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Spirit of Texas Bancshares (NASDAQ:STXB)
Q2 2021 Earnings Call
Jul 22, 2021, 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 second-quarter earnings conference call. [Operator instructions] It is now my pleasure 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 2021 second-quarter results. With me today is Mr. Dean Bass, chairman and chief executive officer; Mr.

David McGuire, president and chief lending officer; and Ms. Allison Johnson, chief financial officer. Following my opening remarks, we will provide a high level review and commentary on the financial details of the second quarter before opening the call for Q&A. I'd now like to cover a few keeping 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 July 29, 2021, and more information on how to access these replay features was included in yesterday's release. Please note that the information reported on this call speaks only as of today, July 22, 2021. And therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening or transcript reading.

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

The comments today will also include certain non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures are included in yesterday's earnings release, which can be found on the Spirit of Texas website. Now, I'd like to turn the call over to our chairman and CEO, Mr. Dean Bass.

Dean?

Dean Bass -- Chairman and Chief Executive Officer

Thank you, Jerry and good morning, everyone. Welcome. During the second quarter, we celebrated our third anniversary as a publicly traded company. Over those three years, we have grown asset size by over 200%, maintained asset quality through challenging times and increased shareholder value through core earnings, share repurchases and quarterly dividends.

This quarter's results represent another strong performance and an established history of profitability and operational excellence. For the second quarter, we earned net income of $12.4 million, representing fully diluted EPS of $0.70 and a return on average assets of 1.57% annualized. Credit quality continues to improve with nonperforming assets declining $2.4 million or 23.9% during the quarter. Additionally, we have been able to maintain the net interest margin above 4%, consistent with our goals.

While we are pleased to report another quarter of solid results, a large aspect of ensuring superior performance in the future is understanding the overall economic trends and positioning ourselves appropriately. With the national and Texas economies booming, we have now shifted our internal discussions from borrower health and credit quality to Federal Reserve policy and overall macroeconomic trends, which impact the yield curve and our ability to enhance profitability in the future. Texas, like other parts of the country, is experiencing staffing pressures, supply shortages and other inflationary forces. While we have not experienced significant labor shortages within our network of bankers, we must understand the impact that these challenges are having on our borrowers and the overall capital markets.

Overall, we have exceeded expectations this quarter as well as over the past three years since becoming a public company. We continue to live in truly unprecedented times, and many of the traditional models of community banking are being challenged, but we are confident that we are well positioned to increase core profitability and continue to increase shareholder value. Now, I'll turn the call over to David to discuss the loan portfolio and asset quality. David?

David McGuire -- President and Chief Lending Officer

Thank you, Dean. Excluding the impact of PPP forgiveness and origination of the most recent round of PPP loans, total loans grew $17.4 million for the quarter or 3.4% annualized. Historically, the first two quarters have always been a period of slower loan growth with the majority of annual growth coming the last two quarters of the year. Currently, we expect this trend to continue and anticipate high single-digit growth overall for 2021, excluding the impact of PPP loans.

Currently, we have $188.3 million remaining of PPP loans with net deferred fees remaining to be recognized of $4.8 million. We anticipate working through significantly all forgiveness applications by the end of the year and anticipate earning materially all of the net deferred fees over the next two quarters. The yield on loans in the second quarter of 2021 was 5.3%, which increased 16 basis points from Q2 2020 and 21 basis points from Q1 2021. The increase in yield related primarily to increased PPP forgiveness and accretion of purchase loan discount, which is earned as the acquired portfolios mature.

Excluding the impact of PPP loans and acquired discount, the loan yield was 4.96% compared to 5.4% at March 31, 2021. During the quarter, we have started to experience competitive pressure on loan rates, which are impacting the entire market. As such, we will focus on quality deals and ensure that our borrowers understand the value we provide, which justifies a higher rate than those offered by other institutions. While we do not expect these competitive pressures to compress the loan yield and overall net interest margin in the near term, we are working diligently to mitigate the impact wherever possible.

Overall, our loan pipeline continues to build each month and we expect closure rates to return to pre-pandemic levels in the next two quarters. Additionally, deploying excess liquidity into higher-yielding loans will significantly assist net interest income in the coming quarters. During the second quarter, asset quality improved significantly with nonperforming loans declining $2.4 million or 23.9% for the first quarter of 2021. Nonperforming loans to outstanding loans decreased to 33 basis points from 41 basis points during the quarter as we have worked through remaining deferments and credits negatively impacted by the ongoing pandemic.

The provision for loan losses for the first quarter was $1.3 million, which was consistent with the first quarter of 2021. At quarter end, the coverage ratio on the organic portfolio was 88 basis points, excluding PPP loans. Annualized net charge-offs were 20 basis points for the second quarter of 2021. Charge-offs for the quarter related to pre-pandemic impaired loans that were fully resolved during the quarter.

Overall, charge-off activity for the remainder of 2021 is expected to remain closer to our annual historical charge-off activity. With that, I'll turn the call back over to Jerry to provide a review of the funding side of the company. Jerry?

Jerry Golemon -- Chief Operating Officer

Thank you, David. Total deposits at the end of Q2 were $2.6 billion, a decrease of $25.4 million or 1% from Q1 2021 and an increase of $157.2 million or 6.5% over Q1 2020. The decrease from Q1 2021 is due to a reduction of $51.3 million in PPP-related deposits as borrowers put the proceeds to use. Exclusive of the reduction in these deposits, total deposits grew $25.9 million from Q1 2021 or 4% annualized.

Noninterest-bearing deposits decreased $28.2 million or 3.5% from Q1, again, with the reduction in deposits related to PPP loans accounting for the decrease. Noninterest-bearing deposits currently make up 30.8% of total deposits. Time deposits decreased by $39.5 million or 6.1% from Q1 2021. Due to aggressive repricing, the cost of time deposits decreased 16 basis points from Q1 2021 to 0.79%.

This improved shift in deposit mix resulted in a 0.32% cost of deposits, a decrease of 5 basis points from Q1 2021. The bank has no broker deposits. The reported loan-to-deposit ratio at the end of Q2 was 88.3%. Excluding PPP activities, the loan-to-deposit ratio is 81%, up from 79.6% at the end of Q1 due to the previously mentioned loan growth of 3.4% annualized for the quarter.

Borrowings decreased by $72.6 million during the second quarter to $119.1 million due to the payoff of PPPLF borrowings after obtaining PPP forgiveness on the loans pledged against it. Borrowings totaled 3.9% of assets at the end of Q2. The company has significant sources of available liquidity, including $50 million in a holding company line of credit, Fed funds lines totaling $118 million and Federal Home Loan Bank availability of $778.2 million. I would now like to turn the call over to Allison to provide a financial overview of the second quarter.

Allison?

Allison Johnson -- Chief Financial Officer

Thank you, Jerry and good morning, everyone. We provided detailed financial tables in yesterday's earnings release. Consolidated net income for the three months ended June 30, 2021, was $12.4 million with fully diluted EPS of $0.70 compared to earnings of $7.7 million and fully diluted EPS of $0.44 in the second quarter of 2020. Net income and earnings per share were primarily driven by the recognition of $2.4 million net accretion of origination fees on PPP loans.

We anticipate the majority of the remaining $4.8 million of net origination fees on PPP loans to be recognized during Q3 and Q4 2021. Non-interest income was $3.9 million for the second quarter of 2021 compared to $2.6 million for the first quarter of 2021, an increase of $1.2 million linked quarter. The increase from Q1 was primarily driven by an increase of $1.3 million of swap fees. We expect non-interest income to continue to increase in the coming quarters as swap products remain a strategic initiative for 2021 as well as we should begin to reap the rewards of our investment in restructuring our SBA department.

Additionally, during the second quarter, we purchased $15 million in bank-owned life insurance products, which has a tax equivalent yield of approximately 3.89% and runs through non-interest income. Non-interest expense totaled $16.8 million in the second quarter of 2021, which was relatively flat compared to $16.6 million reported in the first quarter of 2021. The first and second quarters of 2021 were free of expenses associated with various projects and initiatives, which have historically distorted noninterest expense in previous quarters. These additional expenses include merger-related expenses, branch optimization expenses, strategic hiring and restructuring expenses and expenses associated with balance sheet management priorities.

The approximately $17 million in non-interest expense represents a much clearer picture of our core run rate currently. Moving on to the net interest margin. The tax equivalent margin in the second quarter of 2021 was 4.14% compared to first-quarter 2021 tax equivalent margin of 3.98%, representing a 16 basis point increase sequentially. Excluding the impact of PPP loans, our tax equivalent net interest margin for the second quarter of 2021 was 4.10% compared to 4.02% for the first quarter of 2021.

As PPP loans are forgiven and excess liquidity is introduced, we will continue balancing our liquidity needs to fund future loan growth and investment in higher-yielding products. However, during the second quarter of 2021, we are beginning to see competitive pressure on loan rates in our markets, which will produce headwinds with respect to maintaining our net interest margin above our target of 4%. The provision for loan losses for the second quarter was $1.3 million, which increased the allowance to $16.5 million or 73 basis points of our total loans outstanding or 79 basis points, excluding the 100% government-guaranteed PPP loans. The provision expense for the quarter related primarily to the provisioning of loans moving from the acquired portfolios to the organic portfolio at renewal.

The coverage ratio on the organic portfolio was 88 basis points on the $1.61 billion in organic loans outstanding, excluding PPP loans at quarter end. Additionally, we have $2.3 million unamortized discount on the acquired portfolio at June 30, 2021. We would not expect elevated provision expense for the remainder of 2021 beyond those amounts needed to fund net charge-offs and loan growth. As of June 30, 2021, we continue to enjoy strong capital ratios with a Tier 1 leverage ratio at the bank of 10.47% and 10.06% at the company on a consolidated basis.

A strong capital position provides us the strategic flexibility to assess opportunities going forward. I'd now like to turn the call back over to Dean for closing remarks. Dean?

Dean Bass -- Chairman and Chief Executive Officer

Thank you, Allison. I'd like to close by thanking our dedicated management team and talented network of bankers for another quarter of exceptional performance. Obviously, we wouldn't be here without our supportive investors that share our vision. And of course, thank you to our customer base, which has tripled in size over the last three years.

We have maintained a culture of excellence at Spirit of Texas Bank that speaks for itself each and every time we report quarterly results. I'm confident in the abilities of our team to tackle any upcoming challenges while always looking for the golden opportunities that are hidden within. Our results reflect that we are well positioned for continued growth and profitability. 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 Brad Milsaps with Piper Sandler. Please proceed with your question.

Brad Milsaps -- Piper Sandler -- Analyst

Hey, good morning.

Dean Bass -- Chairman and Chief Executive Officer

Good morning.

Allison Johnson -- Chief Financial Officer

Good morning.

David McGuire -- President and Chief Lending Officer

Good morning, Brad.

Brad Milsaps -- Piper Sandler -- Analyst

Maybe, Allison, I wanted to start with expenses. I think I heard you say that $17 million would be a pretty good run rate. I think last quarter, you talked about the run rate maybe being closer to $18 million to $18.5 million. Just kind of curious kind of what's kind of brought those numbers down.

I know 1Q benefited from some FAS 91, but it seems like you're doing really well on the revenue side. And just kind of curious, are some projects you put off or you just kind of found some more expense savings to kind of bring your thoughts around that run rate down?

Allison Johnson -- Chief Financial Officer

Yeah. So really, our run rate going forward, if you add back Q1 and Q2, if you add back $1 million in origination fees, deferred costs associated with origination fees or origination of PPP loans really gets us to that core run rate of 17 and a half. So what occurred in Q2 is we just -- we were able to squeeze out a little bit more cost savings out of our mergers from the past. So we really expect that 17 and a half to continue going forward.

With that being said, we are projecting an increase of about three and a half percent annually for salaries, for raises and bonuses going forward. And we also are open to hiring additional producers to help facilitate the increased loan demand we're anticipating for the back half of the year. So you may see that increase a little bit going forward.

Brad Milsaps -- Piper Sandler -- Analyst

OK. Great. And Dave, I think last quarter, you talked about maybe getting the high single-digit-type growth for the year. I apologize if I missed this in your prepared remarks, but do you still feel good about that number? I know you obviously expect it to be more back-half-weighted, but just kind of curious kind of what your thoughts are there.

David McGuire -- President and Chief Lending Officer

Yeah. Just exactly that, Brad. We're looking really good right now. In fact, this month and next month look extremely good.

So it sets us on that pace to reach what by the end of the year what I've guided to. Very, very, very excited about what we're seeing showing up in our pipeline. It's almost like it's returned to pre-pandemic levels and we're seeing a broad spectrum of different type of deals that we like to do, and the borrowers are putting their money up to get deals done now. They're really taking their fingers off the pause button and now putting their money where their mouth is to get things done.

Brad Milsaps -- Piper Sandler -- Analyst

That's great. And maybe just kind of a final bigger picture question, Dean. You guys had another great quarter, easily beat expectations. You got lots of capital, yet the stock is sort of trading $130 million of tangible book value or so.

It's got to be tough maybe to look at acquisitions in that range. Just how do you feel about the buyback given you've got so much capital? Could we see you get more aggressive there, particularly with the strong results you've posted?

Dean Bass -- Chairman and Chief Executive Officer

Well, from the M&A side, it's never been easy for us. It's always been hard, but we've always executed. And I don't know if anyone else has come out of the -- becoming a public company and executed like we have. But -- so we've been -- we're used to playing small ball.

And so that's kind of where we are there on the M&A side. I'll let Allison address the buybacks. We look -- we don't want to look for those opportunities. We would rather that price run up where it's more competitive.

And so we're certainly a bargain. Go ahead, Allison.

Allison Johnson -- Chief Financial Officer

Yeah. So during the quarter, we also renewed our stock buyback plan for another year. So we do have the plan available to deploy. But ultimately, we're looking at the valuations and where our stock price is trading.

And we're going to deploy our capital, which makes the most sense for our shareholders and gives them the greatest rate of return.

Brad Milsaps -- Piper Sandler -- Analyst

Great. I'll hop back in queue.

Operator

Thank you. Our next question comes from Matt Olney with Stephens Inc. Please proceed with your question.

Matt Olney -- Stephens Inc. -- Analyst

Thank you. Good morning. I wanted to ask about loan yields. It sounds like there's incremental pressure that was mentioned in the prepared remarks on the loan yields.

I would love to hear any numbers you can put behind that and what are spreads look like today versus a few months ago. Thanks.

David McGuire -- President and Chief Lending Officer

You know -- Matt, this is Dave. Good morning. We're seeing -- if I'm going to put a number to it, mid- to high fours right now on any term debt of three to five years, which is down about a quarter to 35 basis points from what it was in the first quarter. I think that's kind of where the floor is from our perspective.

We are dedicating ourselves and maintaining our margin at all costs above 4%. And to do that, we need to be in the fours most of the time. It doesn't mean that we won't fight for good business that meets our needs on the quality side. And for us to grow, we'll need those loans.

So there's a little bit of pressure, but it's not as much as you might think. I think that our marketplace and where we play, typically as borrowers with $500 million to maybe $2 million to $3 million in needs in loans, and we're just able to price in that range much more easily than we can on bigger loans. And so as long as we stay to our knitting, that customer base has awakened and so they are requesting loans at a pace that we haven't seen in over a year that if we maintain our pricing, we'll maintain our margins.

Matt Olney -- Stephens Inc. -- Analyst

OK. That's helpful, David. And then last quarter, we talked about loan participations that were sold that could be potentially called back later in the year. Did we see any of that in 2Q or is that something we could see in 3Q or 4Q?

David McGuire -- President and Chief Lending Officer

Yes, Matt, we bought back about $40 million of the...

Allison Johnson -- Chief Financial Officer

14.

David McGuire -- President and Chief Lending Officer

14. Sorry, misstated that, $14 million before the end of the quarter.

Matt Olney -- Stephens Inc. -- Analyst

14. OK. Perfect. I think you maybe sold something north of $40 million in the first quarter.

So is there potential for incremental purchases later in the year?

David McGuire -- President and Chief Lending Officer

Yes.

Matt Olney -- Stephens Inc. -- Analyst

And then on the PPP, obviously, the bank was a big winner in terms of market share growth and new customer wins. I think you've highlighted before bringing over some of those customers on the deposit side. Have you seen any movement yet on the loan side from some of those newer customers? And if not, kind of what's the expectation of when you'll see some of those tailwinds?

David McGuire -- President and Chief Lending Officer

Yeah. Actually, we are just now starting to see that. We are -- like I said, our customer base is awakening, so to speak, and that includes our PPP customers. So we're finalizing bringing over all their deposits and their loans, and they're looking for new loans.

So just this past week, we approved three different new loan relationships that are related to our ability to provide PPP loans to them, and they were significant. And so very excited about that. That's 1,800 unique new customers to the bank that we got through the PPP process.

Matt Olney -- Stephens Inc. -- Analyst

OK. All right. That sounds great. Appreciate your help.

David McGuire -- President and Chief Lending Officer

Sure. Thank you.

Operator

Thank you. Our next question comes from Brady Gailey with KBW. Please proceed with your question.

Brady Gailey -- KBW -- Analyst

Hey, thanks. Good morning, guys. I wanted to follow up just on the loan growth question. So high single digits this year, which you know this year is a unique year.

But when you look out to 2022 and beyond, is that -- I know the percentage growth used to be a lot higher, but you're also a larger company now. So how do you think about kind of loan growth outside of this year into 2022 and 2023?

David McGuire -- President and Chief Lending Officer

Well, we're built to grow. And so we have a lending staff that's got the capacity today and we're adding additional capacity today that we believe that we're going to be able to maintain low to mid-teens in the foregoing years from here. So that's where we'd like to be. We like to see that kind of growth.

It's attainable, and we're built for that. So I would -- if I were looking at it, we were guiding to mid to high teens last year prior to the pandemic. And we're still there. I mean we believe that the economy is functioning properly with our coverage in the state of Texas being in all the major metros, with our lender teams actively being active in those markets and then adding additional lenders that we're going to be able to maintain that kind of guidance to the market.

Brady Gailey -- KBW -- Analyst

OK. All right then in the second quarter, you'll have some really nice swap fees. I know that can be volatile, but it was $1.4 million in the second quarter. I think it was close to 0 in the first quarter.

Maybe just talk about the sustainability or what do you think that kind of longer-term run rate should be on the swap fee side.

David McGuire -- President and Chief Lending Officer

You're correct. It is volatile, but it kind of goes we have a very large owner-occupied CRE commercial -- CRE portfolio. Right now, we're going through -- and in educating the customers on the value of the swap, particularly in a low rate environment right now and preserving that rate for them into the future and that is a sales job, and so we've been very successful in the second quarter with that, and we have the same expectations in the third quarter. It's a little hard to kind of look out past 90 days because those are things, but it's been really accepted very well in our marketplace.

And we think that in looking at that, a reasonable budget might be about $1 million a quarter in that product. And some quarters will be more, and some will be a little bit less. But on average, I think that's a good number to play with. And then also, our new customers that are coming to us, particularly on a fixed rate basis, it allows us really to compete against the larger banks.

And so where we'll get a floating rate, which we like and that we'll get a fixed rate that's very competitive. It might go out seven to 10 years and protect their ability to debt service the debt.

Brady Gailey -- KBW -- Analyst

All right. And then lastly for me. I mean, if you look at the reserve, it was pretty flat linked quarter. It's around 80 basis points of loans ex PPP.

I know you guys have some acquisition marks that make that percentage look higher. Can you just remind us kind of what the reserve is when you put in those acquisition marks and how we should think about that reserve ratio going forward?

Allison Johnson -- Chief Financial Officer

Yeah. So we've got still $2.3 million of unamortized discount on our acquired portfolio. You add that back in, and we're in the 90s on our coverage ratio. Realistically, with oil prices trading where they're at, above $70 a barrel, the GDP where it's landing and just seeing improvements in credit quality quarter over quarter, I mean that's going to be about where we're going to sit going forward.

I just can't tweak those qualitative when the economy is doing so well and then our asset quality just continues to improve. So that's kind of our thought process going forward.

Brady Gailey -- KBW -- Analyst

OK. And CECL is still coming up for you guys on January 1 of '23, right?

Allison Johnson -- Chief Financial Officer

Correct. Yes.

Brady Gailey -- KBW -- Analyst

OK. Great. That's it for me. Thanks, guys.

Allison Johnson -- Chief Financial Officer

Thanks, Brady.

David McGuire -- President and Chief Lending Officer

Thank you very much.

Operator

Thank you. This concludes the question-and-answer portion of the call. I would now like to hand the call back to management for final comments.

Dean Bass -- Chairman and Chief Executive Officer

Thank you very much for the interest in us today, and I appreciate you calling in and very good questions. Thank you very much. Have a good day.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Jerry Golemon -- Chief Operating Officer

Dean Bass -- Chairman and Chief Executive Officer

David McGuire -- President and Chief Lending Officer

Allison Johnson -- Chief Financial Officer

Brad Milsaps -- Piper Sandler -- Analyst

Matt Olney -- Stephens Inc. -- Analyst

Brady Gailey -- KBW -- Analyst

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