Veritex Holdings, Inc.

Good day and welcome to the Veritex Holdings Third Quarter 2021 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. Please note this event is being recorded. I will now turn the conference over to Ms. Susan Cuddle, Investor Relations Officer and Secretary to the Board of Veritex Holdings.

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 statements. 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. 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 8K earnings release. Joining me today are Malcolm Holland, our chairman and CEO, Terry Early, our chief financial officer, and Clay Reby, our chief credit officer. I will now turn the call over to Malcolm.

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 $0.70 a share, up from $0.60 the previous quarter, a 17% increase, while producing a pre-tax, pre-provision return of 1.85%. The third quarter was transformational for our company. We closed our 49% 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 1st. Both of these opportunities led meaningfully to our non-interest income moving forward. Our loan growth continues to perform at a brisk pace. For the quarter, loans net of PPP and mortgage warehouse grew $344 million, or 22% annualized. This is the second straight quarter we have exceeded 20% loan growth. For the first nine months of the year, we are growing at 17%. 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 18 months are starting to produce the results that we had hoped for. But our timing on funding, closings, and payoffs have worked in our favor 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 21 and also for 22. I'd like to speak a bit on the focused hiring we have done for the last 18 months. These new additions are a big part of our current growth and why we are so bullish on the future. Just this quarter, we added an additional 11 FTEs to our production teams and 25 year over year. These totals 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. Our deposit growth continued during Q3, growing at just over 11% annualized, or $200 million. We continue to drive down our cost of total deposits, now at 20 bps, down from 23 in Q2. We are probably at the bottom right here. Credit quality continues its positive trend as we move further and further away from the pandemic crisis in our markets. NPAs decreased for the fourth quarter in a row and now sit at 0.77% of total assets, down 8 bps from the previous quarter. and over 30 percent year-over-year. We feel this ratio will continue to move down considering the resolutions we are currently working towards. Charge-offs were nine BIPs, all of which were fully accounted for in our reserves. I'll now turn the call over to Terry to discuss our detailed financial results.

Thank you, Malcolm. On page five, you'll see multiple graphs, and I want to comment on a couple of these. First, tangible book value per share increased to $17.53 in the third quarter. This translates into growth of 20.1% 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. Second is our operating return on average tangible common equity, which remained very strong in the third quarter at 16.9% and has averaged 16.5% 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 3% down to 48.5%. One thing that's not graphed that I would like to call your attention to is the positive operating leverage in Q3. Operating revenue grew 7% on a linked quarter basis, while operating expenses only grew at 0.6%, resulting in positive operating leverage over 6%, which is pretty strong. On slide six, Malcolm has already mentioned our loan growth for the quarter. We saw growth in all loan segments except multifamily. 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 contributed to the outstanding loan growth for the quarter. Average mortgage warehouse balances increased 2.3 percent in the third quarter, reflecting additional customer acquisition. This portfolio sits at 6.8% of average total loans, excluding PPP. It remains our intent to keep the average mortgage warehouse portfolio at 10% or less of average total loans. Skipping to slide 8, net interest income increased $4.2 million from Q2 level all the way up to $71.3 million 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 3.70%, and Q3 interest-bearing deposit production was at 21 basis points. Next, the net interest margin increased 15 basis points from Q2, up to 3.26%. For Q3, the PPP portfolio represented a 5 basis point drag on the NIM. Average liquidity was approximately $136 million higher than our normal target level, but down significantly from $350 million 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 12 basis point drag on the NIM. 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 $255 million below the ending balance on September 30th. Second, there's $35 million in subordinated debt with a rate of approximately 5.5% that is callable in December of 2021. Third, the earnings impact of the hedge terminated in February of 2021 will start to flow through earnings in Q1 2022. with an annual net interest income impact of $4.3 million. These factors give us optimism that the growth in net interest income from Q3 to Q4 and beyond will be meaningful and that the margins should continue to expand. On to slide nine, another strong non-interest income quarter with $15.6 million in revenue or $13.9 million on an operating basis, excluding the benefit of $1.9 million in PPP forgiveness at Thrive, and $188,000 in securities losses. Operating non-interest revenue represented 16.3% 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 32% year-over-year growth in operating non-interest income, excluding the impact of PPP. Operating expenses on slide 10 decreased $400,000 from Q2. Salaries and employee benefits increased slightly. This higher salary cross from the hiring Malcolm referenced was partially offset by lower benefit costs. The number of employees increased by 10 during the quarter and by 31 year over year as we continue to invest for growth. Skipping to slide 12, capital levels grew approximately $20 million for the quarter. This is net of the $21.3 million we returned to shareholders in the form of dividends or share buyback. For the quarter, we repurchased 328,000 shares at an average price of $34.85. 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 of our stock, are organic growth, dividends, strategic growth, and lastly, share repurchases. On slide 13, 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 $800 million. Year-to-date 2021, origination volume is up just over 60% as compared to the same period in 2020. This compares to the most recent MBA forecast, which is calling for a decrease of 6%. Thrive's purchase-driven origination model has delivered 66% purchase volume for the year to date and over 70% for two consecutive quarters. Since the end of the third quarter, we've signed a correspondent 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. On slide 14, I would like to end with an update on North Avenue Capital. Their loan pipeline remains strong at approximately $400 million. Veritex's Q4 forecasted net income from the North Avenue acquisition should be in the range of $1.5 to $2 million. The 2022 estimated net income remains unchanged from the announcement date at approximately $12 million. We've been working closely with the team from North Avenue since the announcement and are even more encouraged about their earnings potential. They've built a strong market position in USDA lending, and we're committed to helping them build on that leading position. With that, I'd like to turn the call over to Clay for some comments on credit.

Thank you, Terry. Good morning, everyone. The credit picture for Veritex continues to improve. As Malcolm mentioned, our NPAs dropped over the quarter. Our NPAs to total assets have dropped 30% from the high water market experienced in the third quarter of 2020. We continue to see encouraging signs of resolution in our problem loan portfolio. Page 15 of the deck contains the credit metrics for the bank for Q3. The chart in the bottom right-hand of the page reflects the movement in criticized assets over the past four quarters. After a run-up due to the pandemic, we've experienced a 25 percent improvement in our levels of criticized assets from the high-water mark that occurred in the third quarter of 2020. 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 in distress and resulted in a charge down of the subject debt. The second was a contractor that went out of business and the collateral did not sufficiently cover the debt. And finally, we had an SBA loan secured by a 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 loan loss provision. Past dues are up slightly due to one credit in the electrical power generating industry that matured and is in negotiation for a renewal. 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 70% to 42%. Finally, our commercial construction lending is focused in the industrial space, which has been the most active Cree space in Texas for some time. There's tremendous investor interest in this space, and many of our projects pay off before fully funding due to buyer demand. With that, I'll turn it back over to Malcolm for final remarks.

Thanks, Clay. Our continued focus and commitment to operating a risk-focused, growing, and fee-producing efficient business is starting to show the 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. We do continue to see numerous opportunities in the M&A side of our business. We remain confident that we will be involved in any meaningful M&A conversations in Texas. But we will remain very disciplined when it comes to bringing on a new institution into our Veritex family. In closing, let me say how proud I am 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 awfully proud of them. Well done. Operator will now open for any questions.

Thank you. If you would like to register a question, please press star followed by the number 1 on your telephone keypad. If your question has been answered and you would like to withdraw your registration, please press the hand. One moment please for the first question. Our first question is from the line of Matt Olney from Steffens. Your line is now open.

Hey, thanks.

Good morning, guys. Morning. Hey, Matt.

Hey, everybody. Doing great. Congrats on the long growth this quarter. It sounds like you're still guiding towards that low double-digit long growth for the fourth quarter and into next year, which will 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 of some more paydowns. Any more commentary you can provide, or are you just seeing some of the construction loans nearing completion? Thanks.

Yeah, I mean, the paydowns are going to get pretty aggressive here. I mean, we know we just look forward through the pipeline the next quarter and quarter after. You know, we've been really, really active. And obviously, when you're really active, they pay off. And so... We see some of that. Candidly, we're still encouraged by the loan growth, but we're not going to keep up at 20%. We're running them pretty hard at that. The good news is that we're actually doing less and less of that as we move forward. The folks that we're hiring, none are in the real estate side. They're all in the community bank or commercial side.

Malcolm, on the production side, you gave us a great slide there on slide seven, looking at the commitment production improvements of the last few quarters. What's the expectation for that over the next few quarters in terms of incremental improvement from there? You mean in each individual area? Yeah. Well, I was looking at the top right-hand graph on that slide, Devin, the quarterly commitment productions in aggregate.

Oh, got it. I'm sorry. I got it. Okay. I'm on it now. You know, there's a lot going on. My guess is we're going to be continuing to be above that billion-dollar mark going forward just with the new folks that we're hiring and the new efforts that we're putting forth in a couple different areas. But, yeah, I think we're going to be able to hold that line here. Over a billion.

Okay. And then just lastly, and I'll hop back in the queue, I think you disclosed the weighted average rate on new production was around 370. Just remind me, does that include any fees or any other miscellaneous things, or is that just the coupon rate? Thanks.

That's just the coupon rate, Matt, this year. So when you compare... So when you're comparing that to our quarterly yield, you know, one's coupon, one's yield, including deferred fees, fees collected, et cetera. Got it. Okay.

Okay. All back in the queue. Nice quarter. Thanks.

Thank you, Matt.

Thanks, Matt.

Our next question is from Gary Tenner of Davidson. Your line is now up.

Thanks. Good morning. I wanted to just ask you a little bit. I think, Terry, you've talked about this in the past in terms of kind of Veritex's comfort level at various loan deposit ratios. You know, 94% at the end of the quarter, ex-mortgage warehouse, you know, even with a slowdown in the pace of loan growth from here, you know, it would stand that that loan deposit ratio probably continues to cruise higher. So just can you remind us where your comfort level is in terms of that loan deposit ratio?

You know, loan to deposit excluding PPP and mortgage warehouse, we're comfortable up close to 100%. I mean, you know, just right under that, if you will. Because, you know, we know we have a lot of off-balance sheet resources. We know that the mortgage warehouse business has short term times. so that if we need liquidity, we can get it from there. So, you know, certainly slightly slower loan production, loan growth will help, but liquidity, you know, as I sat and looked forecast out, I don't see liquidity as any type of significant constraint as we go, as we, you know, finish 21 and get through 22. Obviously, a key focus on raising deposits And our community bank has done a great job of that. And our commercial CNI lenders are doing a good job, too. So we've got to stay focused there just every day the way we do on the loan side. And then, you know, we'll be okay. And we're comfortable, again, up close to 100% excluding mortgage warehouse and PPP.

All right. Thank you. And then on the construction portfolio, and you kind of, address this in a sense, you know, giving expectations of some increased pay downs in that book, but 14% of loans, ex-mortgagor S and PPP, you know, where, where would you like that portfolio sort of optimally to be brought up to the total book?

You know, it probably right where it is. You know, we don't, 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 that's really, really top notch. So we're going to keep dealing with A borrowers, and I see it staying about the same.

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, what does that look like over time?

Yeah, I'll take that one, Gary. I mean, we're just over 8% today. I mean, I would certainly like to see it get to 10%. 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 15% to 20%. One of the side benefits of that is it certainly carries a lower risk weighting, which will help 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 race cycle and the expectation for future rate hikes in 22-23. But it's a nice tool that we now have, and we've done a fair amount of work over the last 90 days or so to get there. And so, you know, feel good about it. Thrive's been a good partner in that regard. And, you know, we want to grow fast. at reasonable rates, but, you know, not, and just get it to 10, and then we'll go towards the 15 number, if you will.

Thank you very much.

Thanks, Gary.

Next question is from Brad Millsap, Piper Sandler. Your line is now open.

Hey, good morning, guys. Good morning, Brad. Thanks for taking my questions. Terry, just wanted to follow up on the loan yield question. If I'm asked right, I think your core loan yields were maybe down 10 basis points, sling core, 10 or 11, if I exclude sort of all the PPP noise, PCD reversal, things like that. You talked about that 370 new and renew yield. That's without fees. Do you feel like the new and renewed is kind of firming up, or do you think there's more pressure there to come? Just trying to get a sense of, how much more core loan yield pressure, you know, we could kind of see over the near term?

Well, I mean, I think the pace of the decline in loan yields has lessened during the third quarter. But, you know, and I think, you know, it wouldn't have a lot more downward pressure, but there's an external variable here known as competition. And, you know, 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, you know, it's hard to know, you know, but I don't see that that's going to get a whole lot better. You know, we've been coaching our team all year long that pricing was going to get tougher as the year went on. And so that's another part in this a little bit slower growth is we've certainly had a good, I mean, for the 17% 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've 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 there's increasing 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 of Clay and the credit team and our bankers for holding the line well there, as you can see.

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, you know, 25 new lenders here today. As you think about the next 12 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, you know, size of a potential, you know, M&A target? I know you've talked about maybe potentially, you know, going to the more rural franchise, it might have more funding, um, you know, versus a more Metro franchise. She's kind of wanting to get a sense of, of kind of how you're thinking about, you know, size of deals, et cetera.

Yeah. Um, you know, in terms of the organic inorganic, a lot of these folks we have hired recently are what we would call community bankers. Um, the community bank is, uh, you know, loans, 10 million less, uh, companies, 25 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 have 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. There's two big mergers in town that have created a whole bunch of – I will say one of the mergers in town we've gotten over 10 people from, and several have reached out to us. And that's not just production people. It's actually probably more like 15. So, you know, I think there's going to be a fair amount of organic growth, albeit it might be on the smaller side because the majority of these folks are community bankers. But we're still pushing on. We have two big hires on the commercial side that I think are going to be really, really nice opportunities. In terms of M&A, you know, here's our thinking. You know, we've grown about 800 million this year, and so it seems to us that it'd be hard for us to dip down that low if we can grow it that size. But we recognize that at the growth rates we are, albeit there'll be less in the last two quarters, we're going to need some funding at some point in time, 2023, 2024. And so funding's You know, we're looking out far enough. And so, yeah, you know, the smaller banks with, you know, 60% loan-to-deposit ratios that reside in slower-growth towns but still in Texas are something that we're looking at and have looked at and 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 $600 million in loans. We've got to have a reason behind doing it. And so we're going to be pretty disciplined there.

Great. Thank you, guys.

Thanks, Brad.

And your next question is from Woody Lay of KBW. Your line is now open.

Hey, good morning, guys. Good morning, Woody. So as you mentioned, you know, you've done a really great job on the fee income side, thrives in the numbers and North Avenues. closing in November. I guess my question is just longer term in an ideal world, where would you like, you know, fees to revenue to ultimately represent, like the 25% range or maybe even above that? Go ahead, Jerry.

Yeah, we're kind of focused on getting to 25. We've made good progress. I mean, as a management team, we sat here just over 12 months ago, and we were about 10th. And this quarter we were at 16 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, you know, would we be happy over 25? Yes. But, you know, 25 is a good place to get to. And the thing I would remind all investors and analysts 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. about to be in starting next Monday. 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 25 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 wanted to take this opportunity to remind everybody it's a lumpy business and – 2025, I think we'd be really, really happy. I think that the revenue diversification, including one very counter-cyclical investment in Thrive, we have a much more diversified and stable earnings picture from that, stable revenue picture from that. So there you go.

Yeah, that's good color. And then Related to asset sensitivity, at least based on the ALCO disclosures, it came down a touch quarter over quarter. Is there any color you could give just surrounding that decrease?

Yeah. I mean, you know, 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 lessened our asset sensitivity, I certainly liked what it did to net interest income and the NIMS. So we'll make that trade. I think that, you know, I think the important thing is that the table to the 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 breached, so almost 90% of our loans will reprice when the Fed starts to move. So, you know, I'm encouraged by that, given that we're two-thirds floating or thereabout. So, you know, I hope that helps.

Yeah, and then last for me, it was just nice to see the level of buybacks in the quarter. Was the buyback this quarter 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?

Well, we've always said that we want that to be one of the tools in our toolbox and that we're going to be opportunistic. And when there's weakness in the stock, you know, we like – we certainly – like taking advantage of that. I don't expect us at these valuation levels, don't expect much from us in the buyback. But if you go back to when we started this post-green acquisition, our average purchase price per share has been $25.27. And we've bought back 6.6 million shares. So, you know, I know that's in different valuation environments 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 is going to depend on how the market's valuing the currency, and I wouldn't expect us to be as active going forward.

Yep, that makes sense. All right, thanks, guys. Thanks, Woody.

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.