VBTX (2021 - Q3)

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00:05 Good day, and welcome to the Veritex Holdings Third Quarter twenty twenty one Earnings Conference Call and Webcast. All participants will be in a listen-only mode. Please note, this event is being recorded. 00:21 I will now turn the conference over to Ms. Susan Caudle, Investor Relations Officer and Secretary to the Board of Veritex Holdings.

00:33 Thank you. Before we get started, I would like to remind you that this presentation may include forward-looking statements, and those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to publicly revise any forward-looking statement. 00:52 At this time, if you're logged into our webcast, please refer to our slide presentation, including our safe harbor statement beginning on slide two. For those of you joining us by phone, please note that the safe harbor statement and presentation are available on our website, veritexbank.com. All comments made during today's call are subject to that safe harbor statement. 01:11 Some of the financial metrics discussed will be on a non-GAAP basis, which our management believes better reflects the underlying core operating performance of the business. Please see the reconciliation of all discussed non-GAAP measures in our filed 8-K earnings release. Joining me today are Malcolm Holland, our Chairman and CEO; Terry Earley, our Chief Financial Officer; and Clay Riebe, our Chief Credit Officer. 01:38 I will now turn the call over to Malcolm.

01:41 Good morning, everyone. It's been a very busy quarter for our team, which produced some very favorable results. For the quarter, we produced operating earnings of zero point seven zero dollars a share, up from zero point six zero dollars the previous quarter, a seventeen percent increase, while producing a pre-tax pre-provision return of one point eight five percent. 02:01 The third quarter was transformational for our company. We closed our forty nine percent investment into Thrive Mortgage and realized a full quarter of our investment. We also announced our acquisition of North Avenue Capital, the nation's largest producer of USDA loans. We're scheduled to close this transaction next week on November one. Both of these opportunities will add meaningfully to our non-interest income moving forward. 02:27 Our loan growth continues to perform at a brisk pace. For the quarter, loans net of PPP and mortgage warehouse grew three hundred and forty four million dollars or twenty two percent annualized. This is the second straight quarter we have exceeded twenty percent loan growth. For the first-nine months of the year, we are growing at seventeen percent. 02:49 If you peel back the onion a bit and really analyze our pipelines, it is clear that our investments in loan talent over the past eighteen months are starting to produce the results that we had hope for. But our timing on funding, closings and payoffs have worked in our favor in the last two quarters. As we look forward, we don't see loan growth continuing at these last two quarter levels, but still feel confident that our annual loan growth should hover in the low-double digits for the remainder of twenty one and also for twenty two. 03:20 I'd like to speak a bit on the focused hiring we have done for the last eighteen months. These new additions are big part of our current growth and why we are so bullish on the future. Just this quarter, we added an additional eleven FTEs to our production teams and twenty five year-over-year. These total do not include the non-client facing hires we’ve made in our operations, data analytics, credit and risk areas, which candidly are best-in-class. The market disruption in several M&A deals in our state and the fact that prospective employees in our markets are taking note of our culture and growth profile are prompting these hiring opportunities. 04:03 Our deposit growth continued during Q3 growing at just over eleven percent annualized or two hundred million dollars. We continue to drive down our cost of total deposits, now at twenty bps, down from twenty three in Q2. We are probably at the bottom right here. 04:21 Credit quality continues its positive trend as we move further and further away from pandemic crisis in our markets. NPA decreased for the fourth quarter in a row and now sit at zero point seven seven percent of total assets down eight bps from the previous quarter and over thirty percent year-over-year. We feel this ratio will continue to move down considering the resolutions we're currently working towards. Charge-offs were nine bps, all of which were fully accounted for in our reserves. 04:50 I'll now turn the call over to Terry to discuss our detailed financial results.

04:56 Thank you, Malcolm. On page five you’ve seen multiple graphs and I want to comment on a couple of these. First, tangible book value per share increased to seventeen point five three dollars in the third quarter. This translates into growth of twenty point one percent on a year-over-year basis after adding back the impact of our quarterly dividends. Growing tangible book value per share remains an important priority for our management team. 05:19 Second is our operating return on average tangible common equity, which remained very strong in the third quarter at sixteen point nine percent and has averaged sixteen point five percent over the last four quarters, as Veritex worked through the pandemic. The impact of the Thrive investment can be seen in our efficiency ratio, which improved over three percent down to forty eight point five percent. 05:41 One thing is not graphed that I would like to call your attention to is the positive operating leverage in Q3. Operating revenue grew seven percent on a linked quarter basis, while operating expenses only grew at zero point six percent, resulting in positive operating leverage over six percent which is pretty strong. 05:59 On slide six, Malcolm has already mentioned our loan growth for the quarter. We saw growth in all loans segments except multi-family. The rate of growth in the construction portfolio slowed in Q3 and the level of unfunded commitments remained steady. Improving C&I utilization rates also contribute to the outstanding loan growth for the quarter. 06:18 Average mortgage warehouse balances increased two point three percent in the third quarter, reflecting additional customer acquisition. This portfolio sits at six point eight percent of average total loans excluding PPP. It remains our intent to keep the average mortgage warehouse portfolio at ten percent or less of average total loans. 06:39 Skipping to slide eight. Net interest income increased four point two million dollars from Q2 level, all the way up to seventy one point three million dollars in Q3. The most significant drivers of the increase were loan growth, day count and deposit rates. Also note that Q3 loan production was at three point seven zero percent and Q3 interest-bearing deposit production was at twenty one basis points. 07:04 Next, the net interest margin increased fifteen basis points from Q2, up to three point two six percent. For Q3, the PPP portfolio represented a five basis point drag on the NIM. Average liquidity was approximately one hundred and thirty six million dollars higher than our normal target level, but down significantly from three hundred and fifty million dollars in excess liquidity in Q2. This excess liquidity had the impact of depressing the NIM in Q3 by seven basis points. So in the aggregate PPP and excess liquidity, represent about a twelve basis point drag on the NIM. 07:38 As you model net interest income for future periods, keep the following in mind. First, average loans, excluding mortgage warehouse and PPP for the third quarter are two hundred and fifty five million dollars below the ending balance on September thirty. Second, there's thirty five million dollars in subordinated debt with a rate of approximately five point five percent that is callable in December of twenty twenty one. Third, the earnings impact of the hedge terminated in February of twenty twenty one will start to flow through earnings in Q1 twenty twenty two, with an annual net interest income impact of four point three million dollars. These factors give us optimism that the growth in net interest income from Q3 to Q4 and beyond will be meaningful and that the margin should continue to expand. 08:28 On to slide nine, another strong non-interest income quarter with fifteen point six million dollars in revenue or thirteen point nine million dollars on an operating basis excluding the benefit of one point nine million dollars in PPP forgiveness at Thrive and one hundred and eighty eight thousand dollars in security losses. 08:47 Operating non-interest revenue represented sixteen point three percent of total revenue for the quarter and should continue to improve in Q4 with the closing of the North Avenue Capital acquisition. As a result of Veritex’s strategic intent to diversify revenue sources, we’ve achieved thirty two percent year-over-year growth and operating non-interest income, excluding the impact of PPP. 09:10 Operating expenses on slide ten decreased four hundred thousand dollars from Q2. Salaries and employee benefits increased slightly, as higher salary cross from the hiring Malcolm referenced was partially offset by lower benefit cost. The number of employees increased by ten during the quarter and by thirty one year-over-year as we continue to invest for growth. 09:31 Skipping to slide twelve, capital levels grew approximately twenty million dollars for the quarter. This is net of the twenty one point three million dollars, we returned to shareholders in the form of dividends or share buyback. For the quarter, we repurchased three hundred and twenty eight thousand shares at an average price of thirty four point eight five. All the capital ratios except the leverage ratio declined slightly during the quarter due to balance sheet growth and the shift out of lower risk weighted assets into the loan portfolio. Our capital deployment priorities given the current valuation for stock, our organic growth, dividends, strategic growth and lastly, share repurchases. 10:08 On slide thirteen, I want to provide an update on the Thrive mortgage investment. Thrive continues to perform well as their Q3 origination volume increased slightly to almost eight hundred million dollars. Year-to-date twenty twenty one origination volume is up just over sixty percent as compared to the same period in twenty twenty. This compares to the most recent MBA forecast, which is calling for a decrease of six percent. Thrive’s purchase driven origination model has delivered sixty six percent purchase volume for the year-to-date and over seventy percent for two consecutive quarters. 10:43 Since the end of the third quarter, we've signed a corresponding contract with Thrive, where they will provide fulfillment on all Veritex Bank originated mortgages and a loan purchase agreement allowing Veritex to buy Thrive adjustable rate originations for our own loan portfolio. 10:59 On slide fourteen, I'd would like to end with an update on North Avenue Capital. Their loan pipeline remained strong at approximately four hundred million dollars. Veritex’s Q4 forecasted net income from the North Avenue acquisition should be in the range of one point five million dollars to two million dollars. The twenty twenty two estimated net income remains unchanged from the announcement date at approximately twelve million dollars. We've been working closely with the team from North Avenue since the announcement and are even more encouraged about their earnings potential. They built a strong market position in USDA lending, and we're committed to helping them build on that leading position. 11:35 With that, I'd like to turn the call over to Clay for some comments on credit.

11:38 Thank you, Terry. Good morning, everyone. The credit picture for Veritex continues to improve. As Malcolm mentioned, our NPA dropped over the quarter. Our NPAs to total assets have dropped thirty percent from the high watermark experienced in the third quarter of twenty twenty. We continue to see encouraging signs of resolution in our problem loan portfolio. 12:02 Page fifteen of the deck contains a credit metrics for the bank for Q3. The chart in the bottom right hand of the page reflects the movement and criticized assets over the past four quarters. After our run up due to the pandemic, we've experienced a twenty five percent improvement in our levels of criticized assets from the high watermark that occurred in the third quarter of twenty twenty. 12:25 Our special assets team is doing a great job of reducing our levels of criticized assets and we expect that to continue through the balance of the year. The migration of credits from the line to our special assets team due to deteriorating trends has reduced significantly also, which is encouraging. Charge offs for the quarter are centered in three acquired credits. First was a borrower in the saltwater disposal industry that lost its primary customer, which put the borrower into distress and resulted in a charge down of the subject debt. 13:00 The second was a contractor that went out of business in the collateral did not sufficiently cover the debt. And finally, we had an SBA loan secured by restaurant property that was foreclosed and sold at a loss. The reference charge offs were fully reserved in prior periods and had no impact on our required loan loss provision. Past dues were up slightly due to one credit in the electric coal power generating industry that matured and is in negotiation for a renewal. 13:33 I want to touch briefly on the third quarter loan production details given on page seven of the deck. Our largest area of committed production for the past year has been in commercial construction loans. The chart in the bottom left of the page demonstrates a couple of points worthy of note. Our underwriting standards have not changed over the last year as can be seen in the weighted average LTVs, LTCs and DSCRs. Our reliance on commercial construction loan for production has dropped meaningfully over the last year from seventy percent to forty two percent. 14:09 Finally, our commercial construction lending is focused in the industrial space, which has been the most active CRE space [indiscernible] for some time. There's tremendous investor interest in this space, and many of our project payoff before fully funding due to buyer demand. 14:28 With that, I'll turn it back over to Malcolm for final remarks.

14:32 Thanks, Clay. Our continued focus and commitment to operating a risk focus, growing and key producing efficient business is starting to show their earnings power and efficiency of this company. We continue to be focused on consistent core earnings while executing our conservative risk profile through all parts of the enterprise. We have made a targeted effort to enhance our non-interest income category as well as continue to hire talented staff to take this bank to the next level. 15:02 We do continue to see numerous opportunities in the M&A side of our business. We remain confident that we'll be involved in any meaningful M&A conversations indexes, but we will remain very disciplined when it comes to bringing on a new institution into our Vertex family. 15:20 In closing, let me say, how proud I’m of the entire staff. Delivering these types of results in an extremely competitive market is not easy. Our team should be congratulated and I'm also proud of well done. 15:33 Operator, we'll now open for any questions.

15:38 Thank you. [Operator Instructions] Our first question is from the line of Matt Olney from Stephens. Your line is now open.

16:11 Hey, thanks. Good morning, guys.

16:14 Hey, Matt.

16:16 Doing great. Congrats on the loan growth this quarter. It sounds like you're still guiding towards that low double digit loan growth for the fourth quarter and into next year. Would you obviously be a slowdown from what we’ve seen over the last few quarters? I think you mentioned a few things, one of which was expectations to more paydowns. Any more commentary you can provide or are you seeing some of the construction loans nearing completion? Thanks.

16:46 Yeah. I mean the paydowns are going to get pretty aggressive here and we know, we just look forward to the pipeline in the next quarter and quarter after. We've been really, really active and obviously, when you are really active, they pay off. And so, we see some of that. I mean candidly, we're still encouraged by the loan growth, but we're not going to keep up at twenty percent that's -- we're running them pretty hard at that. And the good news is that we're actually doing less and less of that, as we move forward and the folks that we're hiring, none of them are in the real estate side, so they're all in the community bank or commercial side.

17:28 And Malcolm, on the production side, you gave us a great slide there on slide seven looking at the commitment production improvements of last few quarters. What's the expectation for that over the next few quarters in terms of incremental improvement from there?

17:47 You mean in each individual area?

17:50 Well, I was looking at the top right hand graph on that slide seven, the quarterly commitment production is in aggregate was...

17:57 I’m sorry. I got it. Okay. I'm on it now. There's a lot going on. My guess is, we're going to be continuing to be above that billion dollars mark going forward, just with the new folks that we’re hiring and the new efforts that we're putting forth in a couple of different areas. But yeah, I think we're going to be able to hold that line over one billion.

18:24 Okay. And then just lastly, I'll hop back in the queue. I think you disclosed the weighted average rate on new production was around three seventy. Just remind me, does that include any fees or any other miscellaneous stains or is that just a coupon rate? Thanks.

18:42 That's just a coupon right, Matt, this is Terry. So when you are comparing that to our quarterly yield that once coupon, once yield including deferred fees, fees collected et cetera.

18:57 Got it. Okay. Okay. I’ll hop back in the queue. Nice quarter. Thanks.

19:03 Thank you, Matt.

19:04 Thanks, Matt.

19:09 Our next question is from Gary Tenner of D.A. Davidson. Your line is now open.

19:18 Thanks. Good morning.

19:20 Good morning.

19:20 Wanted just ask a little bit, I think Terry you talked about this in the past in terms of kind of Vertex’s comfort at various loan deposit ratios, ninety four percent at the end of the quarter, ex-mortgage warehouse even with a slowdown in the pace of loan growth from here, would stand that, that loan deposit ratio probably continues to decrease hire. So just can you remind us where your comfort level is in terms of that loan deposit ratio?

19:49 Loan to deposit excluding PPP and mortgage warehouse, we're comfortable up close to one hundred percent, I mean just right under that if you will, because we know we have a lot of off balance sheet resources. We know that the mortgage warehouse business has short turn times. So that if we need liquidity, we can get it from there. So certainly slightly slower loan production, loan growth will help. But liquidity as offset and we’ve forecast out, I don't see liquidity as any type of significant constraint as we get to finished twenty one and get through twenty two. Obviously, key focus on raising deposits and our community bank has done a great job of that and our commercial C&I lenders are doing a good job too. So, we got to stay focused there just every day, the way we do on the loan side. And then we'll be okay and we're comfortable again up close to one hundred percent excluding mortgage warehouse and PPP.

21:02 All right. Thank you. And then on the construction portfolio and you kind of addressed this in a sense, given expectations of some increased pay downs in that book, but fourteen percent of loans ex-mortgage warehouse and PPP. Where would you like that portfolio sort of optimally to be relative to the total book?

21:23 It's probably right where it is. If it shrank a little bit, that'd be okay too. We just have a really, really talented team in that area. They are really good and the credit quality is some of our best because we have an execution team, it’s really, really top notch. So we're going to keep dealing with A borrowers, and I see it's staying about the same.

21:56 Okay. And then finally for me, you mentioned the agreement to purchase variable rate loans through Thrive and having the option there. As you think about expectations for that channel and where you'd want the kind of resi mortgage portfolio to be? Where does that -- what does that like over time?

22:20 Yeah. I'll take that one Gary. I mean, we're just over eight percent today. I mean I would certainly like to see it get to ten, in the intermediate term, if you will, and then go from there. I mean, we would love to have the mortgage consumer part of the book be at about fifteen percent to twenty percent. One of the side benefits to that is certainly carries a lower risk weighting, which was up on the capital ratio front. But we'd like to continue to grow that. Obviously, don't want to go too aggressively there given where we are in the rate cycle and the expectation for future rate hikes in twenty two, twenty three. But it's a nice tool that we now have and we've done a fair amount of work over the last ninety days or so to get there. So feel good about it. Thrive has been a good partner in that regard. And we want to grow at reasonable rates, but just get it to ten and then we'll go towards the fifteen number, if you will.

23:31 Thank you very much.

23:34 Thanks, Gary.

23:33 Next question is from Brad Milsaps, Piper Sandler. Your line is now open.

23:46 Hey. Good morning, guys.

23:47 Good morning, Brad.

23:51 Thanks for taking my questions. Terry, just want to follow-up on the loan yield question. But Mat’s right, I think your core loan yields were maybe down ten basis points linked or ten or eleven if I exclude sort of all the PPP noise, PCV reversal things like that. You talked about that three seventy new and renew yields that’s without fees. Would -- do you feel like the new and renewed is kind of firming up or do you think there is more pressure there to come? Just trying to get a sense of how much more core loan yield pressure we could kind of see over the near term?

24:29 Well, I mean, I think the pace of the decline in loan yields has lessened during the third quarter. But -- and I think it wouldn't have a lot more downward pressure, but there's an external variable here known as competition. And if things were to stay the way they are. I don't think that pressure would be great, but I'm not convinced that competitors who feel pressure to grow are not going to tighten spreads and get really more aggressive on yields. And so it's a hard to know, but I don't see that that's going to get a whole lot better. We've been coaching our team all year long that pricing was going to get tougher as the year went on. 25:20 And so that's another part in this, a little bit slower growth is, we've certainly had a good -- I mean, for the seventeen percent or so in the first nine months. And I'm glad we put it on then when spreads were wider as opposed to having to be stepping into that gap now thinking I got to turn up the growth level when spreads are coming in. So it's one of the hardest things to forecast in our world is what's the competitive pressure on rates, but Brad, there's a lot of capital as you know, there's a lot of liquidity in the system and we should include some pressure from both the buy and sell side to our competitors. And so, I think it's going to be meaningful and look, I don't mind competing on spread, I just don't want to compete on structure. And that's where I'm proud to play in the credit team and our bankers for holding the line well there as you can see.

26:17 Great, Terry. Thank you. That's helpful. And Malcolm, just a question on both organic and sort of inorganic growth. Can you help us think you've hired twenty five new lenders year-to-date? As you think about the next twelve months, what would be a good number to maybe think about, I know it's hard? And then can you also just remind us or maybe how things have changed in terms of how you're thinking about size of a potential M&A target. I know you've talked about maybe potentially going to a more rural franchise it might have more funding versus a more metro franchise? Just kind of wanted to get a sense of kind of how you're thinking about size of deals, et cetera?

26:59 Yeah. In terms of the organic, inorganic, a lot of these folks we have hired recently are what we would call community bankers. The community bank is loans ten million less, companies twenty five million in revenue and less. It’s our most profitable area. It provides funding. It funds the majority of the bank and that's our foundation. So a lot of those people come out of there. So those numbers are smaller. But like I said, they're very profitable and they provide funding. So, they'll be organic. They're moving two big mergers in town that have created a whole bunch of opportunity. I will say one of their mergers in town. We've gotten over ten people from and several have reached out to us. And that's not just production people. It's actually probably kind of more like fifteen. But I think there's going to be a fair amount of organic growth, albeit, it might be on the smaller side because of majority of folks are community bankers. But we're still pushing on -- we have two big hires on the commercial side that I think that are going to be really, really nice. 28:16 In terms of M&A, here's our thinking. We've grown about eight hundred million dollars this year. And so it seems to us that it'd be hard for us to get down that low if we can grow at that size. But we recognize it at the growth rates here are albeit they'll be less than the last two quarters. We're going to need some funding at some point in time twenty three, twenty four. And so fundings we're looking out far enough and so, yeah, the smaller banks with sixty percent loan to deposit ratios that reside in slower growth towns, but still in Texas or something that we're looking at and looked at will continue to, but there's got to be a reason to do a deal. We're not going to do it just to add six hundred million in loans. We've got to have a reason behind doing it. And so we're going to be pretty disciplined there.

29:17 Great. Thank you, guys.

29:20 Thanks, Brad.

29:23 Our next question is from Woody Lay of KBW. Your line is now open.

29:30 Hey. Good morning, guys.

29:31 Good morning, Woody.

29:34 As you’ve mentioned, you've done a really great job on the free income side, the rise in the numbers in North Avenue closing in November. I guess my question is just longer term than and in an ideal world, where would you like fees to revenue to ultimately represent like the twenty five percent range or maybe above that?

29:55 Go ahead, Terry.

29:59 Yeah. Woody, look, we're kind of focused on getting to twenty five, we made good progress. I mean, as a management team, we sat here just over twelve months ago and we were about ten and in this quarter we were at sixteen and we're going up from there. And so, we've been very intentional about growing this. We've made two meaningful transactions between Thrive and North Avenue Capital. And would we'd be happy over twenty five? Yes, but twenty five is a good place to get to. And the thing, I would remind all investors and analyst on this call is that North Avenue Capital is a great business, but it's going to be a lumpy business. It's lumpier than any other business line we are in or about to be in, starting next Monday. 30:45 So, my urging is to think about that over an annual time period and don't get caught up and well, you said your fee revenue goal was twenty five and you went down this quarter. Yeah, but we could be up. It just depends on the timing of closings in that business, and so I know I'm rambling, but I want to take this opportunity to remind everybody is, it’s a lumpy business and twenty five, I think we'd be really, really happy. I think that the revenue diversification including one very countercyclical investment in Thrive is really -- we have a much more diversified and stable earnings picture from that -- stable revenue picture from that. So, there you go.

31:28 Yeah. That's great color. And then related to asset sensitivity, at least based on the [indiscernible] disclosure, it came down a touch quarter-over-quarter. Is there any color you could give just surrounding that decrease?

31:44 Yeah. I mean, when you move loans, I mean, when you move cash off the balance sheet, it's going to move you down. And while that cash moving out lessen their asset sensitivity, I certainly like to what it did the net interest income and the NIM. So we'll make that trade. I think that -- I think the important thing is that the -- take to left on page eight, when you look at how many of our floating rate loans don't have a floor or the floor has been reached, so almost ninety percent of our loans will reprice when Fed starts to move. So I'm encouraged by that, given that we're two-thirds floating or thereabout. So anyway, hope that helps.

32:31 Yes. And then last for me is, just nice to see the level of buybacks in the quarter. Was the buyback this quarter is sort of a reflection that M&A might be coming along a little bit slower than you previously thought or just any comments you can give on the buybacks this quarter?

32:48 Well, we've always said that we want that to be one of the tools in our tool book -- toolbox and that we're going to be opportunistic and when there's weakness in the stock, we certainly like taking advantage of that. I don't expect us at these valuation levels, don't expect much from us and the buyback, but if you go back to when we started this post green acquisition, our average purchase price per share is been twenty five point two seven dollars and we bought back six point six million shares. So, I know that's in different valuation environment than we have now, but it's been a good tool to have and it was a good tool in the third quarter. How much we're going to use it's going to depend on how the markets valuing the currency and I wouldn't expect this to be as active going forward.

33:45 Yeah. That makes sense. All right. Thanks, guys.

33:49 Thanks, Woody.

33:54 And there are no further questions at this time. This concludes today's conference call. Thank you all for your participation. You may now disconnect.

34:05 Thank you.

34:07 Thank you.