VBTX - Veritex Holdings: Main Goal Is To Strengthen The Balance Sheet

2023-10-29 07:39:28 ET

Summary

• Veritex's Q3 earnings disappointed the market, with lower-than-expected EPS and revenues.
• The company has made efforts to strengthen its balance sheet, reducing CRE exposure and improving its LTD ratio.
• The bank is facing challenges with unrealized losses on AFS securities and declining net interest income, but remains optimistic about the future.

The Q3 2023 release did not fully please the market, in fact both EPS and revenues slightly disappointed expectations.

• Expected EPS was $0.64, actual EPS was $0.04 less.
• Expected revenues were $110.54 million, actual revenues were $1.50 million less.

Anyway, despite some underwhelming results, I do not consider this quarterly to be a total failure, in fact there are positive aspects as well.

Balance sheet and income statement

The first aspect I would like to talk about is the strengthening of the balance sheet.

In past quarters, Veritex ( VBTX ) has demonstrated multiple weaknesses stemming from excessive exposure to CRE loans in addition to an LTD ratio above 100%. In recent quarters, management has demonstrated its willingness to reduce the procyclicality of the business model by both increasing the weight of CET1 and reducing the CRE concentration ratio. As we know, the latter is recommended by regulators to remain below 300%, and the impression is that it is heading below this threshold. It has been on a steep downward trend for two quarters now.

In addition, the LTD ratio has returned to more sustainable levels after a series of quarters in which it exceeded 100%. Dependence on wholesale funding has also improved, which may ease the cost of deposits.

Overall, management appears satisfied with this strengthening, but seems intent on continuing in this vein in the coming quarters. Probably, concern about a recession is what has led to such a change from a few quarters ago. Be that as it may, CEO Malcolm Holland made it clear during the conference call that this strengthening will be done in a judicious manner:

I don't think I'm at 85% loan deposit ratio by the end of the year. You know, we could do that because as Terry always says, you misprice your deposits, you can get all you want. And we're not doing that shown by a slower rate than September. So we feel like we're in a comfortable place right now from a balance sheet strength standpoint, but we still have more to do.

Compared to the previous quarter, non-interest bearing deposits returned to growth, precisely by $129.20 million. The latter's bottom may have been reached in the previous quarter, after a first half of 2023 troubled by the distrust generated by SVB's bankruptcy. In any case, on an annual basis, the balance remains negative: -$448.10 million.

In contrast, increasing significantly over last year were brokered CDs. The latter, although they have been crucial in keeping deposits high and reducing the LTD ratio, have significant costs to bear. Replacing non-interest bearing with brokered CDs has had consequences for profitability.

Net interest income and net interest margin continue to decline for the third quarter in a row. Regardless, Veritex's NIM of 3.46% remains good when compared to peers, despite continued declines. For banks with assets between $5-$49 billion the average NIM is only 1 basis point higher, 3.47 percent .

The current production deposit rate is 4.76%, quite high and influenced by the prevalence of brokered CDs. In one year, the cost has increased by 249 basis points. The production loan rate has also increased and reached 8.06%. In any case, in terms of basis points the increase was 237, lower than deposits. Moreover, in absolute terms, deposits have increased more than loans, which is why the LTD ratio has been decreasing in recent quarters.

Finally, looking at average values, the cost of total deposits in the last quarter increased more than the yield on loans: 42 basis points versus 7 basis points, respectively. Still, 76 percent of loans are variable rate, so they benefited from the Fed Funds Rate increases. This result could mean that the trend of the rising cost of deposits is not yet over and could continue in the coming quarters. Anyway, according to CEO Malcolm Holland's words , we should be close to the bottom of the NIM despite everything:

We're not really happy with how the NIM performed in the quarter, especially as I look across the industry, but you know as I said pricing competition on the deposit side is pretty intent, but we were able to pull back meaningfully on hours in September. We can see it in the data And so I'm hopeful that there's -- I think, there's going to be some -- especially CDs roll there's going to be some NIM pressure, but you know, it looks like in their own internal modeling that, you know, we're getting near the bottom anyway.

Unrealized losses and tangible book value per share

One of the main problems of almost all banks concerns unrealized losses on AFS securities due to the continued increases in the Fed Funds Rate. Veritex is also suffering from this, although not to an excessive extent.

Its investment portfolio is small compared to total assets, yet it is generating unrealized losses of $128.80 million, just under 14 percent of tangible common equity. In short, this is not an insignificant amount.

The duration of the portfolio is 4.26 years and has a yield of 3.87 percent. If the Fed Funds rate has peaked, time is Veritex's best ally since unrealized losses will gradually reduce as the securities in the portfolio expire. To date, however, it remains something to monitor because it is negatively affecting both capital requirements and tangible book value.

Finally, taking a look at tangible book value growth over the long term, adding dividends the CAGR was 10.80%.

Yet, since the IPO, the total return excluding dividends has been only 22 percent, as this bank has lost over 60 percent of its market value in the past two years. So it would seem to be the right time to purchase its own shares, but CEO Malcolm Holland does not seem to favor this option at the moment:

Our thinking right now is the environment that we're in. It's just to continue to add capital. And, you know, we know there's potential options down there, but we don't see a buyback in our immediate future. You know, I think, it's just wise to build the capital base a little bit more. And, again, the options are always there.

In other words, now buying back own shares comes secondary to strengthening the balance sheet since the bank is still too exposed to CRE loans and expensive brokered CDs.

Conclusion

Overall, although EPS and revenue expectations have not been met, I evaluate the company's willingness to strengthen the balance sheet positively. There are many doubts about the consequences of such a rapid rise in interest rates, and it is probably best to start thinking about it now, especially in the specific case of Veritex. Management's goal is to bring the CRE concentration ratio below regulatory guidelines, but this will not be easy in the current macroeconomic environment where the cost of deposits continues to rise more than the yield on loans.

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