Veritex Holdings, Inc.

Good morning and welcome to the Veritex Holdings Third Quarter 2023 Earnings Conference Call-In Webcast. All participants are in 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 of 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'll now turn the call over to Malcolm.

Good morning and welcome to our third quarter earnings call. We certainly find ourselves in challenging days in our industries and markets, but we here at Veritex continue to focus on building long-term value for our shareholders. Q3 was a transformational quarter for Veritex in many areas. First, I'd like to formally welcome Dominic Carrava as our new president and chief banking officer. Tom's a 28-year banking veteran with a majority of his experience in leading and developing teams in a commercial bank space. Even though he's only been here for six weeks, he's already making a difference at our company. I look forward to you all meeting him soon. Second, I want to talk about our continued commitment and efforts to reposition and strengthen the Veritex balance sheet. Over one year ago, our team stacked hands to build a stronger balance sheet that could withstand all economic environments. We've always been a very profitable bank, shown by our historical PPNR, ROAA, and efficiency ratios, but our balance sheet did not project the strength that is highly valued. Let me discuss four balance sheet ratios we've been keenly focused on. Loan-to-deposit, dependence of wholesale funding, CET1, and our real estate loan bucket concentrations. I'd like to remind you, these efforts were not as a result of March 8th SVB crisis. These efforts have been our major focus and strategy for the last four quarters. I'm happy to say we're making progress, candidly, much quicker than we planned. Our loan deposit ratios come down from a high of 108 at 331 to 95 at 930. Our dependence of wholesale funding has come down from 32% at 331 to 21 at 930. Our CET1 now exceeds 10%. Our CRE portfolio continues to decline despite continued ADC fundings of approximately 400 million a quarter. Total CRE to risk-based capital has declined from 335 on 331 to 317 at quarter end. ADC has declined from 129 to 116 during those same dates. All of this positive momentum towards a stronger balance sheet takes the work and effort of our entire bank. It requires a mindset change to add full client relationships, not just borrowers. It requires disciplined efforts on the deposit gathering space that comes in many forms. Better client selections. Digital banking, direct marketing, MSRs, HOAs, family and friends promotions, commercial and community bank focus, etc., etc. It takes everyone working together with a common goal. That's how we've increased our deposit balances over $1 billion since 12-31-22. I couldn't be prouder of our company and teams to embrace the changes we all felt had to happen. There is still much to do and much to accomplish. With all the great progress on the balance sheet, we understand that in these cycles, earnings will be under pressure. For the third quarter, we reported net operating income of 32.6 million, or 60 cents per share. Our pre-tax provision income for the quarter was $50 million, or 1.62%. Terry will provide some details shortly, but the main three drivers of our slight earnings decline were NIM pressure, continued lack of government loan fees, and increase in operating expenses. In these cycles, loan growth and credit are always at the top of everyone's mind and concerns. For the quarter, loans decreased and are only up $137 million, or 1.4% for the first nine months of the year. We've been able to do this with a focused effort on pruning away loan-only clients and payoffs. mainly from the CRE sales, mainly from CRE sales transactions. NPAs for the quarter did increase 11.5 million to 80 million or 0.65% of assets. This increase was solely from a C&I shared national credit that Clay will discuss shortly. Net charge-offs were minimal at 8 bps. We also increased our ACL from 105 at 630 to 114. Looking forward, our growth profile for 2024 will continue being below the middle single digits. Our pipelines are off over 80%, and candidly, the demand from our clients have been muted. In our opinion, this will continue until some economic and rate certainty is established. I'll now turn the call over to Terry. Thank you. Malcolm has covered the progress we've made in strengthening our balance sheet. I think it is fair to say that we've made more progress and in a quicker timeframe than I ever expected. I want to spend some time drilling into the results for the third quarter and the year-to-date numbers. I think this is important because some of our businesses are seasonal, and we think about them on an annual basis and not just quarterly. Starting on page four, Malcolm mentioned operating earnings were at 60 cents a share. This is down slightly to 32.6 million. Tangible book value per share was also up slightly to $19.44. even with rising rates impacting accumulated other comprehensive income, AOCI, by approximately 45 cents per share. Focusing on year-to-date results, pre-tax, pre-provision operating earnings increased 14% from 2022 to almost $175 million. Pre-tax, pre-provision return on average assets is flat year-over-year at 190 basis points. Veritex continues to be one of the more profitable banks among its peer group. Consistent with our intent to strengthen our balance sheet, we've only grown loans $615 billion in the last year, while growing deposits $1.4 billion on a year-over-year basis. Year-to-date annualized charge-offs have been 20 basis points. Finally, we've grown CET1, about 102 basis points over the last four quarters, to 10.11%. We achieved this target of being over 10% one quarter earlier than forecast. Moving to slide five, Veritex made meaningful progress improving its liquidity and funding profile over the third quarter. Since June 30th, Veritex has grown deposits by $963 million, and only $192 million of that was in the growth category. The deposit growth, coupled with some reduction in earning assets, allowed us to reduce federal home loan bank borrowings by over $1.1 billion. As we've said before, Veritex shifted its focus to the right side of the balance sheet late in Q3 of 2022. We started slowing loan growth. We shifted our loan production focus away from commercial real estate and ADC to C&I and small business. We changed our banker incentive program at the beginning of 2023 to give deposits a higher weight. We reallocated marketing spend to deposit products and launched a multi-wave direct marketing campaign in February. Additionally, our digital bank, which we started in the second quarter, is having a meaningful impact on our deposit growth. Success on the deposit front for Veritex has three components, growing deposits, increasing our client acquisition rate, and increasing net client growth. I'm pleased to note that our net client acquisition rate in the third quarter was a little more than double what we saw in the first half of the year. Similarly, our net client growth in the third quarter was up more than four times over the levels we had experienced in the first half of the year. The effect of the Fed's interest rate hikes on deposit mix stabilized in the second quarter, and our non-interest-bearing deposits to total deposits remained in the 23% to 24% range. Deposit price competition continues to be intense, resulting in a total deposit rate of approximately 57%. Finally, uninsured and uncollateralized deposits are at 31.5% in total, and our liquidity capacity is 2x of the uninsured deposits. In thinking about the loan portfolio, the shift away from ADC is showing progress. Our concentration level in Cree moved down during the quarter, and the goal is to continue to move these levels down below the regulatory guidelines. The payoffs in the Cree portfolio remain strong. It should range between $800 and $900 million for 2023. A sure sign of strength in the Texas economy. Unfunded ADC commitments continue to drop at the rate of $300 to $400 million per quarter and are now well below total capital. Looking forward into 2024, we forecast ADC fundings to decline by 75% as compared to 2023. On slide seven, we're frequently asked about our out-of-state loan portfolio. As you can see, our national businesses and mortgages comprise 13% of our total loan book. Our true out-of-state portfolio is about $1.2 billion and makes up about 12.5% of the total book. Two-thirds of the out-of-state portfolio are loans where we have followed Texas developers. The rest are SNCC syndicated loans and C&I. A breakdown of the out-of-state commercial real estate portfolio is shown on the bottom right of the slide. Moving on to slide eight. Net interest income decreased by 1.5 million to just under 100 million in Q3. The biggest drivers of the decrease were higher earned loan yields, day count, and lower volume, i.e., primarily FHLB volume, offset by increases in rates on deposits. The net interest margin decreased five basis points from Q2 to 3.46%. The NEM was helped by the increase in average non-interest bearing and the drop in volume and yield on our FHLB borrowings. Given the deposit growth through the end of August, we were able to pull back on deposit pricing in September. This resulted in monthly deposit production rates falling for the first time in 2023. All this to say, based on our current internal forecast, the net interest margin is nearing the bottom, assuming our deposit mix remains stable from here. On slide nine, please note our loan yields were up seven bps to 6.92% basis points. Q3's new loan production had a production rate of 8.06 and a spread of 330 basis points. Slide 10 shows certain metrics on our investment portfolio. The key takeaways are it's only 8.6% of assets, the duration is 4.3 years, and 83% of the portfolio has been available for sale. Overall, the mark-to-market on the portfolio has a minimal impact on tangible equity and doesn't have any impact on our capital issues. Non-interest income decreased by $4 million to $9.7 million. These declines were generally across the board. Thrive's production volume increased 1% to $564 million, while its gain on sale margin declined by 43 basis points to 257 basis points. To maintain volume, Thrive had to sacrifice rate and therefore gain on sale margin. Moving to slide 12 on the USDA front, We've always said we need to think about this business on an annual basis. It's been a record 12 months for this business. They produced over 21.6 million revenue over the last four quarters. I was happy to get any revenue in Q3 of 23, given the funding situation to be in that vertical at the USDA. But we could only get one loan closed in Q3. Our pipeline is at record levels, which bodes well for future revenue, and Q4 revenue should be meaningfully higher than Q3. But given the potential government shutdown and funding the government with continuing resolutions, it makes it highly unlikely that Q4 will be as strong as Q4 of 22. Non-interest expenses increased $2.2 million, driven by higher personnel costs and regulatory fees. The increase in personnel costs is a function of hiring bonuses, variable compensation for deposit growth, and lower loan production cost deferrals. Salaries are up slightly, but this was not the driver of the increase. On slide 13, total capital grew approximately $35 million during the quarter to almost $1.5 billion. Our CET1 ratio expanded 35 bps for the quarter and 101 basis points year-over-year. It now stands at 10.11%. A significant contributor to the expansion of the capital ratios has been the decline in risk-weighted assets. It's worth noting that since Veritex went public in 2014, it has compounded tangible book value per share at a rate of 10.8%, including the dividends that have been paid to our shareholders. Finally, on slide 14, note that we continue to build the ACL. Since the beginning of 2023, we've grown it by $19 million, or 21%. These additions to the allowance have increased it by 18 basis points to 1.14%. Given all the uncertainty facing the U.S. and Texas economy, we decided to allocate more weighting to the downside scenarios in the model. Two factors continue to make up a sizable part of our ACO.