SPIRIT OF TEXAS BANCSHARES: Discussion and analysis by management of the financial situation and results of operations (form 10-Q)
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The following discussion and analysis is intended to assist readers in understanding our financial condition as of and results of operations for the three and six months endedJune 30, 2021 and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto included in this Quarterly Report on Form 10-Q (this "Form 10-Q") and in our Annual Report on Form 10-K for the year endedDecember 31, 2020 filed with theSecurities and Exchange Commission (the "SEC") onMarch 5, 2021 (the "2020 Form 10-K"). Unless we state otherwise or the context otherwise requires, references in this Form 10-Q to "Company," "we," "our," and "us" refer toSpirit of Texas Bancshares, Inc. , aTexas corporation, and our wholly-owned banking subsidiary,Spirit of Texas Bank SSB , aTexas state savings bank. References in this Form 10-Q to "Bank" refer toSpirit of Texas Bank SSB . References in this Form 10-Q to "Houston metropolitan area," "Dallas/Fort Worth metropolitan area," "Bryan/College Station metropolitan area," "San Antonio /New Braunfels metropolitan area," "Corpus Christi metropolitan area" "Tyler metropolitan area" and the "Austin metropolitan area" refer to theHouston -The Woodlands -Sugar Land Metropolitan Statistical Area, the Dallas-Fort Worth-Arlington Metropolitan Statistical Area, the College Station-Bryan Metropolitan Statistical Area, theSan Antonio /New Braunfels Statistical Area, the Corpus Christ Statistical Area, the Tyler Statistical Area and the Austin Metropolitan Statistical Area, respectively. Unless otherwise indicated, the reported results are for the three and six months endedJune 30, 2021 with the "same period," the "comparable period," and "prior period" being the respective three and six months endedJune 30, 2020 .
Caution Regarding Forward-Looking Statements
Statements and financial discussion and analysis contained in this Form 10-Q that are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We also may make forward-looking statements in our other documents filed with or furnished to theSEC . In addition, our senior management may make forward-looking statements orally to investors, analysts, representatives of the media and others. These statements are often, but not always, preceded by, followed by or otherwise include the words "believes," "expects," "anticipates," "intends," "projects," "estimates," "plans" and similar expressions or future or conditional verbs such as "will," "should," "would," "may" and "could" or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about our industry, management's beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.
We have made the forward-looking statements in this Form 10-Q based on assumptions and estimates that we believe are reasonable based on information currently available to us. However, these forward-looking statements are subject to important risks and uncertainties and could be affected by many factors. These factors include, but are not limited to, the following:
1.risks linked to the concentration of our activities in
the risks associated with any slowdown in the real estate sector and the risks
associated with a decline in the value of single-family homes in our
markets;
2. general market conditions and economic trends nationally, regionally and
particularly in our Texas markets, including a decrease in or the
volatility of oil and gas prices;
3.the impact, duration and severity of the ongoing COVID-19 pandemic, and the
Emerging Delta variant, the response of government authorities to the
COVID-19 pandemic and our involvement in government linked to COVID-19
programs such as the Paycheck Protection Program (“PPP”), the Paycheck
Protection Program Liquidity Facility (the "PPPLF"), andMain Street Lending Program; 4. risks related to our concentration in our primary markets, which are
sensitive to severe weather events that could have a negative impact on the
economies of our markets, our operations or our customers,
could have a material adverse effect on our business, financial condition
and the results of operations;
5.Our ability to execute our growth strategy, including identifying and
make suitable acquisitions, raise additional capital to finance
such transactions, entry into new markets, possible failures in the achievement of
anticipated benefits from such acquisitions and an inability of our
personnel, systems and infrastructure to keep pace with such growth;
6.Risks associated with the integration of acquired businesses, including
exposure to potential risks related to asset quality and credit quality and unknown or
contingent liabilities, time and costs associated with integration
systems, technological platforms, procedures and personnel, the need to
additional capital to finance such transactions, and possible failures in
the realization of the expected benefits of acquisitions;
7. changes in
specifically the Section 7 (a) program and Section 504 loans, or changes in
SBA standard operating procedures;
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8.risks associated with our ability to control our loans and to deposit
accounts of foreign nationals;
9.Risk associated with the relatively unseasoned nature of a
part of our loan portfolio;
10. the accuracy and sufficiency of the assumptions and estimates we make in
establish reserves for potential loan losses and other estimates;
11. the risk of deteriorating asset quality and higher loan charge-offs;
12.Risks relating to the large amount of credit that we have granted to
a limited number of borrowers and in a limited geographical area;
13. our ability to maintain adequate liquidity and raise the necessary capital
to finance our acquisition strategy and operations or to respond to
minimum regulatory capital levels;
14. significant decreases in the amount of deposits we hold, or failure to grow
our deposit base as needed to help fund our growth and operations;
15. changes in market interest rates that affect the pricing of our loans and
deposits and our net interest income;
16. Potential fluctuations in the market value and liquidity of our investment
securities;
17. the effects of competition from a wide variety of local, regional,
national and other providers of financial, investment and insurance
services;
18. our ability to maintain an effective system of disclosure controls and
procedures and internal controls over financial reporting;
19. risks associated with fraudulent, negligent, or other acts by our
customers, employees or vendors;
20. our ability to keep pace with technological change or challenges when
implementation of new technologies;
21. the risks associated with system failures or failures of protection against
cybersecurity threats, such as breaches of our network security; 22. risks associated with data processing system failures and errors;
23. potential impairment on the goodwill we have recorded or may record in
connection with business acquisitions;
24. initiation and outcome of litigation and other legal proceedings
against us or to which we become subject;
25. our ability to comply with various governmental and regulatory
requirements applicable to financial institutions, including
requirements to maintain minimum capital levels;
26. the impact of recent and future legislative and regulatory changes,
including changes in banking, stock exchange and tax laws and regulations and
their application by our regulators, such as the implementation of the
Economic Growth, Regulatory Relief and Consumer Protection Act (the
"EGRRCPA");
27. changes in tariffs and trade barriers;
28. government monetary and fiscal policies, including government policies
29. our ability to comply with supervisory actions by federal and state
banking agencies;
30. changes in the scope and cost of
("FDIC"), insurance and other coverage;
31. systemic risks associated with the soundness of other financial
institutions;
32. the cost savings resulting from our recent acquisitions and disposals of branches could
not be fully completed or may take longer than expected to be completed;
33. operating costs, loss of customers and business interruption following the
acquisitions, including negative effects on employee relations,
may be greater than expected; and
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34. competition from other financial services companies in the
markets.
Other factors not identified above, including those described under the heading "Risk Factors" in the 2020 Form 10-K and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-Q may also cause our results to differ materially from the anticipated or estimated results described in our forward-looking statements. The foregoing factors should not be construed as exhaustive, and you should consider these factors in connection with considering any forward-looking statements that may be made by us. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statements speaks only as of the date on which it is made, and we undertake no obligation to release publicly any revisions to any forward-looking statement, to report events or to report the occurrence of unanticipated events unless we are required to do so by law. Ongoing COVID-19 Pandemic Our business has been, and continues to be, impacted by the recent and ongoing outbreak of COVID-19. InMarch 2020 , COVID-19 was declared a pandemic by theWorld Health Organization and a national emergency by the President ofthe United States . Efforts to limit the spread of COVID-19 led to shelter-in-place orders, the closure of non-essential businesses, travel restrictions, supply chain disruptions and prohibitions on public gatherings, among other things, throughoutthe United States and, in particular, the markets in which we operate. Although many of these restrictions have been lifted and society has begun to re-open, the COVID-19 pandemic is ongoing and additional uncertainties exist which may continue to impact our customers, employees and vendors; the financial services and banking industry; and theTexas andU.S. economies as a whole. These uncertainties include, among other things, the extent and severity of the spread of COVID-19, the length of the pandemic, and future actions taken by governmental authorities to contain the pandemic or to mitigate its impact. In addition, a new Delta variant of COVID-19, which appears to be the most transmissible variant to date, has begun to spread inthe United States . The impact of the Delta variant cannot be predicted at this time, and could depend on numerous factors, including vaccination rates among the population, the effectiveness of COVID-19 vaccines against the Delta variant, and the response by governmental bodies and regulators. The COVID-19 pandemic has negatively affected, and is expected to continue to negatively affect, our business, financial position and operating results. In light of the uncertainties and continuing developments discussed herein, we are currently unable to fully assess or predict the extent of the effects of the COVID-19 pandemic on our operations as the ultimate impact will depend on factors that are currently unknown and/or beyond our control. Please refer to Part I, Item 1A, "Risk Factors" of our 2020 Form 10-K. In theState of Texas , economic disruption as a result of the COVID-19 pandemic continues to impact our operations, as well as the operations of our customers. In order to facilitate the continued delivery of essential services while prioritizing the safety of our customers and employees, we implemented the following measures:
• We have activated our communication plans to ensure that our employees, customers and
critical vendors are kept informed of new developments affecting our
operations.
• Masks recommended to be worn by all customers and employees in all of our
halls and other company facilities.
• Extensive availability of remote access to ensure employees have the capacity
to work from home or other remote locations.
Actions of the
Recent actions taken by the federal government and the
In an emergency measure aimed at blunting the economic impact of the COVID-19 pandemic, theFederal Reserve lowered the target for the federal funds rate to a range of between zero to 0.25% onMarch 15, 2020 . This action by theFederal Reserve followed a prior reduction of the targeted federal funds rates to a range of 1.0% to 1.25% onMarch 3, 2020 . Our earnings and cash flows are largely dependent upon our net interest income. As our balance sheet is more asset sensitive, our earnings are more adversely affected by decreases in market interest rates as the interest rates received on loans and other investments fall more quickly and to a larger degree than the interest rates paid on deposits and other borrowings. The decline in interest rates has already led to new all-time low yields across theU.S. Treasury maturity curve. If theFederal Reserve decreases the targeted federal funds rates even further in response to the economic effects of the COVID-19 pandemic, overall interest rates will decline further, which will negatively impact our net interest income and further compress our net interest margin. Alternatively, if the COVID-19 pandemic abates and general economic conditions improve, theFederal Reserve may determine to increase the targeted federal funds rates and overall interest rates 34 --------------------------------------------------------------------------------
will likely increase, which could have a positive impact on our net interest income, but could have a negative impact on commercial lending activity and the
The PPP was established by the Coronavirus Aid, Relief and Economic Security Act
("CARES Act") and implemented by the SBA with support from the Department of the
Treasury . The PPP is a federally-guaranteed, low-interest rate loan program that
is designed to provide a direct incentive for small businesses to keep workers
on the payroll. Businesses may use PPP loan funds to pay up to eight weeks of
payroll costs as well as to cover other eligible business expenses. PPP loans
may be partially or fully forgiven by the SBA if the funds are used for eligible
expenses during the relevant forgiveness period and the borrower meets the
employee retention criteria. Any PPP loans that are not fully forgiven will
carry an interest rate of 1% with a maturity of either two or five years,
depending on the date of origination. PPP loans that the SBA approved on or
after June 5, 2020 will have a maturity date of five years. Payments for PPP
loans are deferred until the SBA issues a forgiveness decision or ten months
after the end of the forgiveness period if the borrower fails to apply for
forgiveness. All PPP loans are fully guaranteed by the SBA and are included in
total loans outstanding. The results of our participation in the PPP are
discussed below.
The Federal Reserve has created various additional lending facilities and
expanded existing facilities to help provide up to $2.6 trillion in financing in
response to the financial disruptions caused by COVID-19. The programs include,
among other things, (i) the PPPLF, which is intended to extend loans to banks
making PPP loans, (ii) the Municipal Liquidity Facility, which is intended to
facilitate the purchase of eligible notes from states, and certain counties and
cities around the country, and (iii) the Main Street Lending Program, which is
intended to facilitate credit flows to businesses affected by the COVID-19
pandemic with up to 10,000 employees or up to $2.5 billion in 2019 annual
revenues. In addition to the PPPLF, we may participate in some or all of these
facilities or programs, including as a lender, agent or intermediary on behalf
of customers or in an advisory capacity in the future.
Overview
We are aTexas corporation and a registered bank holding company located in theHouston metropolitan area with headquarters inConroe, Texas . We offer a broad range of commercial and retail banking services through our wholly-owned bank subsidiary,Spirit of Texas Bank, SSB . We operate through 37 full-service branches located primarily in theHouston ,Dallas/Fort Worth ,San Antonio /New Braunfels ,Corpus Christi ,Austin , andTyler metropolitan areas. As ofJune 30, 2021 , we had total assets of$3.08 billion , loans held for investment of$2.27 billion , total deposits of$2.57 billion and total stockholders' equity of$377.8 million . As a bank holding company, we generate most of our revenues from interest income on loans, gains on sale of the guaranteed portion of SBA loans, customer service and loan fees, brokerage fees derived from secondary mortgage originations and interest income from investments in securities. We incur interest expense on deposits and other borrowed funds and noninterest expenses, such as salaries and employee benefits and occupancy expenses. Our goal is to maximize income generated from interest-earning assets, while also minimizing interest expense associated with our funding base to widen net interest spread and drive net interest margin expansion. Net interest margin is a ratio calculated as net interest income divided by average interest-earning assets. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings that are used to fund those assets. Net interest spread is the difference between rates earned on interest-earning assets and rates paid on interest-bearing liabilities. Changes in market interest rates and the interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities and stockholders' equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions inTexas , as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target markets and throughoutTexas . Results of Operations
Our operating results are largely dependent on net interest income and non-interest income. Other factors contributing to our results of operations include the level of our non-interest expenses, such as salaries and benefits, occupancy and equipment and other miscellaneous operating expenses.
Net interest income
Net interest income represents interest income less interest expense. We
generate interest income from interest, dividends and fees received on
interest-earning assets, including loans and investment securities we own. We
incur interest expense from interest paid on interest-bearing liabilities,
including interest-bearing deposits and borrowings. To evaluate net interest
income, we measure and monitor (1) yields on our loans and other
interest-earning assets, (2) the costs of our deposits and other funding
sources, (3) our net interest spread, (4) our net interest margin and (5) our
provisions for loan losses. Net interest spread is the difference between rates
earned on interest-earning assets and rates paid on interest-bearing
liabilities. Net interest margin is calculated as the annualized net
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interest income divided by average interest-earning assets. Because
noninterest-bearing sources of funds, such as noninterest-bearing deposits and
stockholders' equity, also fund interest-earning assets, net interest margin
includes the benefit of these noninterest-bearing sources.
Changes in market interest rates and the interest rates we earn on
interest-earning assets or pay on interest-bearing liabilities, as well as the
volume and types of interest-earning assets, interest-bearing and
noninterest-bearing deposits and stockholders' equity, are usually the largest
drivers of periodic changes in net interest spread, net interest margin and net
interest income. We measure net interest income before and after provision for
loan losses required to maintain our allowance for loan and lease losses at
acceptable levels.
Non-interest income
Our noninterest income includes the following: (1) service charges and fees; (2) swap fees; (3) SBA loan servicing fees; (4) mortgage referral fees; (5) swap referral fees; (6) gain on the sales of loans, net; (7) gain (loss) on sales of investment securities; and (8) other.
Non-interest charges
Our non-interest expenses include: (1) salaries and benefits; (2) occupancy and equipment expenses; (3) professional services; (4) data processing and network; (5) regulatory assessments and insurance; (6) amortization of intangible assets of basic deposits; (7) advertising; (8) marketing; (9) telephone charges; (10) processing costs; and (11) other.
Financial condition
The primary factors we use to assess and manage our financial condition include liquidity, asset quality and capital.
Liquidity
We manage liquidity based upon factors that include the amount of core deposits as a percentage of total deposits, the level of diversification of our funding sources, the allocation and amount of our deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets to be readily converted into cash without undue loss, the amount of cash and liquid securities we hold, and the repricing characteristics and maturities of our assets when compared to the repricing characteristics of our liabilities, the ability to securitize and sell certain pools of assets and other factors.
Asset quality
We manage the diversification and quality of our assets based upon factors that include the level, distribution, severity and trend of problem, classified, delinquent, nonaccrual, nonperforming and restructured assets, the adequacy of our allowance for loan and lease losses, discounts and reserves for unfunded loan commitments, the diversification and quality of loan and investment portfolios and credit risk concentrations.
Capital city
We manage capital based upon factors that include the level and quality of capital and our overall financial condition, the trend and volume of problem assets, the adequacy of discounts and reserves, the level and quality of earnings, the risk exposures in our balance sheet, the levels of Tier 1 (core), risk-based and tangible equity capital, the ratios of tier 1 (core), risk-based and tangible equity capital to total assets and risk-weighted assets and other factors. Performance Highlights
Operational and Financial Highlights for the Closed Quarter
include the following:
• Net income for the second quarter of 2021 was$12.4 million . • Diluted earnings per share were$0.70 for the second quarter of 2021.
• The net interest margin and the net tax equivalent interest margin were 4.06% and
4.14%, respectively. • Return on average assets was 1.57%, annualized.
• The book value per share was
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Tax equivalent net interest margin, adjusted net income, adjusted basic and
diluted earnings per share and tangible book value per share are financial
measures not in accordance with U.S. generally accepted accounting principles
("GAAP"). See our reconciliation of non-GAAP financial measures to their most
directly comparable GAAP financial measures under the caption "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Non-GAAP Financial Measures."
Analysis of the results of operations
Net income for the three months endedJune 30, 2021 totaled$12.4 million , which generated diluted earnings per common share of$0.70 for the three months endedJune 30, 2021 . Net income for the three months endedJune 30, 2020 totaled$7.7 million , which generated diluted earnings per common share of$0.44 for the three months endedJune 30, 2020 . The increase in net income during the three months endedJune 30, 2021 compared to the prior year period was driven by an increase in net interest income of$3.7 million that was primarily attributable to accretion of net loan origination fees on PPP loans. Noninterest expense during the three months endedJune 30, 2021 was mostly consistent with noninterest expense during the three months endedJune 30, 2020 . Income tax expense during the three months endedJune 30, 2021 increased$1.0 million compared to the three months endedJune 30, 2020 as a result of higher pre-tax earnings. Our results of operations for the three months endedJune 30, 2021 produced an annualized return on average assets of 1.57% compared to an annualized return on average assets of 1.07% for the three months endedJune 30, 2020 . We had an annualized return on average stockholders' equity of 12.83% for the three months endedJune 30, 2021 , compared to an annualized return on average stockholders' equity of 8.93% for the three months endedJune 30, 2020 . Net income for the six months endedJune 30, 2021 totaled$22.5 million , which generated diluted earnings per common share of$1.28 for the six months endedJune 30, 2021 . Net income for the six months endedJune 30, 2020 totaled$11.8 million , which generated diluted earnings per common share of$0.65 for the six months endedJune 30, 2020 . The increase in net income during the six months endedJune 30, 2021 compared to the prior year period was driven by an increase in net interest income of$7.7 million that was primarily attributable to accretion of net loan origination fees on PPP loans. Noninterest expense during the six months endedJune 30, 2021 also declined$3.6 million compared to the six months endedJune 30, 2020 , which was primarily due to deferred costs on newly originated PPP loans and the lack of merger related expenses during the first half of 2021 compared to$1.5 million of merger related expenses for the first half of 2020. Income tax expense during the six months endedJune 30, 2021 increased$3.4 million compared to the six months endedJune 30, 2020 as a result of higher pre-tax earnings and a nonrecurring carryback claim recorded in the first quarter of 2020 which reduced income tax expense by$575 thousand . Our results of operations for the six months endedJune 30, 2021 produced an annualized return on average assets of 1.45% compared to an annualized return on average assets of 0.90% for the six months endedJune 30, 2020 . We had an annualized return on average stockholders' equity of 12.39% for the six months endedJune 30, 2021 , compared to an annualized return on average stockholders' equity of 6.83% for the six months endedJune 30, 2020 .
Net interest income and net interest margin
The following table presents, for the periods indicated, information about
(1) average balances, the total dollar amount of interest income from
interest-earning assets and the resultant average yields; (2) average balances,
the total dollar amount of interest expense on interest-bearing liabilities and
the resultant average rates; (3) the interest rate spread; (4) net interest
income and margin; and (5) net interest income and margin (tax equivalent).
Interest earned on loans that are classified as nonaccrual is not recognized in
income, however the balances are reflected in average outstanding balances for
that period. Any nonaccrual loans have been included in the table as loans
carrying a zero yield.
Three Months Ended June 30,
2021 2020
Average Interest/ Annualized Average Interest/ Annualized
Balance (1) Expense Yield/Rate Balance (1) Expense Yield/Rate
(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits in other banks $ 115,322 $ 40 0.14 % $ 220,940 $ 148 0.27 %
Loans, including loans held for sale (2) 2,347,636 30,995
5.30 % 2,332,707 29,911 5.14 % Investment securities and other 469,365 1,719 1.47 % 93,256 495 2.13 % Total interest-earning assets 2,932,323 32,754 4.48 % 2,646,903 30,554 4.63 % Noninterest-earning assets 241,133 228,203 Total assets$ 3,173,456 $ 2,875,106 Interest-bearing liabilities: Interest-bearing demand deposits$ 518,240 $ 159 0.12 %$ 346,220 $ 175 0.20 % Interest-bearing NOW accounts 10,572 1 0.05 % 29,087 18 0.25 % Savings and money market accounts 667,434 691 0.42 % 539,533 825 0.61 % Time deposits 622,390 1,230 0.79 % 719,498 2,927 1.63 % FHLB advances and other borrowings 184,472 972 2.11 % 150,388 558 1.49 % Total interest-bearing liabilities 2,003,108 3,053 0.61 % 1,784,726 4,503 1.01 %
Non-interest bearing debts and
shareholders' equity:
Noninterest-bearing demand deposits 782,158 742,542
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