Stellar Bancorp, Inc. (STEL) Q3 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the CBTX Q3 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Justin Long. Thank you. Please go ahead.

Thank you, and good morning. I'm Justin Long, the General Counsel of CBTX and our management team would like to welcome you to the CBTX, Inc. earnings call for the third quarter of 2021. We appreciate you joining us. We issued our earnings press release yesterday afternoon and copy of which is available on our website, along with the slide presentation that we will refer to during this presentation. We also filed our quarterly report on Form 10-Q for the third quarter yesterday afternoon. 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 or 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 report on Form 10-Q for the third quarter, and our other filings with the SEC, which can all be accessed on our Investor Relations website at ir.cdtxinc.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 used to the most directly comparable GAAP financial measures is included in our earnings release and investor presentation. I'm joined this morning by Robert Franklin, our Chairman, President and CEO; Ted Pigott, our CFO; 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.

Thanks, Justin. Welcome to the earnings call for CBTX, Inc. for the third quarter of 2021. We are proud to present our third quarter results which continue to be indicative of the transition from the COVID impacted economy through most of the first half of the year to an improved economic environment nationally and in our markets. As we enter the fourth quarter, our credit quality is stabilized and deposits continue to grow. Our customers are starting on new projects and continuing to grow their businesses as confidence grows in the local economic environment. During most of 2020 through early this year, we curtailed our commercial real estate lending due to uncertainty in the sector, largely due to uncertain effects of the pandemic. Additionally, we began in the second and third quarter a return to a natural flow of payoffs, but also have experienced some acceleration due to the pent-up demand for the products we traditionally finance. Thus the combination of not filling – continuing to fill that pipeline over the proceeding quarters and the accelerated payoffs have slowed our portfolio growth. That said, our lenders have done a good job during the third quarter in rebuilding our loan pipeline and we continue to see those efforts into the fourth quarter. We continue to remain disciplined in our credit decisions and believe that our portfolio will stabilize during the fourth quarter, allowing us to return to our traditional growth rate over the next couple of quarters. With the continued low interest rate environment and our liquidity build during COVID, we have increased our bond purchases during the third quarter and will continue additional bond purchases at a measured pace. However, we know that our best efforts should remain toward building our loan portfolio. Although we monitor our cost structure regularly, as we set our budget for 2022, we will be evaluating our expense base to look for ways to improve our efficiency. Lastly, we have made significant progress on the regulatory front. The OCC terminated the formal agreement relating to our Bank Secrecy Act and Anti-Money Laundering program on September 7. As I have said previously, the work on the Bank Secrecy Act program was a bank wide effort and the agreement was lifted in approximately 14 months. We believe this timing is a testament to our people, our program and our work with the OCC. We believe that our BSA program today complies and is quite capable of taking on additional scale. In addition, as we set forth in our 10-Q, we have entered a confidential settlement discussions with FinCEN relating to a potential resolution of its investigation into our BSA program. Although I may unable to speak to specifics of the settlement discussions, we are working diligently to resolve any outstanding matters relating to past workings of our BSA program. We believe that we are well positioned entering the fourth quarter. We have an experienced lending staff and significant capital that gives us flexibility in supporting our future growth and expansion decisions. We have strong liquidity and maintained a loyal low cost relationship-driven deposit base that provides significant shareholder value. Our focus will remain on driving long-term value for our shareholders. Now, I'll turn it over to Ted Pigott, our Chief Financial Officer.

Thank you, Bob. Certain financial information for the third quarter and prior periods begins on Slide 4 of our investor presentation. The company reported net income of $14.4 million or $0.59 per diluted share for the quarter ended September 30, 2021 compared to $11.7 million or $0.48 per share for the quarter ended June 30, 2021 and $6.4 million or $0.26 per diluted share for the quarter ended September 30, 2020. Third quarter results. Our net interest income for the third quarter 2021 was $31.2 million, an increase of $231,000 from second quarter 2021. The net interest margin on a tax equivalent basis was 3.22% for the third quarter 2021, a decrease of 7 basis points from second quarter 2021. The loan yield increased 16 basis points to 4.52% for third quarter compared to second quarter 2021. The cost of interest-bearing liabilities was 30 basis points for second quarter compared to 32 basis points for first quarter 2021. The provision for credit losses was a recapture of $4.9 million for the third quarter is compared to a recapture of $5.1 million for second quarter, primarily due to continued improvements in the national economy, economic forecasts, loan quality and the size of our loan portfolio. Non-interest income for the third quarter 2021 increased $1.5 million from second quarter to $5.6 million, primarily due to an increase in earnings on bank-owned life insurance, which we realized $1.9 million gains. Gains on other sales of assets were $246,000. Non-interest expense for the third quarter decreased $825,000 from second quarter to $24.4 million. The increase in third quarter resulted from decrease in professional and director fees of $874,000. Financial condition, the total assets at September 30, 2021 increased $142.6 million to $4.2 billion compared to June 2021. This growth was driven by net deposit inflows of $114.8 million. Loans, excluding loans held for sale at September 30, 2021 decreased $121.1 million to $2.6 billion compared to June 30, 2021. PPP loans, net of deferred fees and unearned discounts were $100.8 million at September 30, 2021 and $179.1 million at June 30, 2021. Compared to September 30, 2020, loans excluding PPP loans decreased 5% on an annualized basis. Deposits at September 30, 2021 increased $114.8 million to $3.5 billion compared to June 30, 2021. Compared to September 30, 2020 deposits increased 11.4% on an annualized basis. The company maintains strong capital ratios as the total risk-based capital ratio increased to 18.12%. The CET1 capital ratio increased to 16.87% and the Tier 1 leverage ratio increased to 11.69% at the end of September 30, 2021. Asset quality, non-performing assets totaled $20.6 million or 0.49% of total assets at September 30, 2021 compared to $21 million or 0.52% of total assets at June 30, 2021. The allowance for credit losses for loans was $32.2 million or 1.23% of total loans at September 30, 2021 compared to [$32.2 million] or 1.36% at total loans on June 30, 2021. The ACL decreased during the third quarter 2021, primarily due to a recapture of $5.1 million in the ACL for loans and a provision of $893,000 for unfunded commitments due to improvements in the national economy, economic forecast, the reduction of loan portfolio and the improvement in loan quality. Net qualities were $82,000 for the third quarter compared to net recoveries of $499,000 for the second quarter of 2021. Now, I'll turn it over to Joe West.

Thank you, Ted. I'll speak a bit to our loan portfolio beginning with Slide 7 from the investor presentation. For the third quarter, our net loans were down at $2.58 billion versus $2.69 billion at the end of the second quarter of 2021, a decrease of approximately $116 million primarily due to paydowns and payoffs for sale of businesses, projects and some refinancings during the third quarter of 2021 of approximately $38 million of commercial loans. Our net PPP loans decreased approximately $78 million during the third quarter. Our loan deferrals related to COVID decreased and we had seven loans with principal totaling $18.8 million on deferral at the end of the third quarter. For the quarter, C&I was down approximately $62.5 million or 2.5% compared to Q2. However, net of PPP payoffs, C&I increased $19 million for the quarter. CRE was down 5.8% quarter-over-quarter and down 1.2% compared to the end of 2020. C&D was down 19.4% compared to the second quarter. 1-4 family was down 3.4% and multifamily was up 7.8%. Slide 8 sets forth the components of our commercial loans and our gross commercial loans were down slightly for the third quarter at $2.3 billion versus $2.41 billion at the end of the third quarter, including our PPP loans. As you turn to Slide 9, you will see our construction and development loan components. Our construction and development loans were down approximately $32.5 million when compared to June 30, 2021, due to payoff as well as some existing C&D loans reaching completion and moving to permanent loan classification. Slide 9 sets forth our oil and gas exposure, including how we quantify our direct and indirect exposure. Our direct and indirect oil and gas loans for the third quarter increased slightly to $85.4 million compared to the end of the second quarter. Slide 10 sets forth the information about our PPP loans. During the third quarter, our net PPP loans decreased to $100.7 million and we received $78 million related to forgiveness or payments from customers. The table at the bottom Slide 10 sets forth our average yield on our loan portfolio. Our average yield on our PPP loans and the average yield on our loan portfolio, while taking out the PPP loans. Slide 11 sets forth information about our allowance for credit losses. As Ted noted, our allowance for credit losses to loans was 1.23% at September 30, 2021. Turning to Slide 12. Our non-performing assets decreased again slightly during the third quarter and our credit quality remains strong. Slide 12 shows information regarding our non-performing assets to our total assets, which was 0.49% as of September 30, 2021 compared to 0.52% as of June 30, 2021. As with the second quarter, our recoveries during the third quarter exceeded our charge-offs, resulting in a net recovery of $82,000. With that, I’ll turn it back over to Bob Franklin.

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

Thank you. [Operator Instructions] Your first question comes from the line of Will Jones with CBW.

Hey. Good morning, guys. This is Will with KBW. How are you all?

Good morning, Will. We're wondering who is CBW.

Yes. I don't know who is CBW is either, but anyway. So I just wanted to start on loan growth. I know loans were down again and you guys had some optimism coming off with 2Q. But Bob, you cited a little bit of pressure from a lag in your CRE pipeline. Just curious if this was a trend you guys saw in the second quarter as well, or if this is kind of new and unique to the third quarter?

It started to begin – well, it began sort of late. We weren't sure whether it was continuous or trim, but it sort of began late in the second quarter, I guess. As the payoffs accelerated a bit, and we were a little bit surprised that people were coming back to purchase these strip centers that tend to be the ones that we’re paying off initially. We also saw the opening up of permanent markets like that again, and then – so people did refinance some of them out to permanent loans, but we were surprised that there was capital ready to go out and buy sort of unanchored centers that typically had some issues around tenants, et cetera. And as they were starting to firm back up, we thought, well, this would take a while for this to happen, but it didn't. And actually, I think to the testament to our customers, they did get their tenants back up and paying rents and made it attractive for people to buy. So I think we are going to start to get back to a more normalized repayment of these loans and payoffs. We're starting to catch up with that. Our pipeline is built up again. So we start every month catching up to the payoffs that we have to catch up to. So we're making loans, it's just trying to get beyond what's paying off. So it's getting there, and I'm pretty happy with where our guys are from a pipeline standpoint. I think this fourth quarter will be good and sort of set us up as we go into 2022.

Yes. That totally makes sense. And do you think it's fair to say, loans may still feel a little bit pressure next quarter as you kind of restart this growth engine and that it really will be early 2022 that we see that return to that 5% to 8% growth that you guys are so good at generating?

Yes. I think by the time we make it to the first quarter and trying to live quarter-to-quarter is not a great idea. But I think we feel like we're starting to get back into our normal turns that could change a bit depending on payoffs. But the pipeline that we see in front of us and the payoffs that we think are going to happen, we should start to get back to our more normalized growth as we enter 2022. So by the time we get into the first and second quarters, I think we're going to be back to where we've been traditionally.

Okay, great. And then next, I just wanted to move on to expenses. It was really great to see you guys get the BSA behind. I know you guys have spent a lot of time and money on that over the past year, but just thinking in terms of expenses, BSA costs were down really nicely linked quarter. Just trying to get a sense of good run rate for that professional fee lines moving forward now with BSA gone, I know if you back out the $200,000 or so you spent this quarter that those fees are kind of in the $1.3 million to $1.4 million range. Is that a good way to think about that fee line or that expense line moving forward?

Yes. I think we need to think about it in two ways, Will. And one is the go-forward expense of attorney's fees, consultants and that kind of thing. That's on the downturn. But I will caution, we still are negotiating as I talked about in my opening remarks with FinCEN. So there's still some pain to be had for what FinCEN does from a penalty standpoint. And so as we negotiate that out, that's still in front of us. But again, we're talking about the past, so there's some pain to be paid for the past. But as we look to the future, those expenses are basically going to go away as soon as we get this settled out. And we're currently, as we talked about earlier in negotiations with them, and it's our hope that this gets concluded by the end of this quarter.

Okay. Great. Thanks for taking my questions.

You bet.

Your next question comes from the line of Charles West with Piper Sandler.

Hey. Good morning, guys.

Good morning.

I just want to start on the liquidity front. So I see that averages balances are up around – to around $854 million. Can you just talk about some of your plans to just deploy that excess capital? Especially just like how aggressive you'll be given current yields and – or do you feel more comfortable being patient as loan growth returns?

Well, as we went through COVID, we tried to assess what was happening to us. PPP was a bit of surprise that all that money seemed to stick as well as it has. I think over time, I don't think people will be patient with having their money earned zero. So we're a bit cautious around what liquidity will do over time. But we're going to continue to increase our bond purchases a bit. We don't think it's rationale to just jump into the bond market full force. So I think we should – we're going to measure ourself into that. We're going to continue to look the way to deploy more of that money into loans, which is the primary sort of thing that we want to do. But we're going to do it on a measured basis and that's kind of how we see the world and how we've lived for a number of years. So that's how we'll do it.

Okay, great. Thanks. And then shifting over to the reserve, you had another substantial negative release bring it down to around 123 bps. Do you think we're starting to get to a more normalized level here giving some of the growth expectations coming into the end of the year and into 2022?

We're getting close. I think depending on where loans go and I think we will start building back, it could call – we're so – ACL now with CECL is just sort of driven by formula. As we add portfolio, we will tend to add more in the way of ACL, but we still haven't tweaked – totally tweaked down all of the Q factors that we have. So as economic conditions continue to get better, there's still some room around Q factors, it might change that a bit, but we were sitting on a pretty large reserve probably more than we needed. But as we – we're staying true to our model and that's where we are. So I think right now, if we continue to add loans the way we think we are, this might be a good place for it. If we continue to move back a bit, then it may come down a bit.

Okay, great. That's it for me. Thanks guys.

Thank you.

Your next question comes from the line of Thomas Wendler with Stephens Inc.

Hey. Good morning, guys.

Good morning.

It looks like we saw some repurchase activity this quarter and you guys have a pretty decent amount remaining of authorization. Can you give us an idea of how active you plan on being in the near-term?

Yes. I don't think that's a big activity for us. I think it was pretty small.

Okay. And then just moving on then, on expansion plans, you guys mentioned Dallas and Houston previously is your main focus. Are those still going to be the main focus moving forward? And if you choose to do any M&A activity, can you give us an idea of the size of the institutions you'd be considering?

Yes. I mean, I think our focus tends to be around the $500 million to $1 billion mark, and Dallas and Houston are still our focus. But we look at everything. I mean, we've looked at some things that are larger than that. We've looked at MOEs. We've looked at various other options that we have, and we'll continue to do that over time as we always do. But if we're focused on the best thing for us from an acquisition standpoint, I think the best piece of that would be that $500 million to $1 billion mark.

All right. Sounds good. That's all my questions, guys. Thank you.

Thank you.

[Operator Instructions] And so at this time, we have no further questions.

Very good. Thank you very much for your interest in CBTX. And with that, we're adjourned, I guess.

Ladies and gentlemen, thank you for your participation on today's call. At this time, you may now disconnect.