Spirit of Texas Bancshares (STXB) Q3 2021 Earnings Call Transcript

Spirit of Texas Bancshares (STXB)
Q3 2021 Earnings Call
Oct 28, 2021, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Spirit of Texas Bancshares 2021 third quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded.

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 third 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 third quarter before opening the call for Q&A. I would 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 November 4, 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, October 28, 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 would 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. I'm extremely pleased to announce a strong performance for Q3. Our goal has always been to service the vibrant markets in which we operate.

The engine that drives community banking is the demand for quality loans. Our strategy has always been to retain talented bankers and high-growth markets and capitalize on opportunities as they arise. While the past eighteen months have been extremely challenging for the banking industry, we are now experiencing the loan demand that will drive organic loan growth and profitability higher in the coming quarters. During the third quarter, loans grew an impressive 12% annualized, when excluding the impact of PPP loans.

We anticipate these trends to continue and expect to have an exceptional fourth quarter with respect to loan growth. In addition to strong loan growth, during the quarter, we earned net income of $10.5 million representing fully diluted EPS of $0.59 and a return on average assets of 1.33% annualized. We also increased our quarterly dividend from $0.09 per share to $0.12 per share and have maintained our net interest margin near 4% despite market pressures with respect to rates. I continue to be extremely impressed with the resilience and commitment of our talented bankers who drive successful results quarter after quarter.

We are well-positioned to meet the needs of our community with respect to loan demand and are truly excited to see successful projects that our borrowers will bring to the community in the coming quarters. Now I'll turn the call over to David to discuss the loan portfolio and asset quality. David?

David McGuire -- President andChief Lending Officer

Thank you, Dean. As Dean mentioned, we are extremely pleased to return to low double-digit annualized loan growth. The deals currently being funded are high-quality projects at competitive rates. Many of these deals carry opportunities to earn swap fees as our new borrowers are more concerned with future interest rate swings.

We anticipate the fourth quarter to also be a strong quarter with respect to loan growth despite increasing competition in many of our markets. We are working diligently to assist remaining PPP borrowers through the forgiveness process and hope that by the end of the fourth quarter, the remaining balance of PPP loans will be negligible. Asset quality continues to improve with loans migrating into lower risk ratings during the quarter due to improved financial performance. Non-performing loans declined $1.3 million or 16.7% from the second quarter of 2021.

Non-performing loans to outstanding loans decreased to 28 basis points from 33 basis points during the quarter, as more borrowers begin to show signs of strength coming out of the COVID-19 pandemic. The yield on loans in the third quarter of 2021 was 5.09%, which increased 22 basis points from Q2 2020 and decreased 21 basis points from Q2 2021. The yield on loans continues to be impacted by increased PPP forgiveness and accretion of purchase loan discount which is earned as the acquired portfolios mature. While loan demand has returned to near pre-pandemic levels, competitive pressure has also returned that may require us to record loans at a lower rate to remain competitive.

Wherever possible, when competing on a rate, we also offer customers swap offerings that lock in lower rate for the customer while generating new non-interest income. The loan pipeline continues to build each month and we are currently experiencing higher closer rates as more deals pull through to funding. The provision for loan losses for the third quarter was $306,000. The lower provision for the quarter was due to risk rate migration within the organic portfolio.

At quarter end, the coverage ratio on the organic portfolio was 82 basis points, excluding PPP loans. Annualized net charge-offs were 10 basis points for the third 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. Deposits continue to show strong growth as Q3 ended the total deposits of $2.7 billion, an increase of 98.4 million or 15.3% annualized from Q2 2021, and an increase of $383.1 dollars or 16.8% over Q3 2020. Non-interest-bearing deposits decreased $4.6 million or 0.59% from Q2 with a reduction due to PPP related deposits as borrowers put the proceeds to use. Non-interest-bearing deposits currently make up 28.7% of total deposits.

Interest-bearing demand deposits increased $35.3 million or 6.7% from Q2, primarily due to balances associated with new accounts, opened by customers generated from the paycheck Protection Program and the Main Street Lending program. Savings and money market accounts increased $91.2 million or 14% from Q2 also due to success retaining in growing the relationships associated with COVID-19 related assistance programs. Time deposits decreased by $23.4 million or 3.8% from Q2 2021. Due to aggressive repricing, the cost of time deposits decreased to 11 basis points from Q2 2021 to 0.68%.

This improved shift in deposit mix resulted in a 0.28% cost of deposits, a decrease of four basis points from Q2 2021. The bank has no broker deposits. The reported loan to deposit ratio at the end of Q3 was 84.4% excluding PPP activities, the loan deposit ratio is 80.4%. Borrowings decreased by $39.8 million during the third quarter to $79.3 million due to the payoff of PPP LF borrowings.

Borrowings totaled two point five percent of assets at the end of Q3. The company has significant sources of available liquidity, including $50 million in a holding company line of credit, Fed funds land totaling $118 million, and Federal Home Loan Bank availability of $804.4 million. I would now like to turn the call over to Alison to provide a financial overview of the third quarter. Alison?

Allison Johnson -- Chief Financial Officer

Thanks, Jerry, and good morning, everyone. We provided detailed financial tables in yesterday's earnings release. Consolidated net income for the three months ended September 30th, 2021 was $10.5 million with fully diluted EPS of $0.50, compared to earnings of $7.1 million and fully diluted EPS of $0.44 in the third quarter of 2020. Net income and earnings per share were primarily driven by the recognition of 2.2 million net accretions of origination fees on PPP loans.

We anticipate the majority of the remaining 2.5 million of net origination fees on PPP loans to be recognized during Q4 2021. Non-interest income was 3.3 million for the third quarter of 2021, compared to 3.9 million for the second quarter of 2021, a decrease of $573,000 linked quarter. The decrease for Q2 was primarily due to lower swap-related fees. Demand for swap products began to increase during the second half of the third quarter, and we expect non-interest income to increase in the coming quarters due to demand for swap products.

Loans held for sale grew 3 million, as SBA loan production has begun to increase from our SBA department restructuring. This will translate into loan sales in the coming quarters and a return to the gain on sale of SBA loans contributing out to the overall non-interest income. Non-interest expense totaled 18 million in the third quarter of 2021, an increase of 1.2 million from the 16.8 million reported in the second quarter of 2021. The increase was primarily due to an increase in salaries and benefits expense of 1.4 million, resulting from higher medical expenses due to non-recurring large claims during the quarter and in additional pay period.

With respect to net interest margin, the tax-equivalent margin in the third quarter 2021 was 4%, compared to second quarter 2021 tax-equivalent margin of 4.14%, representing a 14 basis point decrease sequentially. While the overall cost of funds continues to decline, competitive pressures on loan production is negatively impacting the yield on loans. However, using excess liquidity to fund strong loan growth will assist the overall margin in the coming quarters. The provision for loan losses for the third quarter was 306,000, which increased the allowance to 16.3 million or 72 basis points of our total loans outstanding or 75 basis points excluding the 100% government-guaranteed PPP loans.

The provision expense for the quarter related primarily to the provisioning of new loans. The coverage ratio on the organic portfolio was 82 basis points on the 1.8 billion in organic loans outstanding, excluding PPP loans at quarter end. Additionally, we have 2.1 million unamortized discounts on the acquired loan portfolio at September 30th, 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 September 30th, 2021, capital ratios remain strong and book value per share and tangible book value per share have increased to $22.49 and $17.67 respectively. 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. It makes my job very easy when we report solid earnings, improved credit quality, and strong loan demand. All that is left to say is, thank you to our team who made these results possible. Our bankers have expertly navigated us through very challenging times.

And I am excited to see what is in store for Spirit of Texas in the coming quarters. Expectations are high. This concludes our prepared remarks. I'd like to ask the operator to open up the line for any questions.

Operator?

Questions & Answers:

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator instructions] Our first question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Brad Milsaps -- Piper Sandler -- Analyst

Hey. Good morning, guys.

Jerry Golemon -- Chief Operating Officer

Good morning, Brad.

Allison Johnson -- Chief Financial Officer

Good morning, Brad.

Brad Milsaps -- Piper Sandler -- Analyst

Just wanted to maybe touch on loan growth for a moment. I know you guys expressed confidence in hitting your eight to 12% goal for the year. I think that would -- we need to believe there would be a pretty big step up in the fourth quarter. Are you expecting kind of outsized kind of catch-up in the fourth quarter to get to that goal and kind of how do you think about growth heading into 2022?

Jerry Golemon -- Chief Operating Officer

Yeah, Brad, excuse me, we are continuing to believe that we're going to be in that eight to 12% growth year over year into the fourth quarter. We're not quite ready to guide for the first or second quarter of 2022 yet, but the pipeline in place today supports continued growth in the low double-digits at this point.

Brad Milsaps -- Piper Sandler -- Analyst

OK. Thank you. And then Allison, I was writing quickly. Expenses maybe came in a touch higher than I was looking for.

Can you maybe speak to any additional color there, maybe on the expense run rate. I know you guys have been working hard to continue to find synergies, but you're small growth companies well, so I know you have to reinvest. Just kind of want to get a sense of the expense rate run rate going forward.

Allison Johnson -- Chief Financial Officer

Sure. So this quarter, we kind of had an anomaly come through in our medical expenses. So that was about $400,000 higher than we had expected. With that being said though, we do have an additional pay period in December.

So I'm going to keep that expense run rate for Q4 at 18 million conservatively with potentially a little bit lower than that, but I'm going to give myself a little later room at that 18 million.

Brad Milsaps -- Piper Sandler -- Analyst

OK. Great. And then maybe just last two housekeeping items for me. Do you haven't had the average balance of PPP loans? And then I think I may have missed this, how much loan discount accretion did you recognize in the third quarter?

Allison Johnson -- Chief Financial Officer

Yeah. Great question. So as far as accretion, accretion came in lighter this quarter than normally. Normally, we collect about 825,000 a quarter.

This quarter, it was only 300,000. We've got 2.1 million remaining on that mark out of that portfolio. And as far as average balances of PPP loans, that was roughly 100 million for Q3.

Brad Milsaps -- Piper Sandler -- Analyst

OK. Great. I'll head back in the queue. Thank you very much.

Dean Bass -- Chairman and Chief Executive Officer

Hey, Brad, one more -- are you still on? Let me just mention to you, I think it's important that the 12% is a strong number by anyone's measurement on the loan growth. But at the same time, of course, income is generated by how soon it gets into the quarter, right? And so as we trying to fund these, sometimes it's later in the quarter, which was the case this time. So it didn't generate as much revenue as we would have wished early on. But of course, that's a catch-up in 2014.

So you'll see that continue to help us along the way.

Brad Milsaps -- Piper Sandler -- Analyst

Great. Thanks, Dean.

Operator

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

Brad Gailey -- KBW -- Analyst

Hey. Thanks. Good morning, guys.

Jerry Golemon -- Chief Operating Officer

Good morning.

Allison Johnson -- Chief Financial Officer

Good morning.

Brad Gailey -- KBW -- Analyst

So you're talking about a better and higher level of fee income going forward. You specifically mentioned swap fees doing well. It sounds like you'll have some added fee income from the restructuring of your SBA. Maybe just talk about the upside you think you could see from those two initiatives and where you think fee income could get to on a quarterly run rate by next year?

Allison Johnson -- Chief Financial Officer

Yes. So I'm expecting swap fees to come in. We're budgeting around $1 million a quarter. And then with our SBA production, we'll see a pickup in Q4, but really in 2022 is where we expect that group to really shine through.

So for my run rate, on noninterest income for Q4, I'm anticipating between 3.5 and $4 million, and that will just continue to grow into 2022 because of that SBA department restructuring.

Brad Gailey -- KBW -- Analyst

OK. All right. And then when you look at the net interest margin, I know there's a lot of moving parts here. But how do you think your net interest margin or either NII will trend from here?

Allison Johnson -- Chief Financial Officer

So I think this quarter was kind of a low point. I expect it to go up from here. As Dean alluded to, the majority of our loan growth occurred in the -- toward the end of September. So you'll see that pick up in NII in Q4 as well as with David's pipeline, we fully expect our asset mix to improve as we deploy some of that excess liquidity into loans.

Brad Gailey -- KBW -- Analyst

All right. And finally for me, just anything on the M&A front, you'll continue to look for downstream targets or conversations active? What's the latest on M&A?

David McGuire -- President andChief Lending Officer

Very active. Things are from my seat, I see more discussions going on than in the past. There's a lot more interest by a lot more different-sized banks.

Brad Gailey -- KBW -- Analyst

All right. Thanks, guys.

Operator

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

Matt Olney -- Stephens Inc. -- Analyst

Thanks for taking my question guys. I want to circle back on loan growth. I think historically, much of the banks -- or a lot of the bank's borrowers have seasonal borrowing needs that results in fourth quarter being the strongest quarterly growth for the bank in most years. How much of the outlook in the fourth quarter from seasonal tailwinds versus how much of it is more of a inflection in borrower needs that we could see carry into 2022?

David McGuire -- President andChief Lending Officer

Well, Matt. That's seasonal versus what we see, I'd say it's -- the fourth quarter has traditionally been very strong for us, historically. It's been that way every year. So I hate to attach anything to any seasonality other than that's just the way it works.

But the last couple of years have been extremely strong even in 2020. So our expectation is that will continue this quarter based on the pipeline I have in place that were almost 40% of the loans that are in the pipeline are approved and have a good chance of being closed and funded in this quarter. And it will -- there'll be some run over into the first quarter, just like there was earlier this year. So the needs of the borrowers seem to be normalized now.

And the activity that we're seeing is just normal in all respects to us. And we're just trying to get it done and get it in as quickly as possible. We see an opportunity here to continue to grow our market share in each of our major metros, which with the teams that we have in place, we have the capacity to do so. And then as I've said before, we are continuing to look for those veteran bankers in market that will give us additional capacity to continue to grow our pipeline so that in 2022, we can maybe guide to high teens growth for 2022.

Dean Bass -- Chairman and Chief Executive Officer

Matt, I might add something to what David has seen in the past is a strong finish for the year, except for COVID, when COVID hit. Now that brings to bear what we've seen over the last six to nine months, I would say, post-COVID is a buildup and an excitement that we haven't seen in our lifetime, so to speak, people are trying to come alive, so can get their lives back. At the same time, some fear of taxes we've seen in the last 12 months where people would be selling the properties and trying to reduce their debts in some areas, and you see some payoffs, some early payoffs, and some properties that they might would have turned or kept for earning producing, and they might have gone ahead and out of that fear. What you've seen is that sort of settled down a little bit.

So the paydown, payoff on the large side, and you see now more actively building on the future. So you see a lot more excitement in that way. And I think that contributes to each of these metro market communities that are now looking for the opportunities for the future. And so I think that's building David's pipeline right at the right time for us.

Matt Olney -- Stephens Inc. -- Analyst

OK. Thanks for that. And then, I guess, what about on the competitive side as far as loan growth I think we saw a move down on the core loan yield front, lots of banks are talking about increased competitive pressures. What are you guys seeing on core loan yields more in the newer production? And how much pressure should we be anticipating on these core loan yields from here as we start to book some increased production in the next few quarters? Thanks.

Dean Bass -- Chairman and Chief Executive Officer

Our targets have changed just because of competition. We have a lot of liquidity like a lot of banks in our markets. it's down to pricing in a lot of respects. The competition that we're seeing is mainly around pricing and not necessarily around credit, which I like actually.

So it gives us an honest chance. If it's a good deal, we're going to play ball. If it's a deal that's marginal, it's got to pay the rate where we're not interested. Marginal, not from a credit perspective.

But -- In the end, our rates are falling in the prime plus one range. And if it's a fixed rate deal, it's going to be in the mid-fours to closer to five depending on the term. And we're still able to compete at those levels. A lot of -- we're seeing some stuff that we don't like that we're seeing sub-three fixed-rate 10-year fixed deals.

That's not who we are. And we would rather bring them in as a customer and get them a good deal on swap that fixes them for seven to 10 years. We pick up a nice fee on that, and then we've got a floating rate loan. So right now, we're in really good shape.

62% of our loans are floating. Half of those, if we got a rate bump are going to be immediately impacted positively for us and our net interest income is going to appreciably increase.

Matt Olney -- Stephens Inc. -- Analyst

Good. OK. Perfect. And then on the deposit side, Allison, we saw some really good improvement on the funding costs coming down? Just any color on how much more room you have to bring down deposit costs there? And I think there was a comment on prepared remarks that mentioned that you expect most of the fourth quarter loan growth to be funded by liquidity? Just any clarification there.

Thanks.

Dean Bass -- Chairman and Chief Executive Officer

Well, from a cost-of-deposit standpoint, there is a little room for it to come down a little bit further. What we saw in Q3 is each month of the quarter, it ticked down a little bit more. So about half of our CD portfolio reprices in the next six months. So that will provide us some additional benefit there.

We also had some pretty sizable public fund contracts that repriced in September. So we'll see the full quarter impact on that where those reprice to much more favorable terms. So again, a little bit of room, maybe in another three or four basis points in Q4 is what I'm looking for.

Allison Johnson -- Chief Financial Officer

Yeah. And we saw quite a bit of deposit growth during the quarter. I don't know if you want to touch on where that came from, Jerry?

Jerry Golemon -- Chief Operating Officer

Yeah. we keep expecting the deposit growth to moderate, and it's just not happening. Again, another 15% annualized in Q3. And a lot of that came from new customers that we picked up through the PPP process or the Main Street Lending Process.

And those have ended up being very good deposit customers. But those are businesses that are -- they're smart businesses, they're looking to put that money to use at some point in time. But right now, they are very liquid as well, and that cash is sitting on their balance sheet and in our bank. But we're -- again, they're going to have future borrowing needs outside of Main Street or PPP that we're going to be able to step up and meet.

Matt Olney -- Stephens Inc. -- Analyst

And just lastly, on the stock repurchase plan, just remind me of the authorization and any commentary on the appetite to focus on the buyback more near term? Thanks.

Allison Johnson -- Chief Financial Officer

Yeah. So we still have our stock repurchase plan in place with an authorization of 10 million to repurchase there. Again, we've got that plan under 10b5-1 and if it's activated, then it will go ahead and start repurchasing shares. We have seen some improvement in our tangible book.

So in our -- excuse me, our multiple -- our trading multiple. So again, I think we're seeing some improvement there to allow us to use our capital in other ways, but we're constantly monitoring that.

Matt Olney -- Stephens Inc. -- Analyst

OK, guys. Thanks for your help.

David McGuire -- President andChief Lending Officer

Thank you.

Jerry Golemon -- Chief Operating Officer

Thanks, Matt.

Operator

Thank you. There are no further questions at this time. I'd like to turn the floor over to Dean Bass for closing comments.

Dean Bass -- Chairman and Chief Executive Officer

Thank you for attending our Q3 2021 earnings announcement. Appreciate your continued support. Thank you.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Jerry Golemon -- Chief Operating Officer

Dean Bass -- Chairman and Chief Executive Officer

David McGuire -- President andChief Lending Officer

Allison Johnson -- Chief Financial Officer

Brad Milsaps -- Piper Sandler -- Analyst

Brad Gailey -- KBW -- Analyst

Matt Olney -- Stephens Inc. -- Analyst

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