Veritex Holdings, Inc.
Q2 2020 Earnings Call Transcript

Published: 31 Jul 2020

[Operator:]

Good day, and welcome to the Veritex Holdings Second Quarter 2020 Earnings Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I will now turn the conference over to Susan Caudle, Investor Relations Officer and Secretary to the Board of Veritex Holdings.

[Susan Caudle:]

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 Web site, veritexbank.com. All comments made during today's call are subject to that Safe Harbor statement. On slide three, we have provided an update to our risk factors, specifically regarding the impact of COVID-19 could have on our business. In addition, 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. I'll now turn the call over to Malcolm.

[Malcolm Holland:]

Good morning, everyone. I hope all of you all are staying safe and healthy during these unique times. Q2 for Veritex was much like the times we are currently experiencing; a lot of moving parts of many twists and turns along the way. As always, we desire to be transparent on where the bank is both financially and from a credit perspective. We intend to be more granular with the fact as we know them today, but please remember that we are in a season with many things changing daily. Today, we'll cover five main topics

[Clay Riebe:]

Thank you, Malcolm, and good morning, everyone. As you would expect, it's been a very busy quarter for our credit teams. The portfolio is performing as expected within PAs and past dues remaining relatively stable. Overall, the credit metrics are relatively flat to Q1 metrics, with the exception of the movement that we made to downgrade certain credits in connection with our pandemic portfolio review that Malcolm mentioned. So, let's begin with slide 11, which covers the total portfolio metrics for Q2. The chart at the bottom of the page reflects net charge-offs for Q2 of 0.03% of total loans. The increase in NCOs is from one C&I credit in the amount of $1.8 million that was fully reserved in the Q1 ACL and then subsequently charged off in Q2. Past dues in the 60- to 89-day category bulged, primarily due to two assets. The first is a CRE office building asset that is in the process of a workout that's expected to be completed by the end of Q3. The second is a retail CRE asset with a significant guarantor that's being called on to cure the delinquency. Moving to slide 12, you'll see a summary of the pandemic portfolio review we conducted during the month of June. Malcolm gave a high level description of the project, and I want to give you a summary of scope and results. Total penetration of the portfolio review touched 55% of the total portfolio's committed balances. Our credit team made decisions on financial data that was available to them at the time, and we conducted portfolio review sessions with our lending teams who gathered anecdotal evidence on the performance of their borrowers over the first 90 days of the pandemic. The results of the portfolio of the pandemic portfolio review were that $203 million in loans were moved to special mention. 75% of that movement came in the hospitality and retail CRE portfolios. $31 million was moved to substandard as a result of the effort. The downgrades from the review accounted for $235 million of the $290 million in migration of criticized assets for the quarter or 81% of total migration for Q2 came from this effort. We will continue to process quarterly as we are able to gather hard data on the performance of the loans in the high-risk categories. Slide 13 gives you a summary of Round one and Round two deferrals granted by the bank as of July 24, as well as expected additional deferrals in Round 2. Round two requests are being evaluated for necessity by reviewing actual financial data. The round one deferrals totaled $1.2 billion or 18.2% of the book. Round two deferrals granted to date have been very light, as you can see. We have pulled our lending staff to determine the expected volume of additional Round two deferrals, and that data has provided to you for you by product type in the Round two data. We expect total Round two deferrals to be less than 20% of total Round one deferrals or 4% of outstanding loan balances. It should be noted that most of the pre product types like retail, office and multifamily that received Round one deferrals are not requesting second round deferrals. We view that as a positive indication of the strength of the loan portfolio. Slide 14 highlights the hospitality book for you. One of the pleasant surprises in this book has been the performance of the lower end owner-operated properties. Occupancy has been above breakeven in several of these properties that focus on more essential workforce accommodations. Many of these properties have not requested a loan deferral. Our top 25 exposures in the hospitality portfolio reported an increase in occupancy of 18% from May to June, ending the month of June at 42.5% weighted average occupancy. Revenues in this same group increased 103% from May to June. That being said, we downgraded 35% of the hospitality book to a criticized asset grade during the quarter, and this portfolio is receiving oversight by our special assets team. We expect the volume of Round two deferrals in the hospitality book to be roughly 36% of outstanding balances, down significantly from 59%. Let's take a look at slide 15, which highlights the details of our retail CRE portfolio. Only 6.8% of the retail book was downgraded during the quarter, with over 90% of the downgrades going to special mention. Second round deferrals have been very light in this book as of today and are expected to be less than 2% of the retail CRE book. The past dues in this portfolio were previously identified problem credits. The only NPA in this book was a small retail strip center that was sold to a third-party buyer at foreclosure sale on July seven and an immaterial loss. Moving to slide 16, which highlights the metrics from our restaurant portfolio, we've seen some encouraging signs in this book in that three of our largest non-real estate exposures have fully repaid their working capital lines during the second quarter. Also our largest restaurant CRE customer has resumed making regularly scheduled payments after receiving a Round one deferral. Most of the credit issues that are in this book were previously identified, so downgrades in the space of $3.2 million were fairly light. A good portion of this book is in the government guaranteed loans, which is getting payments from the SBA that will continue through Q3. The NPAs are, for the most part, exclusively SBA loans that were problems prior COVID. Slide 17 gives you a visual of the high-risk industries within the portfolio. Of the top three portfolios highlighted, we feel the best about our largest exposure in retail CRE. While we do expect some stress in that portfolio, we believe our exposure is well underwritten with a weighted average LTV of 55% with quality sponsorship. Hospitality is our most concerning portfolio, given the lack of business and leisure travel and the potential slow recovery in this space. Our credit and special assets teams are fully engaged in these portfolios and working with our lenders to identify potential problems as they arise. And with that, I'll now turn it over to Terry to cover our financial results. Terry?

[Terry Earley:]

Thank you, Clay, and good morning, everybody. Let's jump back to slide five. This page gives you a good idea of the second quarter and how we're trying to position the company for these uncertain times. To start, earnings per fully diluted share were $0.48 as we built the allowance for credit losses and recognize substantial PPP fees. We're focused on three things

[Malcolm Holland:]

Despite these unique times for our country and uncertainty in our industry, we are constantly looking for ways to make our company better, and we are always trying to move forward. I often say to my team that these days provide many opportunities for companies like ours to embrace the challenges that the market gives you. This is a time when great companies become even greater, and this is what we did with the June 15 announcement of hiring Jim Reese and Cara McDaniel. Despite having them here only seven weeks, we have already benefited greatly from their experience and leadership. Additionally, Scooter Smith, a 40-plus year banking veteran in the private bank wealth management space, has recently joined our team. He will ultimately office in Houston and lead our private bank initiative. We're grateful to have all of them as part of the Veritex team. Terry has given you some detail and perspective on our capital position. You should know that we have stressed our capital every way we know how, and we always conclude that the bank remains in a well-capitalized position in every scenario. As reported, we have declared a quarterly dividend of $0.17 per share again this quarter. We strongly believe that as long as our projections hold true, the company will have ample income to continue to pay out at this level. However, we also have the flexibility to make proper adjustments, if needed. I do not say this every quarter, but I truly could not be any prouder of our Veritex team. They're talented, experienced and passionate about delivering a quality banking product with the upmost and excellence. Operator, we're open to take a few questions.

[Operator:]

[Operator Instructions] Our first question comes from Gray Tenner with D.A. Davidson.

[Gray Tenner:]

Hey, good morning guys. This is Gary Tenner.

[Malcolm Holland:]

Hey, Gary.

[Gray Tenner:]

Hey. Had a couple of questions, I guess, first, in terms of the C&I utilization rates, obviously, C&I being lower, a big driver of that sequential decline in period end loans, what was the utilization rate at quarter end, Terry, versus the March 31 number?

[Terry Earley:]

Are you talking about fundings on lines of credit, Gary?

[Gray Tenner:]

Yes.

[Terry Earley:]

What I can tell you is the utilization rates down, I don't know that I have the exact number, or Clay has the exact number of that. I can tell you that just from our restaurant portfolio, we had three of our largest lines of credit, if you will, they all funded up at the end of the quarter in March, this uncertainty, and they've all fully repaid those. So -- but we don't have the exact -- we can certainly get that, but I don't have that number.

[Clay Riebe:]

Sure. We'll follow-up with you on that, Gary.

[Gray Tenner:]

Okay, that would be great. Thank you. And then, Terry, just in terms of some of your margin commentary, I've grabbed what you mentioned at the end, kind of the three things that will benefit the second-half, but did you make your comment earlier about either some late quarter or early July deleveraging?

[Terry Earley:]

It was late quarter deleveraging. We shrunk the balance sheet in the back- half of the quarter, about $500 million, back down to about $8.5 million, and that was one of the positives to me is that we could fund $400 million in PPP loans and the balance sheet not grow that much, but that's just because we were carrying so much liquidity late in Q1, early in Q2, and so, we just took that liquidity and just deleveraged the balance sheet. Just because it just gotten a little bit bigger than we felt like it needed to be, and it was just wasn't as efficient as we wanted it to be.

[Gray Tenner:]

Okay, great. I appreciate that. And then finally, Malcolm, I'm just wondering if you could maybe differentiate to the degree you can right now between kind of business activity levels between DFW and Houston and kind of the puts and takes between the two markets right now.

[Malcolm Holland:]

There're certainly differences, but I will tell you, I think they're both seeing some our pipelines, albeit not like they were nine months ago, are still fairly active, and I would tell you that Houston is as active as Dallas is. It's not as diversified, just industry-wise as Dallas is, but I would put them at pretty equal footing right now. I mean I feel good about what our folks are being able to do, even though they're working from home and getting in front of clients, but we're still in a wait-and-see-a-little-bit of attitude, but we our pipelines are -- they're okay.

[Gray Tenner:]

Okay. Thanks for taking my questions.

[Malcolm Holland:]

You get it.

[Operator:]

And our next question comes from Brad Milsaps with Piper Sandler.

[Brad Milsaps:]

Hey, good morning guys.

[Malcolm Holland:]

Good morning, Brad.

[Terry Earley:]

Hey, Brad.

[Brad Milsaps:]

More around Just wanted to follow-up on Gary's question regarding the margin. Terry, I appreciate all the color, particularly around the CD book. You guys have been bringing those down quite a bit. Just curious, if you expect those to renew, or do you expect further kind of shrinkage in the CD book as you kind of think about the back-half?

[Terry Earley:]

I think you'll see further shrinkage. I mean there's not a there's not a lot of rate benefit to tie money up for a year vis-à-vis the money market option you got, and so I think we're already seeing that shift, and customers are saying, "Look, I'm willing to take a little bit less yield, but I keep the liquidity flexibility." And so, I think that's a trend that really started in Q2. Q1 was pretty good on the CD front, as I recall, but Q2 really changed when the Fed dropped rates, 150 bps late in March, and I think you're going to continue to see that. There is just not enough premium in term rates to incent people to move out of the money market side.

[Brad Milsaps:]

Got it. And your comments around putting some liquidity to work, you've got about $300 million of PPP loans on average. I think by my math, you may be carrying $170 million of excess liquidity. Where are you thinking about, if loans are flat, where are you thinking about putting that money to work, given the shape of the curve and all that's going on with interest rates. Are you thinking about adding bonds or paying off borrowings, just further shrinkage as you did late in the quarter, just kind of wanted to get a sense of what was kind of driving some of those comments.

[Terry Earley:]

Well, I think first place we'd probably be looking to do is still grow our mortgage warehouse business. The yields in that are better than anything we can get in the investment side of the house, other than unless we're willing to take credit risk. And so, first, I'd say, expect to see the mortgage warehouse business continue to grow. Second, if we're going to go to the investment portfolio, we're most likely to do longer-dated CMBS type products that will give us reasonable fixed rated yields because we're still asset sensitive, and then if we decide to, we could do some type of forward starting derivative to swap it to floating three to four years out, and the cost to hedge that just isn't that high right now, but I'm not saying we're going to do that. That's just something we're looking at. We're also thinking about deleveraging. The mortgage warehouse is a given. The others, we're still evaluating, and we've got to get the PPP money back before we can do that. But one thing you saw in the deck is that 75% of our loans and numbers are at $150,000 and under in terms of size. And that's where the forgiveness should be the easiest and the money to flow back the quickest. So we're thinking about all that. I think, between the CDs and the PPP and the excess liquidity. All of those things are going to have a pretty as they happen over the back part of the year, I think they're all going to have pretty meaningful impacts on the NIM, and as I think I said this last quarter, I thought Q2 was going to be the bottom of the NIM. And our modeling internally indicates it's going to have some meaningful expansion as we go through the back-half of the year.

[Brad Milsaps:]

Great. That's helpful. And just to follow-up on your comments around warehouse. You did have some nice growth in the quarter. Obviously, some related to refi activity picking up, but it sounds like you guys have been able to pick up share there as well. Can you kind of just offer a little more color on kind of what you've been able to do? How big can this business get? And how big do you want it to get maybe as a percent of earning assets?

[Terry Earley:]

Yes. If you recall, Brad, we hired Amy Sake about a year ago.

[Malcolm Holland:]

May last year.

[Terry Earley:]

May last year, so a little over a year; very, very talented gal, who is very experienced, and so, she the market share comment is right on. We picked up and actually increase the level of the credibility, credit underwriting of the client that we have is much higher and greater. And there are, I will tell you, there are some in the pipeline right now that are best-in-class, and it's because of Amy and her experience and her relationships in the industry. So we do see a greater market share. Listen, we don't want to become massively dependent on the mortgage warehouse business. That's not our goal. My guess is we're going to play between 5% and 10% of total loans outstanding, and we're probably not going to play any higher than that. We think it's a nice add-on to the business. It's certainly countercyclical to what we're dealing with right now. So we can see that. We I think you'll see it between five and 10, but outside of that and in the normal business time, I don't think you'd see it much over 7. So that's kind of what we're thinking, but we do like the business and the space, and the credit quality of our borrower is a lot higher than it was a year ago.

[Malcolm Holland:]

Yes. Let me tag on two things. One, to me, I look I view it as this wonderful bridge as a way to deploy excess liquidity until the normal economic activity around DFW in Houston becomes gets back further, and it's to me, it's a place where you can put money with good customers, very low risk, high risk-adjusted returns, high returns on allocated capital, and it's a great bridge to the economy comes gets back further.

[Brad Milsaps:]

Great, thank you guys.

[Malcolm Holland:]

I appreciate it.

[Operator:]

And your next question comes from Matt Olney with Stephens.

[Matt Olney:]

Hi, thanks, good morning guys.

[Malcolm Holland:]

Hey, Matt.

[Matt Olney:]

Hey, Great details on the credit deep dive, very helpful. Can you give us the balances of the special mention loans and the sub senior loans as of June 30? It may have been that deck, I just missed it.

[Malcolm Holland:]

As of June 30, you're talking about total for the bank?

[Matt Olney:]

Yes.

[Malcolm Holland:]

Okay. Yes, hang on.

[Terry Earley:]

This is in the press release, right? In the call. Totals for criticized assets of $607.8 million.

[Malcolm Holland:]

Committed or outstanding?

[Terry Earley:]

That's outstanding.

[Malcolm Holland:]

You there, Matt?

[Terry Earley:]

Is that what you're looking for, Matt?

[Matt Olney:]

Yes. Perfect. Thank you. And then on the PPP side, I just want to isolate the financial impact in 2Q results. And Terry, I think you said on the fee side, it looks like you took all the accrued benefits and the fees into 2Q. Can you confirm that we impact beyond 2Q in the fees? And then what was the impact, if any, on the expense side, deferred comp or otherwise from just PPP.

[Terry Earley:]

Look, as we said, we had about $12.5 million in fees. We took $10.5 million of that this quarter. We took $12.5 million technically in fees. But in the fair value, we wrote the discount to par that's going to come back as these loans are forgiven or we sell. And there's I get approached every single day, at least once, if not multiple times from people wanting to buy these loans. So there's a couple of million dollars of discount. It's going to come back over the next seven quarters, if you will. I think most people are expecting, especially with us having all those loans under $150,000, I think those are going to come back pretty quick. On the expense side, we didn't defer any cost on this. So we got no reduction in NIE from any cost deferral.

[Malcolm Holland:]

That was in our COVID-related expenses, Matt, that we called out? No.

[Terry Earley:]

No, no. He's talking about normal origination cost you would defer. Many of our peers have talked about pretty significant expense deferrals in their releases. And we didn't defer any because we were taking all the PPPs in through the fair value option.

[Matt Olney:]

Yes. Okay. That's helpful, Terry. And then on the COVID expenses that Malcolm mentioned, is it fair to say that could remain somewhat elevated here in the near term, given all the uncertainty out there?

[Malcolm Holland:]

No. No, I don't think so. I mean a lot of those were one-time expenses.

[Terry Earley:]

Yes. The two biggest were the contributions that Malcolm in his opening comments. We were really investing in our communities where people were really struggling, food banks, things like that. And then the other was some money we spent because we had a team of between 90 and 100 people who worked on the PPP and we did some incentive stuff to really benefit those folks that did work nights and weekends to help our customers.

[Malcolm Holland:]

Yes. So those benefits will be nonrecurring. Will we continue to invest in our communities? Quite possibly, we would continue at the 400-plus level. I don't think so, but I don't think it'll be that high.

[Matt Olney:]

Okay. That's helpful. And then my last question on the loan growth. I think there was some commentary in prepared remarks that it would remain relatively flat in the back-half of the year. Did I catch that right? And is that I assume exclude both PPP and the mortgage warehouse?

[Malcolm Holland:]

That's correct.

[Matt Olney:]

Okay, thank you guys.

[Malcolm Holland:]

Thanks, Matt.

[Operator:]

And your next question comes from Michael Rose with Raymond James.

[Michael Rose:]

Hi, guys. How are you?

[Malcolm Holland:]

Hi, Michael.

[Michael Rose:]

Just a few follow-up questions, just following up on Matt's question, so if I exclude the COVID expenses and some of the elevated credit fees, it sounds like the run rate for expenses is going to be down on kind of a core basis as we move forward, but you also did add some people in the quarter. Wanted to just talk about if that's kind of in the ballpark? And then I know you'll be selective on hires as we move forward, but if you can discuss kind of the opportunity set to make investments at this point?

[Terry Earley:]

Yes, Michael. I mean, you're right. I mean, I'm expecting expenses to be down going forward in spite of the hires just because now the one. I say that because we the COVID expenses, there's some other little things in the quarter that I don't think are necessarily going to be as high going forward, but the wild card or it is problem loan asset cost. You saw them go up $1 million this quarter. And I don't know that it's going to be that way in Q3, but as we get in Q4 and beyond, I think that cost has got to go up just as we work through the credit wave that's coming, if you will. So but generally down, especially other than that.

[Malcolm Holland:]

Yes. And in terms of investment in new hires, yes, I mean, there's some opportunities out there. You know there's some pretty good disruption that continues in our marketplaces, both Houston and Dallas were worth. So we're not going to be crazy about it, but there are a few opportunities that we're looking at right now. And this is actually a pretty good time to do it. You get in the back-half of the year. It's usually hard to hire people at the back-half of the year because there're bonuses in the first quarter. Well, there's not a lot of activity, and there's not a lot of bonuses. So I think we're going to have some opportunities. But again, I don't think it's going to be crazy, but there's several in both markets that we're looking at.

[Terry Earley:]

Yes. Michael, from a as we said, one of the key things we're focused on is maintaining our pre-tax pre-provision. And so, I agree with Malcolm, I think we're going to have the opportunity to invest. I think we've got to be willing to invest in technology and people, and we've got to weigh the revenue expense mismatch to that and how quickly can investments get up to scale and start carrying their load, if you will, but you've always got to be willing to make those investments.

[Michael Rose:]

Understood, I appreciate all the color. And I appreciate the color on the in the slides. I had a question on the retail free book. What's the debt service coverage ratio? And are you seeing any notable differences between whether it's not owner-occupied or not or owner-occupied between the Dallas and Houston market, it sounds like there might be a little bit more stress in Houston at this point, but natural gas and oil prices have come back a little bit.

[Malcolm Holland:]

Yes. I don't think we're seeing any meaningful difference between the two markets relative to overall debt service performance. The number of deferrals in the Houston market is meaningfully less than what we're seeing in the Dallas market. So I don't really see any real differences there between the two markets and the performance of the retail CRE book.

[Michael Rose:]

Thanks for taking my questions guys.

[Malcolm Holland:]

Thanks, Mike.

[Operator:]

Your next question comes from Woody Lay with KBW.

[Woody Lay:]

Hey, good morning guys.

[Malcolm Holland:]

Good morning, Woody.

[Woody Lay:]

So I realize there's a fair amount of uncertainty still, but with the ACL look to 2.01%, that screens pretty favorably among peers. Assuming the macro forecast doesn't worsen much from here, do you see yourself building the reserve from current levels?

[Terry Earley:]

No. I mean, if the forecast doesn't deteriorate, I think it stays there. Now the one thing that if the portfolio migration is worse than we're forecasting, potentially. But we're being pretty conservative on that as you can tell from the deep dive that Clay and his team did. So I think we're in a good place where we could see lower provisions, unless this economy just they start to shut down.

[Malcolm Holland:]

There's only two things that are going to really drive that number higher, Woody. And that's going to be unforeseen credit losses that we don't see right now are some crazy moody forward-looking economic data. I mean those are the two things that really can drive it materially, and we don't see either one of those right now. And so, to answer your question, I don't see a greater reserve build just to build. Terry stated we kind of we were aggressive on our two factors, which moved the reserve up an additional 35 to 40 bps. So we're even ultra conservative in that regard. So, we feel really good about where we stand on our reserve bill.

[Woody Lay:]

Got it. That's helpful. And then last for me, with capital levels expected to build over the back-half of the year and assuming we get some clarity on the macro environment, is the buyback something you would consider later in the year? Or is that more of a 2021 event?

[Malcolm Holland:]

Yes. It's off the table for this year. We're not it's not in any plan that we have. We still have approval for a little bit less. It's not even that much left under our initial approval. I think we have $31 million left, so there's not even a great deal that's even approved. So but it's not in any of our models.

[Terry Earley:]

It's just there's too much uncertainty. This is not the time to go. Even though the valuation is attractive, you would love to be buying. It just doesn't seem prudent, given the economic uncertainty that we're facing.

[Woody Lay:]

Got it. Thanks, guys.

[Operator:]

And you do have a follow-up from Gary Tenner with D.A. Davidson.

[Gary Tenner:]

That shows. I just wanted to follow-up on the mortgage warehouse commentary and to kind of grow share in that business. Yields there, I think, averaged about 3% for the quarter. Can you talk about the kind of competitiveness of the pricing environment there? And do you think you could kind of hold that yield around 3% while gaining share, or do you have to sacrifice more on pricing?

[Malcolm Holland:]

No. I think we can definitely hold it. There are some folks in our market that are actually contracting, which is given, at least in our local market, the ability to hold pricing pretty firm, but I don't see that reducing from where we are right now.

[Gray Tenner:]

All right, thank you.

[Malcolm Holland:]

All right. Thank you, Gary.

[Operator:]

There are no further questions. I would now like to turn it back over to our speakers for any closing remarks.

[Malcolm Holland:]

Thank you, everybody, for your time today. And if anybody has any further questions, you're welcome to reach out to us directly. Make a good day. Thank you.

[Operator:]

That does conclude today's call. You may now disconnect.