bank's directors management and investors, and of course, our outstanding employees. This concludes our prepared remarks.

I'd like to ask the operator to open up the line for any questions. Operator?

Questions & Answers:


Operator

[Operator instructions] Our first question comes from the line of Brad Milsaps with Sandler O'Neill. Please proceed with your question.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

Hey, good morning. I was curious if you guys could maybe just give a little more color on the net interest margin. Jeff talked about a little bit you would expect the loan yield to come down with another cut from the Fed, just kind of curious by order of magnitude kind of what you guys are kind of thinking in terms of NIM compression? Obviously, the loan yield has held in very well for the last couple quarters, but it sounds as if you may see some pressure as you kind of move through the next several quarters?

Jeff Powell -- Chief Financial Officer

Yes, I think if rates -- when the Fed brings rates down and I'll let Jerry and David give a little bit more color on it, but I think, overall our margin will hold up. It will probably drop a couple of basis points, but I think, overall it will hold up. David, I don't know if you want to give any color on that?

David McGuire -- President and Chief Lending Officer

Brad, this is David. We are seeing since the last cut, the rates that are in competition out there kind of stable. So there was -- the yield was impacted slightly by the last cut, I'd say, overall. But as you can see from our results, we're able to maintain our margins through that.

And if we get another cut, I would expect the same.

Jerry Golemon -- Chief Operating Officer

On the deposit side, our cost of deposits, I think we have done a really good job over the last year on controlling our deposit beta. And I think we're in a good position with our improved deposit mix that will enable us to react quickly to further rate cuts. A year ago, we were 50% -- almost 50% CDs, that number now is down to 39% and that should come down even further with the Citizens acquisition. So I think, we should be able to trend our deposit rates down as our loan yields go down.

Jeff Powell -- Chief Financial Officer

Yes, a couple of other things. As far as Citizens State Bank, that merger, I think 36, 38% of their book is non-interest-bearing.

Jerry Golemon -- Chief Operating Officer

36% is non-interest-bearing.

Jeff Powell -- Chief Financial Officer

In addition, right now, we have over $100 million in cash on the balance sheet. So that's puts us in a good position where we don't have to negotiate up on deposits. We can make sure that we are doing it at a favorable rate both for the customer and for ourselves.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

David, what's the loans that you put on this core, are they still coming on the books above 6%?

David McGuire -- President and Chief Lending Officer

Yes.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

OK. And then just one follow-up, maybe for Jeff. I was writing quickly on expenses. It sounds like you'll start to see some additional cost saves in the fourth quarter.

It looked to you like you also may have had a little bit of credit from the FDIC like other banks have seen this quarter. Just kind of wanted to get a sense of kind of the absolute level of expenses you kind of expect going forward given the cost saves and then other investments that you're also making?

Jeff Powell -- Chief Financial Officer

That's a really good question. I'm thinking that expenses, we were -- total non-interest expense was 15.5 million for this quarter. In second quarter, it's 15.8 million, so I'd expect it to still keep trending down. I'd say we'll be in the low 15s for the quarter, but usually, at year-end, you have got some holiday celebrations and different things in there, but it's not going to go up that much.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

Did you recognize kind of all your credit this quarter or do you still have more to come from the FDIC?

Jeff Powell -- Chief Financial Officer

No, we pulled it all through.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

OK, great. All right, thanks. I'll hold back in the queue.

Operator

[Operator instructions] Our next question comes from the line of Brett Rabatin with Piper Jaffray. Please proceed with your question.

Ben Gerlinger -- Piper Jaffray -- Analyst

Hey, good morning, guys. This is Ben on for Brett. I was wondering if you guys could talk about your loan-to-deposit ratio, seems like every time you are really outsized growth, so roughly 20% this quarter it jumps up, and then you're bringing up partnerships that have good solid deposits. So I was wondering since you guys are now a bigger bank, I was wondering if you had any sort of thresholds that you'd be operating? Obviously, you are much lower than you were a year ago, so I was wondering if that stance has changed on where you will love that run through?

Jeff Powell -- Chief Financial Officer

Right now where we are at and then once we bring Citizens on, it looks like that number -- if he is 930, Citizens has filed their call report. If you combine at 930, we'll be at 94.8, which we're at right around 94 ourselves. So that's I think 94, 95, 96 in that area is a sweet spot. You make more money when you're running at that level, but in the past, I think, we have been up as high as 110.

But there is no anticipation to run that high.

Ben Gerlinger -- Piper Jaffray -- Analyst

OK. So you're really not looking to go above 100.

Jeff Powell -- Chief Financial Officer

That's not in the plan.

Jerry Golemon -- Chief Operating Officer

Yes, and part of that increase in Q3 on the loan-to-deposit ratio is because of the drop in public fund deposits, which as we mentioned in the -- that it is cyclical and those fund should start coming in again late Q4 and in Q1 of 2020. So I think if you adjust for that, I would anticipate our Q4 loan-to-deposit ratio being stable or possibly going down a little bit because of that inflow of deposits.

Ben Gerlinger -- Piper Jaffray -- Analyst

OK. Great. And then if you can take a step back into kind of the bigger picture with M&A. Over the past 12 months was kind of have -- a little bit of a roller coaster with last year everything kind of freezing up and then things falling out, if you will, in beginning half of the year.

I was wondering if you guys have any updated commentary on conversations you might have had with some other banks in Texas? Or if you're more focused on just the integration of kind of what you've put on over the past couple of years in the partnerships that you have created?

Dean Bass -- Chairman and Chief Executive Officer

Two things. I really like your term partnership. You get it. And I like that.

Yes, it's -- and you also, I like what you said freezing up and falling. It seems like as the market economy there is a pressure on bank stocks and different issues play into this psyche of directors and teams around the state just trying to analyze and make the right decision for their boards and their shareholders. And so it does freeze up some and it seems like it retracts back a little bit through the discussion, but we are actively involved with different partnerships throughout the state at different stages, different levels, different locations that's strategic to us. And we like trying to add.

I think we coin the phrase one partnership at a time. That strategically impacts us. So I think we can look forward to us having more the same. We didn't think this was a roller coaster.

We felt it was normal.

Ben Gerlinger -- Piper Jaffray -- Analyst

OK. Yeah. That's great color. I appreciate the answers and I'll jump back in to.

Operator

[Operator instructions] Our next question is a follow-up question from Bradley Milsaps with Sandler O'Neill. Please proceed with your question.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

Hey, guys. I just wanted to follow up on a couple of things. Really great loan growth this quarter. It kind of bounce back after maybe a little slower start to the year than it's typical for you guys, but kind of curious just on the pipeline and how you think about that near 20% pace? Do you think that was a little bit of an aberration or do you expect to stay kind of in that mid-high teen kind of pace over the near term?

David McGuire -- President and Chief Lending Officer

Brad, this is David. Our pipeline is still remaining very, very strong all across the state in all of our markets, we are not seeing any economic deterioration in any of the markets. And so with that, I've got to expect that we would still be able to grow the portfolio organically in the low to mid-teens like we've always said. This year it was a little bit tepid in the first half of the year, but we were, and I think a lot of it went back to the interest rate increases in the fourth quarter of '18.

And it made a lot of our customers stop and think. And so now that we've got a cut with potentially more, they are coming back in the market and wanted to go forward with the projects they had planned for the businesses or -- and development. So I feel good about it. A low to mid-teen growth organically for the bank over the year.

And going into next year, I'm thinking that we can do the same, again.

Dean Bass -- Chairman and Chief Executive Officer

And I'm going to add. This is Dean Bass. We had a solid core, a strong production team in place, very experienced and it worked closely with executive management over the years. And we continue to add these outstanding banks, these outstanding performers in these different regions.

And now we are adding Citizens State Bank with David Monk and John Mills and some outstanding performers in their regions, and so we see that continuing in that region. And so you add that -- first you add the list out from activity that's going on within each of our market areas. And we have been very successful in pulling those key list-out personnel that can help us going forward. So that's why I think Dave is very confident in how he speaks and the direction of the portfolio.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

OK, that's helpful. And then maybe just one final follow-up, looks like there might have been just a small pickup in NPLs, obviously coming off very small numbers, anything to note there? Or is that just kind of normal ebb and flow within the book?

David McGuire -- President and Chief Lending Officer

I would characterize this as exactly that. It is one loan and it will be dealt with in this quarter with the expectation that will go back into our historical NPL numbers by the end of the year.

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

Right. Thank you, guys.

Operator

Our next question comes from line of Matt Olney with Stephens. Please proceed with your question.

Unknown speaker

Hey, good morning, guys. This is Garrett on for Matt. So just wanted to start off looking at your fee income line this quarter. Noticed that you guys had substantial boost in your SBA loan service and fees.

Just wanted to see what you guys are thinking going into 4Q '19 in terms of kind of a run rate on that. Do you expect a boost and could you just provide a little bit color on that going forward?

Jeff Powell -- Chief Financial Officer

Garrett, this is Jeff. What I'll tell you. To me that is one of the trickiest parts of trying to project our income stream on that and -- because that is a valuation that is done on the servicing portfolio meaning what are those servicing rights worth. And it takes into account what rates are doing, it takes into account payoffs, it takes into account a number of variables.

And I think, we even look out what's going on with peers as well. It tends -- I mean, if you left it alone, if you didn't put the valuation on it, it will run around $500,000 a quarter. And -- but once the valuation piece is added -- that's why you see it, I think in the fourth quarter last year, it went up $500,000, and I think in January, it went down $500,000 and then in the second quarter, it went -- they took about $500,000 out of it as well too. And then this quarter it picked up, the valuation came back.

So it -- there -- I'm going to say it's almost like a black box when we shift those numbers over to at the end of the quarter. If there were no valuation adjustments on it, I'd say it be worth about $2 million a year.

Unknown speaker

OK, got you. It sounds great. And then just as a quick follow-up question. Taking a look at your loan growth this quarter, saw that it was very solid up about 5.6% linked quarter.

Just wanted to get a little bit more color from you all on what drove the loan growth whether it was a decline on pay downs or seasonal strength if you could just provide a little bit more insight on that?

David McGuire -- President and Chief Lending Officer

Garrett, as I said earlier, I think, there is a -- the market that we are in, in Texas. And I don't know outside of Texas what it was like, but I'm telling you that our customers took a hiatus as far as borrowings in the first half of the year because of the cost of what they were looking at and with the anticipation of rates going higher. As you remember, in the first quarter, there was a lot of talk about that and a lot of misdirection being signaled by on what rates we're going to be doing and the customers were looking at that. And so after we got comfortable, after the last rate decrease, that helped -- it seemed to help a lot and just that kind of color for our markets.

But this happened to us before in 2016, where we had very little growth in the first half of the year, and then we were able to do it in the second half of the year. And it's kind of looking like that in its own way, but I will say that our pipeline remains as large as I have ever seen it in the history of this bank and that we have got an incredible lending staff that is out there trying to grow their book of business. And the pay downs were not -- we didn't see a slowdown in pay downs, they're kind of running somewhere between 15 and 25 million a month and that seems to be where it's at and we're doing our part to replace it and grow the book.

Unknown speaker

All right. Sounds great. Well, appreciate the info on that. That's all I've got for you guys, so I'll jump back into the queue.

Thanks.

Operator

We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Dean Bass -- Chairman and Chief Executive Officer

Just want to thank you, everyone, for being on the call. And we look forward to another great quarter, and thank you very much for being on.

Operator

[Operator signoff]

Duration: 33 minutes

Call participants:

Jerry Golemon -- Chief Operating Officer

Dean Bass -- Chairman and Chief Executive Officer

David McGuire -- President and Chief Lending Officer

Jeff Powell -- Chief Financial Officer

Brad Milsaps -- Sandler O'Neill + Partners, L.P. -- Analyst

Ben Gerlinger -- Piper Jaffray -- Analyst

Unknown speaker

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