Stellar Bancorp, Inc. (STEL) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you standing by, and welcome to the Third Quarter 2020 Allegiance Bancshares, Inc. Conference Call. [Operator Instructions] As reminder, this call is being recorded. I would now turn the conference to your host, Courtney Theriot. Ma'am, you may begin.

Thank you, operator, and thank you to all who have joined our call today. This morning's earnings call will be led by Steven Retzloff, CEO of the company; Ray Vitulli, President of the company and CEO of Allegiance Bank; Paul Egge, Executive Vice President and CFO; Okan Akin, Executive Vice President and Chief Risk Officer of the company and President of Allegiance Bank; and Shanna Kuzdzal, Executive Vice President and General Counsel. Before we begin, I need to remind everyone that some of the remarks made today may constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend all such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Act. Also note that if we give guidance about future results, that guidance is only a reflection of management's beliefs at the time the statement is made. Management's beliefs relating to predictions are subject to change, and we do not publicly update guidance. Please see the last page of the text in this morning's earnings release for additional information about the risk factors associated with forward-looking statements. If needed, a copy of the earnings release is available on our website at allegiancebank.com, or by calling Heather Robert at (281) 517-6422, and she will e-mail you a copy. We also have provided an investor presentation on our website. Although it is not being used as a guide for today's comments, it is available for review at this time. At the conclusion of our remarks, we will open the line and allow time for questions. I now turn the call over to our CEO, Steve Retzloff.

Thanks, Courtney. Welcome, everyone, to our third quarter conference call, and thank you for your attendance. This is our third conference call since the pandemic and associated economic impact interrupted the nation's extended recovery from the Great Recession. Although as everyone originally anticipated that the virus, at least as it relates to business interruptions would have been in the rearview mirror by now, we are all receiving forecast that a full recovery will likely extend well into 2021 with some segments even further delayed. Allegiance Bank has played our role to the full success possible as the community bank as we not only supported our pre-existing customers, but extended a helping hand to over 3,200 small businesses in our region through the PPP program who are not our customers. In fact, though we have an approximate 1.5% deposit market share in the Houston MSA, we completed over 7% of the region's PPP loan advances. We continue to work closely with all of these customers through their forgiveness phase, where our customer-facing portal was open during the third quarter with some forgiveness applications already being submitted by September 30. In addition, our customers are hearing from our bankers as we reached out to virtually all of them in late Q3. This extensive outreach was not only constructive for our ongoing loan grading process but further exemplifies our value-added 1 customer at a time approach to building relationships. We are left with an optimistic outlook for the recovery of our customer base while remaining cautious and prepared for stress scenarios. Though we have an active central marketing and PR department, it is every employee, every lender who, in fact, deliver our greatest PR impact. We are proud of our bankers and like our customers are so very appreciative of their selfless efforts. To this point, we have not only received recognition as a top places to work, but have recently been named -- been a top 10 finalist for the National Association of Corporate Directors NHT Award for our commitment to diversity, equity and inclusion. We believe our culture and super community bank strategy are key driving contributors to our past and future growth. We are committed to continuing our strong performance with an unending focus toward continuous improvement of customer and employee experiences that will build excellent long-term value for our shareholders. Our record third quarter results reflect our ongoing progress and disciplined strategies as we ended the quarter with record earnings per share, very low net charge-offs, strong deposit growth and stronger-than-ever capital, allowance and liquidity positions. These earning power improvements is due to meaningfully growing our earning assets while maintaining the strength of our net interest margin and holding the line on noninterest expenses. We believe that our performance and balance sheet well position us as we remain cautiously optimistic given the ongoing uncertainties. I will close my remarks, emphasizing that Allegiance Bank is clearly more nimble than ever related to business continuity. We are accelerating our shift to more paperless and efficient processes and service deliveries and are better positioned than ever to achieve our objective of organically driven market share growth. Next, Ray will describe our loan and deposit production results as well as an outlook on credit, followed by Paul, who will cover our financial results. We will then open the call up for questions.

Thanks, Steve. During the third quarter, our bankers continue to outreach effort to our borrowing customers to get updates on financial condition, perspectives on how the pandemic is affecting their industries, and to continue the relationship development of our new customers as a result of our outsized PPP effort. The scope of this outreach resulted in contact with customers representing $3.6 billion in loans or 79% of our funded loan portfolio. In addition to the outreach put forth by our bankers during the quarter, we saw a nice rebound in levels of new loan originations, continued growth in new treasury customers as a result of the PPP, solid core deposit growth, the reopening of our lobbies for most of our bank offices and launch of a first-class PPP loan forgiveness platform with subject matter experts available to guide our customers through the process, all while being prepared for 2 named storms that were headed our direction. Our bankers have exhibited an extraordinary commitment to get things done and serve our customers, with many also navigating through the challenges of the pandemic at home, including uncertainty with school reopenings, child care needs and taking care of their families. The execution of our business continuity plan has now become a seamless process with minimal disruption to how we conduct business. Whether the pandemic or storm threat, we have the ability, technology and expertise to run the bank as if we were working entirely on-premise. While we have served customers via our drive-throughs and by appointment, since COVID was declared a pandemic, we have reopened 21 of our 28 bank offices to full lobby service and continue to do so, when appropriate, following state and county guidelines. Last quarter, we announced the opening of our 28th bank office located in the historic East end of Houston. This bank office serves a growing and vibrant community and even with the pandemic, there is energy and excitement with what we believe to be a flagship location. We continue to look for opportunities to both further expand our franchise and make sure our existing footprint is optimal for the communities we serve. As a result, earlier this month, we announced the permanent closing of our Anton office located in Northwest Houston, an area where we have other Allegiance offices nearby to serve our customers. In terms of PPP, we are very pleased with our loan results and the impact of our efforts on the Houston region. As of September 30, we funded 6,334 loans, totaling $710.2 million, affecting more than 60,000 jobs. Our approach to provide PPP loans to both existing customers and new customers has further strengthened our market presence. We are now executing on the forgiveness process of PPP and working with our customers to complete the appropriate forgiveness application for further submission to the SBA. While we were pleased with the recent announcement of the simple forgiveness application for loans up to $50,000, we are hopeful additional legislation will provide for an increased threshold to $150,000. Of all PPP loans we originated, 61% are $50,000 or less and 83% are $150,000 or less in terms of number of loans. To date, we have received forgiveness applications for 384 loans, totaling $160 million. Of those, 221 have been submitted to the SBA with 2 having been approved and funds received. Speaking of the SBA. We are extremely pleased with where we stand in several categories of the recently published September 30 SBA fiscal year-end report. In the Houston District, Allegiance Bank ranked third in terms of SBA dollars funded and fifth in terms of number of SBA loans originated. These results include both PPP and 7(a) loans and reflect our continued market share gains and prominence as a leader in providing SBA solutions to business owners in the Houston region. In addition to helping our customers through the PPP process, we also provided assistance to eligible borrowers with payment deferrals on outstanding loan balances of $1.15 billion or 30% of core loans through September 30. Of this amount, approximately $240 million or about 6% of core loans remain on deferral at the end of the third quarter. I will now go over our quarterly results. Total core loans, which excludes PPP loans and mortgage warehouse lines, ended the third quarter at $3.88 billion, a slight decrease of $5.8 million during the quarter. During the third quarter, our staff and lending team booked $280 million of new core loans that funded to a level of $181 million by September 30 compared to the second quarter, when $234 million of new loans were generated, which funded to a level of $148 million by June 30. Paid off core loans were $181 million in the third quarter compared to $171 million in the second quarter and $204 million in the first quarter of 2020. The average size of the new organic core loans generated during the third quarter was $370,000 with an average funded balance of $240,000, which once again reflects our continued focus on building a diverse and granular loan portfolio. The average size of all funded loans ended the quarter at $343,000. Regarding interest rates on loans. Based on total loan amount, the weighted average interest rate charge on our new third quarter core loans was 4.63%, which is below the second quarter 2020 weighted average rate of 4.84% and the first quarter 2020 weighted average rate of 5.11%. The $181 million of paid off core loans during the quarter had a weighted average rate of 5.33%. Carried core loans experienced advances of $96 million at a weighted average rate of 5.19% and paydowns of $104 million, which were at a weighted average rate of 5.03%. All in, the overall period-end weighted average rate charge on our funded core loans decreased 8 basis points, ending the quarter at 5.16% compared to 5.24% as of June 30, 2020. The mix of new loan production based on third quarter funded levels was represented by the following 4 commercial categories: owner-occupied CRE, nonowner-occupied CRE, commercial term loans and commercial working capital loans. These 4 commercial categories represented 73% of the new funded production for the third quarter compared to 56% for the second quarter 2020, indicating our ongoing commercial concentration. In terms of our overall loan portfolio, the loan type mix was little changed on a linked-quarter basis. The slide deck posted on our website provides added color regarding our overall mix of loans. I would now like to provide some additional information on 3 loan categories that could have heightened risk due to energy prices and/or the COVID pandemic. Those being our oil and gas portfolio, our hotel portfolio and our restaurant and bar portfolio. Despite being a Houston region bank, our overall exposure to oil and gas is largely indirect as we do not have any reserve-based loans. So we have defined the category to be any borrower that operates in or directly supports the upstream, midstream or downstream segments of the industry. As of September 30, this category is approximately 1.6% of our funded loans or $74 million, of which $27.6 million was commercial real estate and $44.4 million was C&I. Of the $27.6 million in CRE, the weighted average LTV for the portfolio was 55.1%. A 20% stress testing of the most recent appraised value plus 6% marketing expenses resulted in an overall collateral deficiency of approximately $397,000 increasing to $1.2 million at a 30% stress test. Regarding our hotel portfolio. At September 30, we had $134 million of hotel loans, of which, $124.6 million was commercial real estate, $10.8 million was C&D and $2.9 million was in C&I. Of the $124.6 million in CRE, the weighted average LTV for the portfolio was 59.4%. A 20% stress testing of the most recent appraised value plus 6% in marketing resulted in an overall collateral deficiency of approximately $1 million, increasing to $5.4 million at a 30% stress test. And regarding our restaurant and bar portfolio. At September 30, we had $117 million of restaurant and bar loans, of which $82 million was commercial real estate, $3.5 million was C&D and $31.5 million was C&I. For the $82 million in CRE, the weighted average LTV for the portfolio was 59.9%. A 20% stress testing of the most recent appraised value plus 6% marketing resulted in an overall collateral deficiency of approximately $1.5 million, increasing to $5.6 million at a 30% stress test. Asset quality at quarter end remained in a manageable position. The level of net charge-offs experienced during the quarter was $291,000 or an annualized rate of 3 basis points. Nonperforming assets, including both nonaccrual loans and ORE, into the third quarter similar to the second quarter, increasing slightly from 77 to 78 basis points of total assets. Nonaccrual loans increased a net of $4.7 million during the quarter, from $33.2 million to $37.9 million, primarily due to $7.1 million in new nonaccrual loans, including a $3 million land loan that has matured and is pending financing from a different bank. The additional $4.1 million increase in nonaccruals was from 16 relationships, 3 of which totaled $2.7 million and the remaining $1.4 million was from 13 smaller relationships. These downgrades were partially offset by $1.9 million in payoffs and payments and $421,000 in charge-offs. ORE decreased to $8.9 million during the quarter compared to $11.8 million for the second quarter, primarily due to write-downs of $1.9 million. The $8.9 million in ORE consists of 4 properties, with the largest a $4.4 million commercial real estate property. The second-largest is a $3.7 million industrial commercial real estate property, and the third-largest is $576,000 residential property. The remaining property is in Beaumont. These properties are actively being marketing with the 2 largest properties in contract negotiations for potential sale. Generally, we believe our nonperforming assets are well collateralized. In terms of our broader watch list, our classified loans as a percentage of total loans increased to 2.4% of total loans as of September 30 compared to 2.06% as of June 30. Criticized loans increased to 5.16% at September 30 from 3.20% at June 30. Specific reserves for impaired loans ended the quarter at 15.7% compared to 12.1% at June 30. On the deposit front, we saw an increase in total deposits in the third quarter by $216.7 million from the second quarter and up $1.02 billion over the year ago quarter. The increase during the third quarter was primarily in money market and savings accounts. The increase over the prior year was primarily in the noninterest-bearing deposit category as a result of new accounts associated with PPP customers as well as higher balances in our carried accounts. Noninterest-bearing deposits increased $18.6 million during the third quarter and were up $44.9 million over the year ago quarter. With that, our noninterest-bearing deposits to total deposit ratio was 36% for September 30, 2020, compared to 37.3% for June 30, 2020, and 31.5% for the year ago quarter. We seek to continue our track record of keeping this ratio at or above 30%. With regards to the pandemic and COVID statistics for the Houston area, as of October 26, Harris County reported 158,758 total confirmed cases and 2,190 total deaths. Contrary to the trends in the broader U.S., Harris County is experiencing both percent of positive deaths and ICU beds occupied by COVID patients at levels well below the peak highs in July. While our trends are headed in the right direction, we remain highly focused on health and safety. During the quarter, the Governor Abbott increased the capacity limit for most retail businesses from 50% to 75%. We remain cautiously optimistic of progress towards the economic recovery in the Houston region, while staying focused on our borrower profile of small- to medium-sized businesses and the resulting granular portfolio with diversification across industries. I now turn it over to our CFO, Paul.

Thanks, Ray. We're very pleased to report record Q3 net income of $16.2 million or $0.79 per diluted share, up from $9.9 million or $0.48 per diluted share in the second quarter and up relative to the $12 million or $0.57 per diluted share posted in the third quarter of 2019. Adjusting for that $1.9 million in OREO write-downs, net income would have been $17.6 million or $0.86 per diluted share in the quarter. Pretax provision income for the third quarter was $21.2 million compared to $22.6 million in the second quarter and $17.7 million for the year ago quarter. Adjusting for that $1.9 million in OREO write-downs, pretax provision income would have been a record $23 million for the third quarter. Net interest income was the key driver to our pretax provision earnings power in the quarter, where we saw net interest income increased $1.1 million or 2.1% to $51.9 million from $50.8 million in the second quarter, primarily due to lower interest expense and the impact of additional income from our larger securities portfolio in the quarter. Total interest expense decreased by $703,000 while total interest income increased by $359,000 during the third quarter. The impact of acquisition accounting accretion continued to decrease in the third quarter. Accretion increased loan income by $516,000 and reduced CD expense by $82,000 for a total positive effect on net interest income of $598,000 during the third quarter versus a total positive impact of $666,000 in the second quarter and $2 million in the year ago quarter. This quarter's accretion leaves $3 million in the loan mark and $281,000 in the CD mark. Yield on loans in the third quarter was 4.89%, impacted by both the full quarter impact of average PPP loan balances in our average earning assets and lower purchase accounting accretion as compared -- this compares with 5.13% for the second quarter and 5.73% for the year ago quarter. Adjusting for acquisition accretion, yield on loans would have been 4.84% for the third quarter, 5.08% in the second quarter compared to 5.53% in the year ago quarter. Excluding PPP loans, yield on loans would have been 5.25% in the third quarter versus 5.44% in the second quarter. The total yield on interest-earning assets was 4.58% for the third quarter, down from 4.83% for the second quarter and 5.43% for the year ago quarter, reflecting the aforementioned effect of PPP balances in lower accretion income as well as higher average securities balances in the earning asset mix. Excluding PPP loans, total yield on earning assets would have been 4.85% for the third quarter versus 5.07% in the second quarter. Our cost of interest-bearing liabilities continued to decrease in the third quarter to 105 basis points from 119 basis points to the second quarter and 188 basis points to the year ago quarter. The overall cost of funds for the third quarter were 69 basis points versus the 79 basis points posted in the second quarter. We are pleased to deliver lower cost of funds, and we expect to continue to improve our funding costs in the current interest rate environment. Notwithstanding such significant average balance mix shift towards lower-yielding PPP loans and securities, we are really proud to have maintained a solid taxable-equivalent net interest margin of 3.95% in the third quarter as compared to 4.10% in the second quarter and 4.16% in the year ago quarter. Excluding PPP loans and related revenue, net interest margin would have been 4.12% for the third quarter. Going forward, we feel well positioned to maintain a strong net interest margin as we seek to further optimize our funding mix and maintain discipline on loan pricing. Our noninterest income increased $1.9 million for the third quarter from -- increased to $1.9 million for the third quarter from $1.6 million for the second quarter. This was largely due to differences in gains and losses on the sales of securities and OREO between the quarters. Otherwise, noninterest income was stable quarter-over-quarter. Total noninterest expense for the third quarter was $32.6 million compared to $29.7 million in the second quarter. The difference is largely attributable to the $1.9 million of write-downs on other real estate owned in Q3, but we should also note that Q2 featured deferred costs related to PPP loans recorded in the second quarter that lowered the salary and benefits line by $1.6 million. While on the topic of PPP loans and income statement impact, we should note that we expect to recognize approximately $21 million in aggregate origination fee income and approximately $1.4 million in remaining aggregate deferred origination costs into the yield over the life of the individual PPP loans. As we experienced SBA forgiveness or early payoff on individual loans, we look forward to accelerating the recognition of the remaining origination fee income and costs. The efficiency ratio for the third quarter was 60.38% compared to the 56.92% we posted for the second quarter and 62.88% for the prior year quarter. Note that if you to -- if you were to adjust the third quarter's efficiency ratio for the OREO write-down, it would have been 57.13%. The provision for loan losses was $1.3 million for the third quarter compared to the provision we took in the second quarter of $10.7 million. Our year-to-date provisions totaling $23 million brings our allowance for loan losses to $48.7 million, representing 106 basis points on total loans. If you were to include the $3 million in loan mark remaining on acquired loans and exclude the PPP loan balances, the ending allowance plus loan mark to core loans would be 133 basis points. As we mentioned in the first quarter call, we elected to take the relief that came with the CARES Act, and we deferred the implementation of CECL. So the reported allowance is under the current incurred standard. Bottom line, our third quarter ROAA and ROATCE metrics came to 1.09% and 12.72%, respectively. And that's with the OREO write-downs in the quarter. Quarter end tangible book value per share was $24.97 which makes for an increase of approximately 10.4% since year-end 2019, which we're pretty proud of, notwithstanding how turbulent in 2020 and so far. While COVID brings about significant economic uncertainties, we are buoyed by our strong margins, recurring earnings power and capital position as well as our prospects for accelerated revenue recognition for PPP forgiveness in the next couple of quarters. All in all, we feel well positioned as we navigate the current economic environment. We feel confident about our ability to maintain a strong capital position and our dividend. To that end, our Board of Directors declared a $0.10 dividend on October 22. I will now turn the call back over to Steve.

Yes. Thanks, Paul. Really great numbers. With that, I will now turn the call over to the operator to open the line for questions.

[Operator Instructions] And first question comes from Brad Milsaps from Piper Sandler.

I wanted to maybe start with the net interest margin. Ray, it sounds like you're starting to see a little bit more pressure on loan yields. I understand you still got some tailwinds on the deposit side of things. But just kind of taken all together, would you guys, to the extent you continue to grow loans, expect, probably not on balance, which you saw in the third quarter, but just incremental pressure from here as you kind of move into 2021?

Yes, Brad, I think there -- we may see a little more pressure, and we're getting to a point where we're hopeful that we start getting to what maybe -- might be a floor, but I think there's still competitive pressure out there. And we dropped quarter-to-quarter 21 basis points in new loans and the new -- and the rate on new loans booked. And that delta did close a little bit from previous quarters. So hopefully, with the pressure, it may not be as much, but we're still seeing competitive deals, and we may have a little bit more pressure. But we were very pleased with the level of new loan originations for the quarter. It was a nice rebound.

And I might add, a lot of the delta in NIM from the second quarter to the third quarter was really structural in nature. And it's largely a function of kind of the new loan, I guess, you could say, with the earning asset mix. We did see signs of stabilization during the quarter, but there is potential for stress. The levers that will drive kind of the forward NIM profile is going to be the extent to which core loan growth can accelerate to kind of change and kind of get us back to a similar earning asset mix or closer to kind of the prior normal from the new normal. But as we're feeling and the rest of the industry is feeling, I guess we're going to get the test of whether there can be too much of a good thing as it relates to excess liquidity on our balance sheet. And we really saw that stair-step move here in this quarter, but we hope we're doing everything we can to predict our margin notwithstanding pressures that out there.

And that said, it's Steve. The weighted average rate in the third quarter of $463 million is some pretty rare error from a lot of the numbers we're hearing out there in terms of -- and we did $280 million of that. So we're -- due to our granularity and focus, we're still able to get, relatively speaking, very good rates.

Yes. Just curious, yes, that was sort of my follow-up is, Ray or Steve, is there sort of a line in the sand that you draw? I mean, what you guys do is pretty unique. Obviously, you want to get paid for the risk you're taking with some of the smaller credits? Is there a level that you guys sort of won't go below? Or at this point, you're just kind of thinking kind of what's out there in the market?

Yes. We're pretty disciplined with our pricing model on our -- on what the rates we offer. We're seeing some 3-handle, even some 2-handle type rates out there. We're probably not going to play in that game, especially for -- when some of these are beyond 5-year fixed rate terms. So kind of the blocking and tackling type lending that we do. I think it should still be in this general range. And if something's coming in with one of these 285 or something that we're probably not going to have a lot of discussion about it. It's a risk-return decisioning as well. And so we always look at risk when we're pricing out loans.

Got it. And just continuing with the margin, Paul, just kind of a housekeeping item. I try to back into it, but were the fees that you recognized with PPP this quarter, right -- just under $3 million, is that the right number? And if I understand correctly, you still have $21 million yet to come?

It's probably closer to $4 million. And if $21 million, you got to net out by, I think, the -- around...

$1 million.

$1-and-change million of deferred costs. So what's less net of deferred cost is just under $20 million to recognize over the remaining life of those loans unless we get reason to accelerate.

And the $4 million would be inclusive of the 1% coupon, right?

Yes.

Yes. Okay. And then just finally on credit. Just -- you guys do a lot of SBA lending. I'm curious if you guys have kind of what percentage of the portfolio is maybe coming off of that 6-month period where the SBA was paying -- making payments on behalf of those customers and sort of kind of how that relates to maybe some of your deferral numbers and how you think about provisioning, if there is any impact at all kind of going forward?

So Brad, it's Okan. Yes, the bulk of our SBA portfolio is actually coming off of the payments that are being received so far. And at end of September, October is where we're seeing that. So we will -- we've been in touch with our customers in the SBA portfolio, and we're seeing some determined requests that are coming in in that portfolio. But overall, the -- between the support that they've received from these payments, PPP monies, idle funds and as well as deferment availability through the bank, the SBA portfolio is holding off fairly well.

And our next question comes from Matt Olney from Stephens.

[Audio Gap] of the level of operating expenses and the run rate from here?

Certainly, yes. Reasonable guidance would be to take that Q3 number and adjusted as OREO expenses. And there's some seasonality and some modest growth to be expected from the but we're working to hold the line as much we can on expenses, really just cognizant of the challenged revenue environment.

Yes. That was maybe my follow-up question was just kind of bigger picture on expenses and the opportunities you see there to cut back on expenses. And as think you mentioned the branch closing, did note there were more opportunities there? And then are you still committed to the new hires that you've been doing now for a number of years?

I'll touch on the branch in the hirings, Matt. The -- probably near term, as far as the further consolidation, not see much near term, but we look -- we constantly look to make sure our footprint is optimal, both on -- as far as consolidating and/or maybe even in long-term, other markets where we do not have the presence. And then on the hiring, we are -- it did slow down a little bit in 2020, but we still, through September, we had 6 producers plus 2 internal promotions from our officer to the lender development program. And we're having meetings every day with -- not every day, but meetings throughout -- regular meetings with potential talent that we're considering. So it's definitely slowed down. It's not so much of a -- this is what we're going to target. It's just when that -- when we have strategic opportunities for talent, we will make that investment.

And want to emphasize too, that we have some kind of embedded capacity with our lending staff at the present time as well to help drive further growth. So some of the younger ones, some of the newer entries into the company still have room to certainly build their portfolio. So there is definitely capacity there. Okan probably had some comments about the productivity.

Yes. I think we can -- we also have some operational efficiency and productivity gains initiatives that are ongoing. Since the beginning of the year, we've deployed our electronic deposit origination solution and loan origination solution that during the funding of the PPP, we saw great adoption from our employees and our customers with those solutions. And they will be actually fully deployed in the first quarter of 2021, where we expect significant process improvements in these functions. We're also building under our CIO's office, a team -- a solutions team that's going to be focusing all through 2021 on additional operational efficiency and productivity gains areas. And so there's some additional expense control that we anticipate from those initiatives.

All right. And then, I guess, switching gears. I think Steve and Ray both mentioned the success of the PPP program for the bank and a big chunk of the -- of your originations went to new customers. How should we think about converting those new customers into loan growth outside of PPP in the future?

What I wanted to just say as fast and as thoroughly as possible. That's how you should think about it. We are all over it. We're evaluating those customers in terms of our outreach to each one of them. Our treasury management group is getting in touch with them through the lenders, and Ray can give you some additional detail. But we're definitely seeing that for ourselves as a great opportunity. I mean it's really one of our strongest opportunities to grow organically and kind of moved our kind of loan-to-deposit ratio -- core loan-to-deposit ratio back up to the levels that we like to see.

Yes, Matt, I would just say that where it starts on the conversion is going to be on the deposit side, and then that will manifest to the loan growth piece. So we're working to convert those customers to full business customers starting with treasury. And when we look at our numbers of onboarding, we've got -- every quarter has been a -- since the pandemic and the PPP, we've had a really solid percentage of onboarding this new -- the new PPP customers. So our bankers are in front of those PPP and there'll be loans coming from that. The kind of the first step is getting the -- on the deposit side.

And even the testimonials from those guys are of value as they say, they weren't able to get the response they were looking for until they turn to Allegiance, and those testimonials are actually good referral sources for us.

Our next question comes from David Feaster from Raymond James.

Deposit growth has been tremendous. I was just curious how much of this has been from the PPP dollars? And how much you estimate that still might be in there? And then how much might be just from the treasury management team or clients holding cash? And what's the early read on the fourth quarter? And how sticky do you think these deposits are going to be as we go through 2021?

So David, on the -- I'll just give you something that you can maybe extrapolate it. But on the -- when we look at the deposits that were brand-new related to PPP because those are -- we can certainly track those, which is a little different than PPP that was to an existing customer. There's something like 20% of those balances might still be here, and that's about half of what the PPP volume was to new customers. So most of our deposit growth has been, what I would say, replacing and then in excess of some of the PPP funds that have come out of the bank. Does that help you?

Okay. That's helpful. And then I guess, how do you think about the reserve going forward? You grew another 2 basis points ex-PPP. I guess, do you think we're there in terms of reserve builds? Or maybe in the fourth quarter, what should we expect kind of a true-up as you implement CECL? Or does your model pretty much already contemplate that through the Q factors?

Good question, David. I'd say kind of reflecting on CECL, we will -- we've got a pretty significant reserve build thus far this year, totaling around $20 million when you go point-to-point. We will be operating under CECL in the fourth quarter, and that will also be taking into account our day 1 adjustment at 1/1/2020. If you guys recall, we gave guidance to around what that was relative to our 12/31 number, it was about 1/3 or so. So really, when you take the totality of where we are, I don't see huge potential for kind of a true-up or catch-up, so to speak. But -- and it's hard to kind of predict what our 12/31 model is going to stay here at the 29th or 30th of October. So ultimately, I don't see there being a huge true-up. But we're going to go based on our model methodology as of 12/31, and it will be kind of our first run -- I guess, second official run with CECL. So we don't have so many reps to tell you -- to really be in a position to predict that right now, but our expectation is not for a huge true-up.

Okay. Got it. And then maybe just one of a high-level question. Just as I step back. I mean, it seems to me like this environment really reinforces kind of your structure and your business model. I guess I'm just curious, how do you think about your posture here? Maybe what lessons have you learned that can help you position even better going forward? And maybe what you're most excited about? Or what initiatives do you think are really going to allow you to outperform your peers going forward?

Well, let me -- I'll let probably everybody chime in here, David. But on the -- what we're extremely excited about is this market share opportunity that we have through PPP. I mean we've got -- we are well positioned with both our lending staff, those new customers that we've -- that we're converting over from PPP. Our brand awareness in the market, it's -- I mean it's growing every day. I mean we talked about us being third in number of PPP loans. I mean that is -- I mean we're talking, as Steve mentioned, we said 11th in deposit market share, and we're cranking out numbers on -- in some metrics that are third in the MSA, which is mostly controlled by out-of-state banks, large banks. So we think there's tremendous opportunity there, and we're hitting it hard. And we're extremely proud of where we sit and where we're positioned.

And I might add, it's really hard for us, right, from where we sit now to really forecast how the loan growth story is going to play out. But we really do feel as well positioned as anyone in our market to get more than our fair share of whatever loan growth there is going to be out there. And that's between the momentum we have and the embedded capacity that Steve's referenced in our team.

Yes. I'm a little bit more boring. And I think guys in our office kind of see me that way as well. But it's just -- we're at 80% roughly core loans to deposits. We need to grow that a little bit. That any incremental gains there over the next year are going to just accrue right to the bottom line as we control our expenses, continue to grow the bank's footings and do the right things with regard to capital management as well. I mean it's a little here, a little there, tuck here, tuck there, and we're going to improve our overall performance. So that's a boring answer, but -- and like Ray said, I think our brand is really taking off. It's been 13 years now. We just celebrated our 13th birthday. And the name Allegiance Bank is getting better and better known every day, particularly with response that we gave to the PPP and the small business customer. So we're pretty encouraged.

[Operator Instructions] And our next question comes from John Rodis from Janney Montgomery.

Interesting times for sure. Just -- most of my questions were asked and answered. But just one question on the securities portfolio. You guys continue to grow that during the quarter. And I'm sure it's a function of what's going on in the loan portfolio and deposits. But how should we think about the size of that portfolio going forward?

We like the where -- the size of it as it currently stands. We don't see -- we don't want to be growing it too much from here, but to the extent we are -- we do grow. It's largely going to be a function of this largest in liquidity. So we'd obviously rather be putting our excess liquidity into loans. We like the overall size. We currently kind of think the overall size of our securities portfolio is optimal. But if we continue to have too much of a good thing as it relates to excess liquidity, we will start to -- we will continue to grow that portfolio, but it will be kind of like holding our notes while we do it because we would much rather put it in loans. But when push comes to shove, the net results up to this point of this kind of generational customer acquisition opportunity, that is PPP, has actually been more deposits. And that's important. We're in the customer acquisition business, first and foremost. Right now, it's manifesting itself in more deposits. 2 years ago, it was manifesting itself in excess loans. So we'll take the customers and we'll serve them well, and we'll really pivot our balance sheet accordingly.

But yes, if I say that the pressure on investment yield and that excess liquidity does embolden us to really be disciplined when it comes to deposit pricing. So we'll -- our team is well aware of those investment yields.

Yes, that's a good point. We do have -- we do have ways to go as it relates to kind of improving our cost of funds, and we're being pretty assertive about that. Of course, not being mindful not to offset the ample part, but we're driving incremental improvements.

Sounds good. And just one other question. Just On the topic of M&A, just any thoughts there? Have you had many discussions? What are you seeing in the market today?

We stay in touch with the local bankers in the other companies around here and on a regular basis, a lot of good banks. There's -- everybody has been kind of in a wait-and-see mode in this past during the pandemic, just due to that kind of uncertainty. So I think it will probably be a market where you'll start to see some activity in 2021. Maybe some conversations heaten up a little late -- maybe even early '21, but there's nothing to announce at this point.

It does take due to tango. So it will be a function of how that -- how it works not only for folks like us for potential buyers, but also people on the other side of that.

I'd just say if there's any of our smaller brother in listening today, we love them.

And our next question comes from Matt Olney with Stephens.

Yes. Just a follow-up on the OREO write-down that you guys had this quarter. Any color you can provide about -- which property that was? Any color at all?

A lot of color. I mean it's just a process. It's a discipline on our part to mark our ORE to current market valuations. And we do have -- on the 2 large pieces, which is the vast majority of our ORE, we do have some negotiations underway right now. We're optimistic about being able to reduce that ORE balance significantly. But it hasn't happened yet. So -- but we're -- the more we're with those properties, the more we're aware of the proper valuation, things changed and the world changes around as one had some COVID-related pressure on it because of the nature of the property and the other one has been on the books for a while. It kind of had a little bit of an oil and gas history to it. So we just -- we think we're at the right level right now on those properties. And again, experience teaches you what those values should be.

Okay. And then any update on the hotel loan that's on nonaccrual. I think it was -- the balance is around $7 million in 3Q, I think it was a similar amount to last quarter as well?

No update. I'd like a lot of Houston, the occupancy, the RevPAR is still challenged, we feel like we're properly reserved on that though. So we keep watching it and we got -- hoping for the best for that particular property. More broadly, we are seeing a little bit of RevPAR increase across the board, although as it continues to be challenging in this market kind of more broadly. There are actually -- some of our properties are doing rather well, but that had a little surge over the summer in Galveston or a couple of other locations. But generally speaking, the experts tell us that it's just going to be a gradual improvement through '21 and even into '22 before the hotels will get better.

Okay. And I know that you still have your script in front of you from prepared remarks, but the level of criticized loans. I want to make sure I got that right. I wrote down the level at September 30 was 5.16%, up from 3.20%. Did I get those numbers right?

Let me look. Ray, did you have on hand. I got it here.

Page 10. So you say criticized, Matt?

Criticized, Yes.

Yes. 5.16% from 3.20%.

Got it. And as you look at that linked-quarter change, any notable takeaways as far as types of credits? Or is it mostly this COVID hotspots we'd be talking about and for you guys has been, what, oil and gas, hotels and restaurants?

So this is Okan. In the third quarter, the largest migration we saw in our portfolio is in the hotel portfolio that's impacted these numbers significantly. Having said that, the overall portfolio, when you look at the hotels, we have 32 loans currently under deferment out of the 81 hotels. So in our conservative underwriting with hotel loans is putting us at an average weighted LTV at 59%. So we're watching this portfolio closely, but that's where we're seeing the most amount of impact on our citizens.

Yes. The hotel industry, the job loss was there and so is it with the restaurants. The hotel is recovering slowly, but it's more -- it's very well collateralized. The restaurant industry had more -- is actually recovering corner Houston data, 60% of the jobs lost in the restaurant and bar industry are actually recovered. So while you have both some C&I and some CRE in that, you actually are having better performance because the governor's opened up those categories. So we feel relatively good about both at this point in time.

Okay. And then, Paul, I think the tax rate was a little bit higher in the third quarter. What's the outlook on the effective tax rate?

It is going to figure a little bit with respect to some of our tax preferential securities have grown, but I think of something with a '19 handle as a more normalized number.

Thank you. And that does conclude our question-and-answer session for today's conference. I'd now like to turn the call back over to Steve Retzloff for any closing remarks.

Just want to continue to thank and appreciate everybody for your time and your interest in Allegiance. We look forward to speaking to you next quarter. So thank you very much. Appreciate it.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect.