Veritex Holdings, Inc.

Good day and welcome to the Veritex Holdings Fourth Quarter 2022 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. Please note, this event will be recorded. I will now turn the conference over to Ms. Susan Cottle, 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 are 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.

Thank you, Susan. Good morning, everyone, and welcome to our fourth quarter earnings call. Today, we want to focus on our fourth quarter results as well as our 2022 year-end results. For the quarter reported operating earnings of $0.74 per share, or $40 million, And for the year, $2.74 per share or $147.9 million. Pre-tax, pre-provision returns were 2.15% for 4Q and 1.97% for the year. Year-over-year metrics continue to perform at levels with ROAA at 1.35%, TBV increase over the year of 6.6%, ROTCE of 16%, and efficiency ratio at 48%. The quarter did have a few items of note, which Jerry will give you additional detail on momentarily. Loan growth, less mortgage warehouse, continues to temper, trending down since 2Q to 25% for the quarter end and 34% for the year. It is clear that loan growth in 2023 will be much lower than in 2022 with our current pipelines down over 76%. We continue to think 2023 loan growth will be in the low double digits, primarily consisting of a to-be-funded construction book. The market is certainly slowing down as the borrowers are uncertain of a looming recession in the interest rate forecast. They have done a good job of self-policing their credit requirements. Payoffs for the quarter remain fairly consistent with previous quarters at $400 million, but we do feel this level of payoffs will continue to decline in the coming quarters. Overall credit trends are moving negatively as we are seeing signs of a slower economy with the rising rates creating some level of stress. We did record a $5 million C&I charge-off of an acquired credit that we've been monitoring for several months. This loan is now fully extinguished. Our total provision of $11.8 million for the quarter accounts for the charge-off, growth and keeps our ACL at 1.01% of loans. NPAs to assets did increase 10 bps but still remain at an acceptable level of 0.36%. Deposit growth continues to be our greatest focus and with most banks our greatest challenge. Our deposits did grow during the fourth quarter 17% annualized and shows our commitment and dedicated strategy to growing deposits at the same rate as our loans grow. We are investing process, people, and technology while making Core Deposit Gathering our top strategic initiative. I'll now turn the call over to Terry.

Thank you, Malcolm. Starting on page five, Q4 was a challenging quarter on several fronts and would have been a lot better without the loss from Thrive and the charge off on the acquired credit that Malcolm referenced earlier. The financial metrics around ROAA efficiency and ROTCE are still very acceptable. Tangible book value per share ended the year up 18.64%, 5.2% for the quarter, and 11% for the year after adding back the effect of our dividend. As you look at the financial results on a year-over-year basis, remember to factor in the capital raised in the first quarter, where we issued approximately 4.3 million common shares and raised 154 million in common equity. Given the current economic outlook, we are pleased to have achieved such a favorable result for the bank. The capital raise certainly weighed on the year-over-year performance in EPS and return on tangible common equity. Additionally, 2021 was a very favorable credit year, as we did need to provide for growth given the reserves established during the pandemic. Finally, in 2021, we also had over $9 million in PPP fees that did not reoccur in 2022. On slide 9, loan production declined 35% from Q3 to Q4. As interest rates continued to increase, economic uncertainty rose and liquidity became more of a concern. With the termination of the interlink deal late in Q3, our focus shifted to growing our deposit portfolio through greater emphasis on CNI and a lower appetite for ADC and CRE. Unfunded ADC construction continues to drop at the rate of $300 to $400 million per quarter. On slide 10, you see the evidence of the greater emphasis on CNI. During the fourth quarter, the CNI accounted for 41% of our production, up from 30% in Q3. On to page 11. That interest income increased by 5.1 million, or just over 5%, to 106.1 million in Q4. The two biggest items in the increase are the Fed raising short-term interest rates, which represents 4.2 million of the increase, and growth, which also accounted for about $700.7 million. The net interest margin increased 10 basis points from Q3 to 3.87%. The margin for the month of December was 3.93%. The Q4 NIM was negatively impacted by interest reversals on problem credits and intense deposit rate competition in our primary markets of DFW and Houston. This competition for deposit volume at a reasonable price is not just limited to other financial institutions. For the first time in my career, banks are competing directly with the U.S. Treasury. At the close yesterday, three-month T-bills were paying 4.7%, creating significant rate and volume pressure on the banking system. All this to say, NIMS are likely at or very near their peak. As the Fed pauses, deposit betas are going to catch up, making growth in net interest income harder to achieve. Veritex asset sensitivity is largely unchanged from Q3. We've been intentionally hedging floating rate loans to mitigate falling short rates out through 2026. On slide 12, please note that during Q4, our loan yield was up 97 basis points to 5.98%, while deposits increased 70 basis points. Q4 loan originations were 93% floating, and these floating rate loans carrying an interest rate at quarter end of 7.19%, so thankful to have a predominantly floating rate loan book to offset the deposit beta impact. Slide 13, a productive quarter on the deposit front with growth of 375 million and a 16% CAGR since the beginning of 2020. Our cycle to date, the total deposit beta is approximately 30% as total deposit rates have increased 119 basis points and the average fed funds effective rate has moved 353 basis points. We've seen the deposit mix start to change during Q4, with DDA declining 6% and time deposits growing 25%. On slide 14, non-interest income increased by 1.2 million to 14.3 million. Great performance in the USDA business was largely offset by an increased loss at Thrive and lower swap revenue. We'll come back with additional comments on USDA and Thrive in just a minute. Non-interest expense, including severance costs, increased 6.1 million to 56.7 million, reflecting the investments in talent we have discussed for many quarters. Salaries were up 1.7 million, and variable comp was up the same. A meaningful part of the variable comp increase is due to the exceptional fee performance at North Avenue Capital during the fourth quarter. The rest of the expense increases reflect inflationary pressure and is spread across the other categories. Even though operating expenses are up, the efficiency ratio remains strong in the 47% range. Looking forward, the pace of hiring is slowing. This seems prudent as loan production and growth slow in 2023. Slower loan growth will translate into stronger capital ratios and less funding pressure. Turning to slide 15. As I noted earlier, Q4 was a great quarter for NAC. With $75 million in USDA loans closed, and additionally for the full year in 22, we closed $117 million. We entered 2023 with positive momentum, premiums looking pretty well, and our pipeline is full. Our SBA business continues to strengthen as new leadership and recent hires gain traction. We closed almost $40 million in SBA volume in 2022. including 16 million in Q4. The pipeline is up 46% since the end of the third quarter. Gain on sale premiums in the SBA business are stronger than a quarter ago, but much weaker than the USDA side. Moving to Thrive. Veritex recorded an equity method loss of over $5 million. Its funded volume decreased to almost 415 million, but gain on sale margins collapsed to 1.89% due to rising rates, significant rate volatility, and the impact of long-dated rate locks. Given these results in Q4, they stopped issuing mortgage rate locks longer than 90 days and initiated an effort to right-size the expense structure of the company, given forecasted 2023 volume. We expect both actions to meaningfully improve Thrive's financial performance. On slide 16, total capital grew approximately $41 million during the quarter and $296 million during 2022. to end the year at 1.4 billion. CET1 ratios have expanded by 51 basis points year over year. Looking forward on capital, we believe that moderating loan growth and lower unfunded commitments coupled with higher earnings from rising rates should allow us to achieve our CET1 target of 10% by the end of 2023. With that, I'd like to turn the call over to Clay for some comments on credit.

Thank you, Terry, and good morning, everyone. Moving to page 17, you can see an increase in criticized assets during the quarter that's driven by our quarterly review process for credit. The largest change during the quarter was driven by a move to special mention of a customer in our note finance business that has experienced negative earnings but continues to maintain good liquidity and capitalization. We downgraded three office properties during the quarter that have demonstrated underperformance. Surveillance is the word of the year for credit team. As Malcolm mentioned, we had an uptick in MPAs during the quarter. That was driven by a downgrade in a PCD pool of loans to non-accrual status. A single credit that made up 95% of the outstanding balance of one of our PCD pools was posted for foreclosure. Because the pool is a unit of accounting for these acquired loans, they all must be graded the same. Our ACL for the quarter grew by $6 million, mostly due to the change in Moody's projections for Texas unemployment and GDP, which accounted for $5.2 million of the increase. Growth in loans accounted for an additional $6.3 million of the bill, offset by charge-offs. During the quarter, we had a bulge in past dues in the 30-60 day range. Most of the increase was created primarily by administrative past dues caused by the end-of-year season delays. 10.2 million of the bulge was cleared in early January. Turning to charge-offs, during the quarter, we experienced an unexpected deterioration in an acquired $5.2 million commercial credit in the power generation space. During the quarter, the borrower became unresponsive and missed several established milestones. that led us to question the viability of the borrower, given the fact that we acted quickly to remove the credit from the books and will treat any collection proceeds as a recovery in future quarters. With that, I'll turn it back over to Malcolm.

Thank you, Clay. As we look into 2023, I think we all have some level of economic uncertainty on our minds. I assure you Veritex is well positioned and remains confident in a positive 2023 performance. With that, we'll be happy to answer any questions. Operator?

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again.

Our first question comes from Brady Gailey with KBW.

You may proceed.

Hey, thank you. Good morning, guys. Hey, Brady.

Hi, Brady.

I wanted to start with your outlook for the net interest margin and the bottom right corner of slide 11, where you talk about your interest rate sensitivity. You have, you know, base case interest rate scenario, and that kind of points to a 368 net interest margin. And, you know, you just said you did like a 393 in December scenario. So I'm trying to reconcile those two numbers. But just some color on the net interest margin and how you think that'll trend in 2023.

Well, I think, you know, as I said, I think net interest margins at or near their peak, if they haven't peaked. Our personal, you know, our view is that, you know, look, we did 106 in net interest income in Q4, and that model shows the base case on the static balance sheet with, you know, 420. So that tells you that even with growth, growing net interest income is really not very possible. In the large view, it's not because of where rates are going from here. It's deposit funding cost pressures. So, you know, I said it's going to be hard to grow net interest income with deposit betas. And so, that's how, you know, that's how we get to a view that NIMS will, it'll be difficult to grow net interest income. NIMS will be under pressure downward likely throughout the year.

Okay.

And just to make sure. Q1 could be flat. But I think it might also be down. It's really, Brady, it's so hard to predict. I've never seen deposit pricing competition like this. And anyone who doesn't believe the U.S. Treasury is our primary competitor is kind of... Head in the sand. Yeah, got your head in the sand.

And just make sure I'm hearing you right. It's hard to grow NII dollars, even including low double-digit. loan growth or is that excluding the loan growth for the year?

I mean, it's a static balance sheet. So it doesn't include what if you just took this balance sheet and roll it forward with a rate shock, knowing what's going to happen to deposit betas. I'm just saying I'm not I'm not I actually think we can grow net interest income next next year because of the loan growth we've been talking about low double digits. It's going to but it's just going to be harder. You're not going to get the same level the same amount of leverage from loan growth in 23 that you've been getting because of the deposit pricing pressures.

All right. That's that's helpful. Then next on expenses, it feels like you got you guys are still hiring and your expenses came a little higher than my estimates. Any color on what you're investing in and how we should think about expenses in 2023?

Yeah, let me just address the hiring piece of it. You know, we still have some replacements that we're working through. There are a couple of key positions that we still are looking at. But I would say most of them are going to be focused on the deposit generation side. Almost all of them would be, actually. We do have an internal audit program that we're going to put in place in 2023. Again, that's growing over $10 billion. uh, size deal, but, uh, the hiring is not going to be, uh, as it's been in the past two or three years, but there are a couple of replacements, um, areas that we have, uh, Kara was telling me yesterday, I think our, our, our total is down less than 50, 60% from where it was in terms of the amount of people. Um, but I don't think that's going to drive a huge, um, increase in where we are from the expense base right now. Do you want to talk about expenses, Terry?

Well, I mean, I think, you know, I think, I mean, inflation is real. Surprise, surprise. I also, in addition to, I don't see the net ads, like Malcolm's saying, the net ads to FTEs are not going to be that great going through 23. We just, we can't do that. But one thing we're going to spend more money on is marketing dollars on the deposit side. You know, we're staffing up that area, and we're going to put way more dollars focused that way to help build this deposit base in a more significant, more granular way. So I think expenses, you know, are probably, if you annualize Q4, and add a little, you're probably about in the right place.

I'll just say this too, Brady. One of the phenomenons where, as I look back on 2022, you could arguably say we bought a $2 billion bank in 2022. I mean, we grew $2 billion. And part of that was, I think our expenses on the comp side were a little, on the salary side, were a little low in the third quarter. We had some people moving out. We had some new people coming in in late 3Q and 4Q. It just kind of all caught up to us. And so we look hard at the efficiency ratio, which has remained stable despite this spike in increases on the expense side. And so I think we're just settling into a new expense level with adding $2 billion in assets over the last year. Let me add to that.

I mean, year over year, total assets, not average assets, year over year are grouped grew, you know, one point, on the average, $1.6 billion. And from Q4 to Q4, they grew over, they grew right at $2 billion. And yet for the year, NIE to average assets is only up five bips, 178 to 183, you know, for the year. And so Malcolm's right. We grew a $2 billion bank. And our NIE to average assets, while up five bips, It's been one heck of an inflationary period.

And then finally for me, a lot of volatility with the USDA fees having a great quarter but then Thrive not having a great quarter. I know it's hard to look at those two on an ongoing basis, but any idea about the forecast for those two volatile line items?

You know, I tried to say it in my comments, which is Thrive is making pretty, not pretty, very significant expense changes. And while their gain on sale margin for the fourth quarter was 183, I think it was 189. The year was 335. Okay. So, if I can just, by stopping the long-dated locks, letting the gain on sale margin revert to where they've historically been, deal with their expense cuts, you should see much better financial performance out of Thrive. NAC, we, you know, I mean, you see their pipeline, you see their quarter, you can tell that, you know, if we close 75 million in the fourth quarter and only 117 for the year, I mean, we've got, some of that's pent up demand after Q2 and Q3, and the USDA really came through for us. But we're pretty, we feel good about 23 in NAC.

All right, great. Thanks, guys.

I can't answer your question, but that's as good as I can do.

I hear you. All right. Thank you.

Thank you. One moment for questions. Our next question comes from Gary Tenner with DA Davidson. You may proceed.

Thanks, guys. Good morning. Good morning. Terry, just to kind of start on your recent comment on the expense line, kind of annualizing the fourth quarter and adding a little bit, as you said, in 2023. You know, I think last quarter you talked about kind of high single-digit growth in 2023. You know, that comment you just made sounds like you're more kind of mid- to high-teens expense growth. Is that what you kind of intended to suggest in your comment?

Well, you know, I'd say high single digits over the four years. High single, low double digits over the full year 2021 is more what I'm thinking right now. But certainly, look, I was surprised by Q4. Just that, you know, it was all across the board. So I'm not trying to, you know, go as high as maybe it seems. So let me, I hope I cleared that up. More high single, low double from 2022 levels.

Okay, thank you. And then also on Thrive, I mean, based on your comments you just made, is there visibility, to the degree there's visibility in mortgage at all, is there visibility in 22 based on, or in 23 based on what you were talking about on the expense side to where at least Thrive would be a break-even

scenario in 2023 to where it's not a headwind for for vbtx uh absolutely that's you know it's look we've spent a lot of time over the last 60 days talking to the some of the best people in the industry and what the success for thrive look like in 23 and it's exactly what you just said it's kind of where the industry is based on all the feedback we can get and and they have they have

put together a clear roadmap to get there. It's not a hope and a prayer. They're making appropriate expense reductions. Candidly, they have some really nice volume. They did a small acquisition at the end of the year that was not very costly that helped on the volume side. And so we feel pretty darn confident in a breakeven year for Thrive.

Okay, great. And then last for me, just on the deposit side and the growth there, I think last quarter you talked about probably utilizing some more in the way of brokered time deposits in the fourth quarter. I didn't see it called out anywhere. I wonder if you could kind of talk about what your activity was on that side of things in the fourth quarter.

Like I've seen many peers report, the brokered side was very meaningful in the fourth quarter. uh you know we still grew absent brokered we still grew we still grew we still grew four or five percent i haven't done the math and i'm doing it my head i'm somewhere out on the link quarter annualized absent brokered but so that kind of that kind of tells you that that yeah that's the right number four to five and if we did 17 that tells you where the rest thought it was okay so can you talk at all about how you kind of laddered those out in terms of maturities We are, from an interest rate risk, I would like to keep them under 12 months. From just thinking about the overall balance sheet and how we balance out liquidity, we're going out 18 to 24 with some. So I'd say it's skewed to 12 months and under, but there is some that we're doing that's a little bit longer. I don't want to go real long because, you know, and customers are – way more frequently asking for longer-term CDs, and that's just not where we're pricing aggressively or as aggressively. We're trying to keep everything, you know, 12, 15, 18 months and in. All right, guys. Thank you. Thanks, Peter.

Thank you. One moment for questions. Our next question comes from Brett Rabitin with Hubby Group. You may proceed.

Hey, guys. Good morning. Morning, Brett. Hey, Brett. Wanted to circle back on credit and just a few pieces to it and just make sure I understood the – I know you guys make downgrades pretty quick and you're aggressive with that, but just the The three office properties, can you maybe talk about that and what you've done, taking a look at your commercial real estate portfolio and maybe what led to those downgrades?

Yeah, so that's a great question, Brad. Thanks for the question. We did a deep office dive during the quarter that we looked at every loan over a million dollars in the book. And, you know, just to make sure that we, you know, appropriately had everything graded and were addressing anything that we saw that had any weakness in the deal. So we looked at every credit over a million dollars in that portfolio, and that's just part of our surveillance process for the entire year.

So any call or what specifically led to the downgrade of those three credits?

Loss of tenants. and then one has just been a historical problem asset that came out of the PCD acquisition of Green Bank that has been, had some damage to it from Hurricane Harvey that has never really recovered from that. So.

Okay. So, it sounds like it's a, it's a, Instead of an LTV, it's basically a cash flow perspective, and they're having issues with, you know. Do you guys have any color on how much Class B office space you might have kind of inside the loop? Inside which loop? Houston specifically.

None that I'm aware of. We have no CBZ office space. exposure uh class b in general that makes up 33 of our office book today um 62 of our office book is in class a which is encouraging to me because that's that's where we'll i think we'll see the least amount of stress okay and were these three sorry for so many questions on this but were these three credits you know the bulk or are all of the increasing criticized assets one quarter No, that's not all of them. The largest one that I discussed within our note finance group, a move to special mention of one of those borrowers, that's actually the largest. Office was second. And then, yeah, so those are the two largest areas of downgrade here in the quarter.

Okay. And then back on deposits for a second, you know, obviously you funded the balance sheet in the fourth quarter with CDs. And, you know, last year, you know, there were some various efforts to find alternative sources to grow funding that would, you know, maybe be market oriented, but maybe not be CDs. Given the environment, you know, and Terry, you guys found a little shell shocked with just the competition from the treasury market, you know, has your view changed or could you maybe pivot to a different strategy in terms of, you know, looking for alternative sources to grow deposits, whether it be, you know, FinTech or other sources that might not entail CD funding?

Yeah, I mean, to answer your question, strategy hasn't changed. It's just ramped up. As I think we said in the third quarter, that this was a multi-year strategy. Candidly, we just hired one of our lead guys. They just started this week. We hired a consultant in the fourth quarter, and he's now producing some really good work. There is no magic pill or magic vertical that's going to solve this funding problem. It's about six, seven, and maybe eight different things. And we're pulling every single one of those levers. And I think you're starting to see some movement. You can see back, you know, we did grow deposits. I know the industry shrank, but we did grow deposits, albeit not what we wanted to. But some of our efforts, a lot of our efforts are moving in a very positive direction. It's just going to take some time. And so as when Terry talks about short-term funding in these CDs, these are, we're hoping these are gap fillers. as we continue to be successful in our strategy. The FinTech piece specifically, I mean, when we talked about hires, there's a couple of hires that we're making in that area. We have a specific group. They have some opportunities as of this week that are going to be nice funding opportunities for us. So we continue on that strategy. We haven't diverted off of it. We think it's the right one. It's just going to take a little bit more time.

And Brett, there are meaningful opportunities there, but they are going to be high beta. But if you're thinking about rates down, that's not a bad thing.

Okay. And maybe just one last follow-up on that. You know, as we think about betas, as you just mentioned, you know, do you guys feel like you took – what percentage of the pain do you guys think maybe you took in the fourth quarter versus where you might have to get to in terms of the relative – Treasury curve.

Say that one more time. You broke up a little bit.

Oh, sorry. So just, you know, just looking at the slide on deposit growth, you know, and the deck and showing rates and average Fed funds effective. And, you know, there's an obvious upward movement in 3Q and then in 4Q, your interest bearing rates and your total deposit rate accelerated 3Q to 4Q. And, you know, I don't know if it has to go to the effective Fed funds rate, but do you feel like you've taken, you know, a meaningful portion of the hit that you need to in terms of deposit pricing pressure?

I think it's still coming just because I think you've got time deposits, you've got money market customers that you're going to, You're going to fight hand-to-hand combat to retain these customers, these relationships, and these dollars. And I think, you know, I think the deposit beta, you know, pricing on the margin every day gets more aggressive is what I would tell you. It's just the way the environment is. And so I don't. I just don't expect this deposit beta thing. We're nowhere near its peak. Okay. Look, if the Fed got another 50 or another 75, you know, somewhere in there, I would say, and then they're going to hang out there, it seems like, for the balance of the year. And that's why I think there's going to be NIM pressure as we get maybe in Q1, but certainly as we get later in the year. Okay.

Thanks for the call, Eric.

All right. Thanks, Brett.

Thank you.

Thank you. One moment for questions. Our next question comes from Michael Rose with Raymond James. You may proceed.

Hey, good morning, guys. Most of my questions have been kind of asked and answered, but just on credit, you know, you guys are sounding a pretty cautious tone. I think that's, you know, your conservative nature, but You know, the loan loss reserve was only up a basis point despite the increase in, you know, criticized classified. You know, why not, you know, just build that a little bit more now, just given the cautious tone? And, you know, would you expect to see that ratio build as we move through the year? Thanks.

I mean, we'd expect to see it build. But, you know, we do have, you know, CECL is a pretty constraining metric. And there's a lot that goes into it, as you well know. And so it's not, you know, we can't tweak here and tweak there. Candidly, we've done a fair amount in changing, you know, our weightings on some of the possibilities that could happen. You know, we haven't messed with our Q factors. And so we work pretty hard to keep it at those levels because the model just spits out a much lower number sometimes. And so it's going to be difficult, but, you know, certainly our desire is to have a little bit more in there. And going forward, yeah, we hope to accomplish it, but we're not certain.

Let me just add to that, which is year over year, our allowance to loans went down from 115 to 104. But our general reserve excluding specifics went up from 82 BIPs to 90. And I would expect that trend to continue. Does that make sense, Michael? Yep.

Got it. And then maybe just back to Thrive. Obviously, the outlook, just looking at the NBA forecaster, you know, down a significant amount in 23. You know, obviously, this is a tough quarter. I understand they're making, you know, expense structure changes, you know, kind of et cetera. But do you actually expect that you can actually earn money from the investment this year?

No, I would go back. I mean, I think success, I mean, is it possible? Yes. And success would be a positive number. I think target is to break even. And look, the only reason this option is available to them is this small acquisition Malcolm referenced that brought on $3 billion in volume at good margins. The margin was 333 for the year where they've had, significant expense cuts. They've been able to strip out close to 60% of the cost to the company, but bring the volume onto their platform. And so that's what, without that and without fixing the long-dated locks and right-sizing the expense structure of Legacy Thrive, and do I think that was, do I think breakeven or better is achievable? No. But that's where we stand heading into 2023. And December was a good month. They closed 567 units in December, which was above their average for last year. And always remember, between 65% and 70% of their business is in Texas. The three key markets is DFW, Houston, San Antonio. And that's why... It's encouraging, and I've already seen that, you know, I've seen the result. I know what the results were for December, obviously. And so that's what tells me that this idea about where we can get, where drives can go is you can see it from here, from the December results.

All right, helpful. And then just finally for me, you know, stock trading about 1.5 times tangible. You noted earlier that you expect capital to grow as kind of loan growth and balance sheet growth slows. Any thoughts around a buyback at this point and. You know what what you could do there? Thanks.

You know, I think that's something we, we think about. In the back half of 2023, when the recession outlook is clear. Credit is the situation is clear. And capital has built close to this 10% if it's at 10% or better and. uh credit the recession looks mild and and credit looks fine it's something we'll think about but i mean it's not that we don't like the evaluation i just don't think now is the time to be right now especially in the first half of the year that's just it's just not the time to be looking at it i just wouldn't rule it out for the back half but right now we have no plans in the back half it's just something that we could get to if everything goes as planned understood appreciate all the color guys thanks thanks michael

Thank you. One moment for questions.

Our next question comes from Brad Millsaps with Piper Sandler.

You may proceed.

Hey, good morning, guys. Good morning, Brad. You've addressed most everything, just a couple maybe housekeeping questions. Terry, I apologize if I missed it, but what was the spot rate for the loan portfolio at the end of the year? i didn't bring that number with me okay no no we can we can follow up later uh i may have it before the end of the call if i do i'll just say it say it but um and then okay and then just curious uh you mentioned the increase in expenses some it was somewhat tied to the to the big quarter you had at nac um just kind of curious is that you know um trying to think about those numbers going forward is, you know, is that kind of a 40% or 50% payout on that revenue? Is that how to think about it? Or is it some, you know, just wanted to see how much of it was actually tied to the good USDA performance?

No, it's not. No, it's not nearly that much. It's, you know, in the low double digits. But it's, you know, it meaningfully moved the variable comp. And that's just the competitive, you know, given the gain wholesale premiums and dollars in that space right now, that's just market if you want to attract the really good producers, and we have some. Got it. And then the 1231 end of year loan rate is 636.

And that's loans held for investment?

Yes.

Okay. And then would... I've noticed the securities yield was up quite a bit as well. Any kind of one-timers in there? Is that just lower yielding stuff rolling off and just a general improvement? I'm sorry.

One more time, Brad. You broke up just a smid.

Yeah, I apologize. The securities portfolio yield was also up quite a bit. Just kind of curious if there's anything in there that would be one-time in nature or if that's just...

Okay. That's it. And also, that rate I gave you does not include mortgage warehouse.

Okay.

But mortgage warehouse rates, they're not materially different, to be honest with you. They are definitely in the 60s, but that rate just excluded them.

Okay, great. And then final, bigger picture question. You know, you guys do a lot of construction. Some of these projects are coming to an end. Can you talk about the environment for, you know, other folks providing, you know, permanent financing? Are you guys doing that in some cases? I know you're pretty tapped out on CRE, but just curious, you know, kind of what the environment is out there for, you know, some of these construction projects, you know, finding a new home once they are completed.

Yeah, I mean, there's still commerce going on. especially in our specific markets. You know, you read the paper every day about a new industrial, I read one this morning, a huge industrial deal was just sold because Nike became the tenant there. And so people are still selling industrial. The cap rate certainly has increased a bit, but there is absolute commerce going on. I think in the fourth quarter, we sold or paid off about 400 million. Half of that was about, was a CRE projects just, We do see that slowing down, but in terms of us doing more term, we haven't really seen the requests come in. A lot of this stuff is coming out of the REITs and the bigger fund-type people that are buying this stuff because they're quality assets, mainly multi-industrial. But we haven't seen it slow down, but we are certainly anticipating it slowing down.

And the agency CMBS is a much more viable outlet than it has been. You can get 10-year fixed rate in the 570, 575 range. Also, I mean, I did a big payoff yesterday in Craig Davis' portfolio in Fort Worth, about $25 million. I mean, I just saw it this morning. But they're going to slow, but, you know, there's viable ways, and then there is a lot of commerce going on.

Okay, great. Thank you, guys.

Thanks, Brent. Thanks, Brent.

Thank you. One moment for questions. Our next question comes from Matt Olney with Stevens. You may proceed.

Hey, thanks. Good morning, guys. Hey, Matt. I want to go back to the credit discussion. And I think Clay referenced a note financing as one of the primary sources of the downgrades in the fourth quarter. Just remind me exactly what it is you're financing in these types of loans and what was the size of the specific credit that was downgraded in the fourth quarter?

So, thanks, Matt. You know, it's very, very granular exposure. It's financing, this particular borrower is financing small fix and flip single family residences. So, that is, yeah. give you some color on the actual, what we're talking about there. The overall no finance portfolio is made up of a broad, uh, categories, you know, touching various product types, but this particular bar is very granular exposure in the single family space. Um, and then the size of that was the total commitments on a hundred million dollar facility.

And if I remember correctly, this is something you guys have been doing for, for several years.

Yes, yes, we have the experience and broad experience in that space.

Okay, and so I guess, let me think about the risk here of these types of loans. Is it more, sounds like it's more residential, single family in the metro Texas markets?

Yes, I mean, yeah, the risk is that, you know, you know, slow in that space, which, you know.

And everyone's got to do it. You have hundreds of borrowers, very, very granular, and we're financing a percentage of what they finance. So it's a, you know, it's a 65%, 70% advance on an already 80%, 75%, 80% advance. So collateral values are way down there. The reason that one hit there was that they had an operating loss, but remained heavy on cash and very strong on capital. This is a very strong company, but we think it's – we're quick to put stuff on special mention when they need to be, and when they showed the loss, that's why they ended up there. We don't have any – we're not – There's not much anxiety on our side that we'd ever get to the collateral. This is a very, very strong company.

Okay, great. Appreciate the color there. And then I guess shifting back on deposits, I think the average non-interest-bearing deposits were down quite a bit in the fourth quarter, and we're seeing this across the industry with all your peers and I guess the message we're getting from others is there could be more headwinds there in the first half of the year from the NIBs. I'm curious kind of what your expectations are of the outflows there for the bank and what do you think those could stabilize?

Well, I think the outlook you just described is accurate. I think it's going to continue to trend down. I mean, customers are as aware as I've ever seen of rates, and there's so much incentive to aggressively manage liquidity. you know, I don't think that, I don't think we have found, we're at the end of that next shift going on, but I think that's why the whole importance of our C&I business, and we've been investing in that heavily over the last year. You see it in the production side, and it's our community and our C&I that are going to help us stabilize and get the deposit growth going. And, you know, even, you know, and they had good years, they had good quarters, but it's just, and especially in community and commercial, it's just a harder time.

Yep. Okay. Thanks for that, Terry. And then thinking about funding securities portfolio, any material cash flows coming off that in 23 that could help kind of fund the loan growth here?

Well, I mean, I think if here's what I would say, if you look at the loan growth minus the loan growth was 445, 445 million, roughly deposit growth with 375, the difference between those two, and we only borrowed 25 million from the FHLB. So we funded $45 million of loan growth from the securities books and earnings, you know, that $50 million a quarter type should continue. Is that, is that helpful? I mean, there's going to be, it's going to be, you know, 100 to 120 million for the year in terms of cash flow projected to come off on the base case of rates. And so, you know, so it's going to continue to meaningfully help us and earnings as well.

Yep. Okay. Thanks, guys. Appreciate it.

Thank you.

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