Veritex Holdings, Inc. (NASDAQ:VBTX) Q4 2022 Earnings Call Transcript

Veritex Holdings, Inc. (NASDAQ:VBTX) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: 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 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 statement. At this time, if you are logged into our webcast, please refer to our slide presentation, including our safe harbor statement beginning on Slide 2. 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 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 will now turn the call over to Malcolm.

Malcolm Holland: 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, we reported operating earnings of $0.74 per share or $40 million and for the year, $2.74 per share or $147.9 million. Pretax 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%, ROATCE of 16% and efficiency ratio at 48%. The quarter did have a few items of note, which Terry 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 the to-be- funded construction book. The market is certainly slowing down as the borrowers are uncertain of a looming recession and the interest rate forecast. They have done a good job of self-policing their credit requirements. Payoffs for the quarter remained 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 in process, people and technology while making core deposit gathering our top strategic initiatives. I’ll now turn the call over to Terry.

Terry Earley: Thank you, Malcolm. Starting on Page 5. 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 ROATCE 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 raise 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 and EPS and return on tangible common equity. Additionally, 2021 was a very favorable credit year as we didn’t 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 continue 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 C&I and a lower appetite for ADC and CRE. Unfunded ADC construction continues to drop at the rate of $300 million to $400 million per quarter.

Photo by Ibrahim Rifath on Unsplash

On Slide 10, you see the evidence of the greater emphasis on C&I. During the fourth quarter, the C&I accounted for 41% of our production, up from 30% in Q3. On to Page 11. Net 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 in growth, which also accounted for about 700 — $0.7 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, 3-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 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 our – 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 to 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 month.

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 gained 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 as 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 rightsize 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 during 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.

Clay Riebe: 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 NPAs during the quarter. That was driven by a downgrade in a PCD pool of loans to nonaccrual 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 almost be great at 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 build offset by charge-offs. During the quarter, we had a bulge of past dues in the 30 to 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 facts that we acted quickly to remove the credit from the books and we’ll treat any collection proceeds as a recovery in future quarters. With that, I’ll turn it back over to Malcolm.

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Q&A Session

Malcolm Holland: 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?

Q – Brady Gailey: Hey, thank you. Good morning, guys.

Malcolm Holland: Hey, Brady.

Terry Earley: Hi, Brady.

Brady Gailey: 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 base case interest rate scenario, and that kind of points to a 3.68 net interest margin. And you just said you did like a 3.93 in December. So I’m trying to reconcile those two numbers, but just some color on the net interest margin and how you think that will trend in 2023?

Terry Earley: 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 – our view is that, look, we did 106 in net interest income in Q4, and that model shows the basic case on a static balance sheet with you know, at 420. So that tells you that even with growth, growing net interest income is really not very possible. In large view, it’s not because of where rates are going from here, it’s deposit funding cost pressure. So you know, I’ve said, it’s going to be hard to grow net interest income with deposit betas. And so that’s how we get to a view that NIMs will – it will be difficult to grow net interest income, NIMs will be under pressure, downward likely throughout the year.

Brady Gailey: And just to make sure…

Terry Earley: Q1 could be flat, but I think it might also be down. It’s really, Brady, it’s so hard to predict. Never seen deposit pricing competition like this. And anyone who doesn’t believe the U.S. Treasury is our primary competitor is kind of…

Malcolm Holland: Head in sand.

Terry Earley: Yeah, is got your head in the sand.

Brady Gailey: Just to 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?

Terry Earley: 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 the rate shock knowing what’s going to happen to deposit betas. I’m just – I’m not – I actually think we can grow net interest income 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 – same amount of leverage from loan growth in ’23 that you’ve been getting because of deposit pricing pressures.

Brady Gailey: All right. That’s helpful. Then next on expenses, it feels like 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?

Malcolm Holland: Yeah. Let me just address the hiring piece of it. 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 size deal. But the hiring is not going to be as it’s been in the past two or three years, but there are a couple of replacements areas that we have. Cara was telling me yesterday, I think our total is down less than 50%, 60% from where it was in terms of the amount of people. But I don’t think that’s going to drive a huge increase in where we are from the expense base right now. Do you want to talk about expenses, Terry?

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

Malcolm Holland: 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, we’re a little on the salary side. We’re a little low in the third quarter because we had some people moving out. We had some new people coming in, in late 3Q and 4Q, just kind of all caught up to us. And so we look hard at the efficiency ratio, which has remained stable despite the 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.

Terry Earley: Yeah. Let me add to that. I mean, year-over-year, total assets, not average assets year-over-year grew you know, 1. – 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 5 bps, 1.78 to 1.83 you know, for the year. And so Malcolm is right. We grew a $2 billion bank. And our NIE to average assets is while up 5 bps, it’s been one heck of an inflationary period.

Brady Gailey: All right. 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. Anyway, it’s – I mean I know it’s hard to look at those two an ongoing basis. But any idea about the forecast for those two volatile line items?

Terry Earley: I tried to say it in my comments, which is Thrive is making pretty – not pretty very significant expense changes. And while the gain on sale margin for the fourth quarter was 1.83, I think it…

Malcolm Holland: 1.89.

Terry Earley: 1.89. The year was 3.35, 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 — I mean, you see their pipeline, you see their quarter. You can tell that 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.

Brady Gailey: All right, great. Thanks, guys.

Terry Earley: Question, but that’s as good as I can do.

Brady Gailey: I hear you. All right. Thank you.

Operator: Thank you. Our next question comes from Gary Tenner with D.A. Davidson. You may proceed.

Gary Tenner: Thanks, guys. Good morning.

Malcolm Holland: Good morning.

Gary Tenner: 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. I think last quarter, you talked about kind of high single digit growth in 2023. That comment you just made sounds like you’re more kind of mid to high teens loan expense growth. Is that what you kind of intended to suggest in your comment?

Terry Earley: Well, what I would – I’d say high single digits over the full year, 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 it was across the board. So I’m not trying to go as high as it maybe it seems. So let me – I hope I cleared that up, more high single, low double from 2022 levels.

Gary Tenner: Okay. Thank you. And then also on Thrive, I mean, based on your comments you just made, is there visibility – to the degree there is 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 breakeven scenario in 2023 to where it’s not a headwind for VBTX?

Terry Earley: Absolutely. That’s – look, we 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.

Malcolm Holland: And they have put together a clear road map to get there. It’s not a hope and a prayer. They’re making the 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.

Gary Tenner: 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?

Malcolm Holland: Like I’ve seen many peers report. It was – the brokerage side was very meaningful in the fourth quarter. We still grew – absent brokered, we still grew – we still grew 4% or 5%. I haven’t done the math, and I’m doing my head. I’m somewhere on the linked quarter annualized, absent brokered. But so that kind of tells you that, yes, that’s the right number, 4% to 5%. And if we did 17 that tells you where the rest of it was.

Gary Tenner: Okay. So can you talk at all about how you kind of laddered those out in terms of maturities. So we’ve got a…

Malcolm Holland: We are – from an interest rate risk, I would like to keep them under 12 months. From a – 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 – 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 12, 15, 18 months and end.

Gary Tenner: Okay. Thank you.

Malcolm Holland: Thanks, Gary.

Operator: Thank you. Our next question comes from Brett Rabatin with Hovde Group. You may proceed.

Brett Rabatin: Hey, guys. Good morning.

Malcolm Holland: Morning, Brett.

Terry Earley: Hey, Brett.

Brett Rabatin: I 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 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?

Malcolm Holland: Yeah. So that’s a great question, Brett. Thanks for the question. We did a deep office dive during the quarter that we looked at every loan over $1 million in the book. And just to make sure that we appropriately had everything graded and we’re addressing anything that we saw that had any weakness in the deal. So we looked at every credit over $1 million in that portfolio. And that’s just part of our surveillance process for the entire year.

Brett Rabatin: So any color on what specifically led to the downgrade of those three credits?

Malcolm Holland: 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…

Brett Rabatin: Okay. So it sounds like it’s – instead of in LTV, it’s basically a cash flow perspective and…

Malcolm Holland: Yes…

Brett Rabatin: And in issues with. Do you guys have any color on how much Class B office space you might have kind of inside the loop?

Malcolm Holland: Inside of which loop?

Brett Rabatin: Houston specifically?

Malcolm Holland: None that I’m aware of, we have no CBD office exposure. Class B in general, that makes up 33% of our office book today, 62% of our office book is in Class A, which is encouraging to me because that’s where I will – I think we’ll see the least amount of stress.

Brett Rabatin: Okay. And were these – and sorry for some of the questions on this, but were these three credits, the bulk or all of the increase in criticized assets linked quarter?

Malcolm Holland: No, that’s not all of them. The largest one that I discussed within our note finance group, a move to a 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 during the quarter.

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

Malcolm Holland: Yeah. I mean to answer your question, strategy hasn’t changed. It’s just ramped up. As we – I think we said in the third quarter that this was a multiyear strategy. Canada, 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 6, 7 and maybe 8 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 – 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 talked about short-term funding in these CDs, these are – we’re hoping these are GAAP fillers as we continue to be successful in our strategy. The fintech piece specifically, I mean, when we talk 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.

Terry Earley: And Brett, those – 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. So, yeah.

Brett Rabatin: Okay. And maybe just one last follow-up on that. As we think about betas, as you just mentioned, 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?

Terry Earley: Brett, let say it one more time. You broke up a little bit.

Brett Rabatin: Sorry. So just looking at the slide on deposit growth in the deck and showing rates in average Fed funds effective. And 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 I don’t know if it has to go to the effective Fed funds rate, but do you feel like you’ve taken a meaningful portion of the hit that you need to in terms of deposit pricing pressure?

Malcolm Holland: No, 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 fight hand-to-hand combat to retain these customers, these relationships and these dollars. And I think the deposit beta – 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.

Brett Rabatin: Okay. And that’s very helpful…

Malcolm Holland: The Fed got another 50 or another 75 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.

Brett Rabatin: Okay. Thanks for the color.

Malcolm Holland: Thanks, Brett.

Terry Earley: Thank you.

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

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

Malcolm Holland: I mean, we’d expect to see it build. But we do have – CECL is a pretty constraining metric. And there’s a lot that goes into it, as you well know. And so it’s not – we can’t tweak here and tweak that. Candidly, we’ve done a fair amount in changing our weightings on some of the possibilities that could happen. 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 certainly, our desire is to have a little bit more in there. And going forward, yes, we hope to accomplish it, but we’re not certain.

Terry Earley: Let me just to 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 bps to 90, and I would expect that trend to continue. Does that make sense, Michael?

Michael Rose: Yes. Got it. And then maybe just back to Thrive. Obviously, the outlook, I’m just looking at the MBA forecasts are down a significant amount in ’23. Obviously, this is a tough quarter. I understand they’re making expense structure changes, kind of et cetera. But do you actually expect that you can actually earn money from the investment this year?

Terry Earley: No, I would go back. I mean, I think success, I mean, is it possible? Yes. With – and success would be a positive number. I think target is a breakeven. And look, the only reason this option is available to them is a small acquisition Malcolm referenced that brought on $3 billion in volume at good margins. The margin was 3.33 for the year, where they’ve had significant expense cuts. They’ve been able to strip out close to 60% of the cost of the company to bring the volume onto their platform. And so that’s what, without that and without fixing the long-dated locks and rightsizing the expense structure of legacy Thrive than 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, close to 65% and 70% of their business is in Texas. The three key markets, DFW, Houston, San Antonio, and that’s why it’s encouraging. And I’ve already seen 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 Thrive can go is you can see it from here from the December results.

Michael Rose: All right. Helpful. And then just finally for me, stock trading by 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 what you could do there? Thanks.

Terry Earley: I think that’s something 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 a 10% CET1 or better. And credit – the recession looks mild and credit looks fine, it’s something we’ll think about. But I mean it’s not that we don’t like the valuation. I just don’t think now is the time to be right now, especially in the first half of the year. 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.

Michael Rose: Understood. Appreciate all the color, guys. Thanks.

Terry Earley: Thanks, Michael.

Operator: Thank you. One moment for questions. Our next question comes from Brad Milsaps with Piper Sandler. You may proceed.

Brad Milsaps: Hey. Good morning, guys.

Malcolm Holland: Good morning, Brad.

Brad Milsaps: You’ve addressed most everything, just a couple of maybe housekeeping questions. Terry, and so apologies if I missed it, but what was the spot rate for the loan portfolio at the end of the year?

Terry Earley: Gosh, I didn’t bring that number with me.

Brad Milsaps: No, we can follow up later.

Terry Earley: I may have it before the end of the call, and I do want to just say it. But…

Brad Milsaps: And then – okay. And then just curious, you mentioned the increase in expenses was somewhat tied to the big quarter you had at NIC. Just kind of curious, is that – trying to think about those numbers going forward? Is that kind of a 40% or 50% payout on that revenue? Is that how to think about it? Or is it – just wanted to see how much of it is actually tied to the good USDA performance?

Terry Earley: No, no, it’s not nearly that much. It’s in the low double digits, but it meaningfully moved the variable comp. And that’s just the – given the go-sell premiums and dollars in that space right now, that’s just a market if you want to attract the really good producers and we have some.

Brad Milsaps: Got it…

Terry Earley: And then Brad, the 12/31 end of year loan rate is 6.36.

Brad Milsaps: And that’s a loans held for investment?

Terry Earley: Yes.

Brad Milsaps: Okay. And then would this maybe say – I’ve noticed the securities yield was up quite a bit as well. Any kind of one-timers in there? Is that just you lower yielding start rolling off and just general improvement?

Terry Earley: I’m sorry. I can’t…

Malcolm Holland: One more time, Brad, you broke up just a slid.

Brad Milsaps: Yes, 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 onetime in nature or if that’s just…

Malcolm Holland: Okay. That’s it. And also that rate I gave you does not include mortgage warehouse. So…

Brad Milsaps: Okay…

Malcolm Holland: They’re not materially different, to be honest with you. They are definitely in the 6s, but that rate just excluded them.

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

Malcolm Holland: Yes. I mean there’s still commerce going on, especially in our specific markets. You read the paper every day about a new industrial – I read one this morning, a huge industrial deal, which is sold because Nike became the tenant there. And so people are still selling industrial. The cap rates certainly have 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 – it 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 and industrial. But we haven’t seen it slow down, but we are certainly anticipating it slowing down.

Terry Earley: And the agency CMBS is a much more viable outlook than it has been. You can get 10-year fixed rate in the 70 – 575 range. Also, I mean, the big payoff yesterday in Craig Davis’ portfolio in Fort Worth, about $25 million. I mean just – I just saw it this morning. But they’re going to slow, but there’s viable ways and then there is a lot of commerce going on.

Malcolm Holland: Yes.

Brad Milsaps: Okay, great. Thank you, guys.

Malcolm Holland: Thanks, Brad.

Terry Earley: Thanks, Brad.

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

Matt Olney: Hey, thanks. Good morning, guys.

Malcolm Holland: Hey, Matt.

Terry Earley: Hey, Matt.

Matt Olney: 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 is your financing in these types of loans? And what was the size of the specific credit that was downgraded in the fourth quarter?

Terry Earley: So thanks, Matt. It’s very, very granular exposure financing, this particular borrowers financing, small fix and flip, single-family residences. So that is – give you some color on the actual – what we’re talking about there. The overall note finance portfolio is made up of a broad categories, you know, touching various product types, but this particular borrower is very granular exposure in the single-family space. And then the size of that was the total commitments on a $100 million facility.

Matt Olney: And if I remember correctly, this is something you guys have been doing for several years?

Terry Earley: Yes. Yes. We have the experience and broad experience in that space.

Matt Olney: Okay. And so I guess something to think about the risk here of those types of loans. Is it more – it sounds like it’s more residential, single-family in the metro, Texas markets?

Terry Earley: Yes. I mean, yes, the risk is that you know, slow in that space, which…

Malcolm Holland: 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 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, right, but remain 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.

Matt Olney: Okay. Great. Appreciate the color there. And then I guess, shifting back on deposits, I think the average deposit – I’m sorry, the average noninterest-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 NIB. So I’m curious kind of what your expectations are of the outflows there for the bank? And what do you think those could stabilize?

Terry Earley: 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. So I don’t think we have found – we’re at the end of that mix 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 even – 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.

Matt Olney: Yes. 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?

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

Matt Olney: Yes. Okay. Thanks, guys. Appreciate it.

Terry Earley: Thank you.

Malcolm Holland: Thank you.

Operator: Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.