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Veritex Holdings Inc (VBTX) Q3 2020 Earnings Call Transcript

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Veritex Holdings Inc (NASDAQ: VBTX)
Q3 2020 Earnings Call
Oct 28, 2020, 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the Veritex Holdings' Third Quarter 2020 Earnings Conference Call and Webcast. [Operator Instructions]

I will now turn the conference over to Ms. Susan Caudle, Investor Relations and Secretary to the Board of Veritex Holdings. Ma'am, you may begin.

Susan Caudle -- Investor Relations and Secretary to the Board

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 two.

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'll now turn the call over to Malcolm.

Malcolm Holland -- Chief Executive Officer

Thank you, Susan. Good morning, everyone. I hope you're continuing to stay safe and healthy during these kind of crazy days. The pandemic continues to be top of mind, but we are learning to deal with the new normal and still run our business in a profitable and efficient way. We have seen our state continue the opening process in all areas of life. We have only had a handful of infections in our bank, and we have slowly and methodically begun the process of moving our employees back to our offices. Today, we still have approximately 48% of our staff still working remotely. The third quarter was a very good quarter for Veritex.

For the first time in six months, we feel we are seeing some clarity on our credit since the pandemic started, and we are starting to see some positive movement in many areas of our business. As has been our history, we will continue to be transparent with our results and granular with another deep dive this quarter into our at-risk credit portfolios and related metrics. For the quarter, we announced operating earnings of $22.9 million or $0.46 per share, an increase of $0.03 over the previous quarter. This includes a provision of $10.1 million, down from the previous quarter of $19 million. Our pre-tax pre-provision continues to be one of our strongest metrics, delivering $39.3 million or 1.82% return on average assets for the quarter and 1.96% for the year 2020.

Concerning our philosophy on the provision, we continue to believe that prudence would have us take a continued critical look at our quarterly provision. Our analyst -- analysis has allowed us to continue to build our loan loss reserve to 2.1% of total loans, excluding PPP and mortgage warehouse. From a growth standpoint, we continue to see new opportunities in both C&I and the CRE space. For the quarter, we saw annualized growth over Q2 of 4.4%, excluding mortgage warehouse and PPP. Our mortgage warehouse continues to benefit from a very hot mortgage market, growing $103 million or 23% on linked quarter. Our pipelines are continuing to build as businesses in Texas are becoming more confident in the economic conditions, and we look for some added growth in the fourth quarter.

We classified prospects in our pipeline into three categories based on their progress, term sheet, underwriting and approved. We also track projected payoffs. Our analyst -- analysis from mid-July to mid-October 90 days shows significant increases. Approved loans were up 156%. Loans in underwriting are up 135%. Term sheets are up 120%, while projected payoffs are up 53%. Obviously all these opportunities do not turn into loans, but it does give you an idea that things are starting to turn more positive.

Now for just a few high-level comments on credit. During the call -- during the quarter, we did see our NPAs increase from 0.62% to 1.11%. At the same time, we saw our pass-through numbers return to lower than pre-pandemic levels and a big decline in deferrals, which currently stand at 2.3% of total loans. Net charge-offs were still somewhat muted during the quarter, but as we expect some further migration, we anticipate charge-offs moving higher in Q4 than the first half of 2021.

Clay will give you some specifics on credit in a moment, but I'll now turn the call over to Terry for our financial update.

Terry Earley -- Chief Financial Officer

Thank you, Malcolm, and good morning, everybody. I want to spend a few minutes on the Q3 financial results and then cover capital and liquidity. On Page seven, you'll see multiple graphs. First is our quarterly trend in EPS. Given the rate environment and the continued build of our ALLL, we're excited to report $0.46 per diluted share and surpass consensus expectations. Below that, you will see the return on average tangible common equity. Other than Q1 2020 when we had a significant build in the ALLL to deal with the pandemic, we have generated very strong operating returns, including 13.3% in Q3.

The return on average assets and pre-tax pre-provision return on average assets trend is in the top middle graph. Veritex has delivered a robust pre-tax pre-provision operating return on average assets for the last six quarters. In Q3, it was 1.82% and has come down given lower market interest rates, but remains one of the greatest strengths of our economy. Second, below that is the operating efficiency ratio, which shows that we have been at or below 48% over the last five quarters, while adding significant talent to the company. This low efficiency ratio achieved through our branch-light business model is the key to maintaining our strong pre-tax pre-provision earnings. Tangible book value continues to grow organically and now sits just over $15 at $15.19.

On to Slide eight. Net interest income was essentially flat from Q2 to Q3 at $66 million. The GAAP net interest margin expanded one basis point to 3.32% in Q3. Lower loan yields negatively impacted the NIM by 14 basis points. Remember that our loan portfolio is 2/3 floating and the primary index is one month LIBOR. Efforts to reprice deposits contributed nine basis points to the NIM. We believe there are additional opportunities to continue to drive deposit rates lower. The Q3 resolution of our largest PCD loan, including the forgiveness of substantial accrued interest, negatively impacted the NIM by four basis points. This was offset by higher purchase accounting adjustments of three basis points.

Also worthy of note in Q3, our loan production carried a weighted average rate of just over 4% at 4.06%, and our Q3 interest-bearing deposit production was right around 30 basis points. Next, there are two primary factors which should help the NIM to improve in Q4 2020 and beyond. First, we have $1.2 billion in CD maturities over the next four quarters. These mature at a rate of 1.29% and should be renewed at a rate of about 30 basis points. Second, forgiveness of PPP loans and the redeployment of this asset into higher-yielding asset classes. For Q3, the PPP portfolio represented a 12 basis point drag on the NIM. Approximately 25% of the outstanding PPP loans have submitted applications for forgiveness.

Another 20% is under $150,000 in loan size and is eligible for blanket forgiveness. The remaining 55% will likely stretch into 2021. Moving on to Slide nine and deposits. Veritex had another strong quarter on the deposit front, as transactional deposits grew $120 million or over 10% annualized. The mix of the deposit portfolio has improved significantly since the beginning of 2019. And noninterest-bearing deposits are at 31% of total deposits, and the reliance on time deposits has dropped to just under 24%. The graph in the bottom left of the page shows the trend in quarterly deposit cost. Average cost of total deposits declined by 13 bps and now sits at 46 basis points. Looking past the third quarter, the table in the bottom right corner of the page shows the time deposit repricing opportunity by quarter that I mentioned earlier.

On Slide 10, another strong noninterest income quarter with $9.8 million in revenue. This result was led by our government guaranteed business, excluding PPP fees which we recognized in Q2. This was the strongest quarter for that line of business since Q1 2019. Production is up, pipelines are stronger, and gain on sale premiums have increased substantially since rates fell so dramatically in Q1. We also had improved quarters in treasury management fees and mortgage origination fees. Expenses on the graph on the right side of the page were down in Q3 and very much in line with management expectations. Now on to Slide 11, which focuses on our allowance for credit losses. This slide lays out the impact from CECL on each loan pool for Q2 and Q3.

Forecasts of Texas unemployment and GDP are the key economic inputs into our seasonal model and are supplied by Moody's. Focusing on the column labeled at September 30, 2020, the improving economic outlook, coupled with weighting of the forecasted scenarios, combined to positively impact our allowance for credit losses on pooled loans to the tune of almost $3 million. We increased our specific reserves on nonaccrual loans to $18.9 million or a reserve level of approximately 21%. Clay will go into additional depth on the NPLs in a minute. Additionally, our reserves for PCD loans declined $4.1 million, driven by the resolution of an approximately $14 million lending relationship.

This resolution came in better than our specific reserves in the range of $450,000 to $500,000 even after the forgiveness of interest that was previously discussed. While NPAs were up during the quarter, it was nice to see such a large PCD loan resolution with favorable economics. As in prior quarters, in addition to the loss history and the economic forecast, we also added in qualitative factors that increased our final allowance by 38 basis points up to 2.10%. Additionally, we still had $18 million of loan interest rate marks on the balance sheet from the Green acquisition. This translates into 31 basis points of additional cushion on the inquired portions of our portfolio.

On to Slide 13. Capital ratios at the holding company and bank started the quarter from a strong position and were generally steady on a quarter-over-quarter basis. The exception is the leverage ratio, which grew about 30 basis points. Tier one capital increased almost $21 million, and total capital increased over $25 million. We declared our regular quarterly dividend of $0.17 per share or a 37% payout ratio after considering the risk profile of the balance sheet and the potential loss content in the loan portfolio. Also, we're acknowledging our intent to resume our share buyback. We have $31 million remaining on the prior authorization, and that now expires March 31, 2021.

Finally, subsequent to the quarter end, Veritex issued $125 million in subordinated debt, with a fixed interest rate of four 1/8 for the first five years. This will add 130 basis points to our total capital ratio. Slide 14 shows that liquidity remains very stable and robust.

With that, I'd like to turn the call over to Clay for the discussion on credit.

Clay Riebe -- Chief Credit Officer

Thank you, Terry, and good morning, everyone. I'd like to begin my comments on Page 17 in the deck that highlights the status of deferrals in our loan portfolio. As Malcolm mentioned, deferrals have dropped from a peak of 20.9% of the portfolio to 2.3% as of October 22. As you would expect, the majority of our remaining deferrals are in the hospitality portfolio, with the rest spread fairly evenly across the book. The reduction in deferrals, combined with the reduction in past due credit, are positive indicators for future credit migration in my view. The third quarter saw a migration of $43 million in credit to NPA status through our continued surveillance of the loan book.

Page 18 in the deck highlights the 10 largest NPAs, which we have in the book, which make up 80% of total NPAs. Our goal here is to provide some granularity so that you get a flavor for loans and NPA status. I'd like to cover the top three loan relationships with some additional color. Our largest NPA is two real estate secured child care centers. This relationship has been in NPA status since fourth quarter of '19 when the loans exceeded 90 days past due from the bankruptcy of the former tenant. The borrower has spent the last nine months obtaining control of the collateral property from the former tenant through a bankruptcy court and replacing the tenant with a new child care center operator.

That was accomplished in the third quarter, and the loan was restructured with the addition of the new tenant. We expect this loan to continue to perform, but as a TDR. The second loan relationship is a three-building office project. The project was on track until COVID hit, and they lost several tenants, which reduced cash flow to the point that the property could not service debt. A major lease to a GSA tenant has been executed, and the TI work is being done with expected occupancy for this tenant to occur in the first quarter of '21. This is a game changer for the project and will allow the project to be liquidated in '21 with no expected loss to the bank, given the current LTV of 76% from an appraisal completed this summer.

The third relationship is a C&I relationship that provides wholesale parts to contractors in the refining and midstream sectors. Revenues of the company have decreased significantly since the company was acquired in 2018. Although the company was current on payments as quarter end, all indications are that the company will not be able to continue to service this debt, and there are questions as to the viability as a going concern. It's important to note that 46% of all NPAs were not past due at quarter end. Page 19 provides a summary of the third quarter pandemic portfolio review as well as the second quarter risk rating project summary. We did a very deep dive on the portfolio in Q2 that covered 55% of the loan book and focused on relationships in high-risk industries, loans receiving deferrals and relationships receiving PPP loans.

We carried on that work in the third quarter, with a review of relationships that had received a new referral [Indecipherable] had change in risk rating between March 31 and August 30 within the C store business who had busted a covenant or borrowing base recently. Our third quarter risk rating review covered $1.9 billion or 15.9% of the committed book. We have credits moving both ways, as you would expect, with actually more credits being upgraded than downgraded during the process. Less than 1% of total commitments were downgraded to a criticized risk rating as a result of the effort, with downgrades evenly split between special mention and substandard. We will continue to make credit surveillance our main priority as we manage the loan book.

We've been encouraged by our discussions with our regulatory agencies as we reviewed our risk rating efforts in our recent visit. Our high-risk portfolios are highlighted starting with hospitality on Pages 20 and 21 of the deck. Page 21 should be a familiar page from last quarter. Hospitality loan deferments have dropped from 59% at 7/24 of '20 to 20% as of October 22. Criticized assets in the hospitality book have gone up from 34.7% to 38.6% of the book as we continue to evaluate the performance of individual properties. Moving on Page 21, you will see a summary of the top 10 loan balances in the hospitality book, which makes up 51% of our current outstandings. Two of the loans are construction loans for properties that have not opened yet. Revenues for the top eight properties have increased 124% in the third quarter over the second quarter.

Average occupancy for the properties rose to 55% as of September, up from 43% as of June. seven of the 10 properties did not receive our round two deferrals. Our special assets team is closely monitoring the performance of these assets, which has for the most part continued to recover as travel restrictions and travel hesitancy have loosened. Moving on to retail CRE, which is on Page 22. Deferrals have dropped to 3% of the book from 52% of the book as of Q2. There is one loan that makes up the majority of our past due non-accruals in the space. The loan in the amount of $3.4 million is secured by 130,000 square foot property in Marietta, Georgia that is struggling from an occupancy standpoint, but has more than sufficient value to secure the loan. The significant reduction in loans on deferral when combined with limited deterioration in credit metrics in this portfolio make me feel comfortable with the prospects of this portfolio continuing to perform.

Page 23 highlights the restaurant portfolio. The criticized and past due portions of this book are almost exclusively in the SBA portfolio that are typically made up of new concept, start-up restaurants that have been hard hit from the occupancy restrictions during this pandemic. Deferments are minimal at this point given the payment support provided by the SBA. The non SBA portion of this book continues to perform well.

I'll turn it back over to Malcolm for closing remarks.

Malcolm Holland -- Chief Executive Officer

Thanks, Clay. As you can see, our clarity and conviction on our credit is becoming clearer and clearer. I feel like our executive leadership team is really gelling, and our prospects for growth are exciting. Although not completed until after the quarter closed, we're super excited by a recent sub debt raise of $125 million at a rate of four 1/8%. Obtaining this supplementary tier two capital gives us additional capital stability and flexibility as we evaluate our options for growth opportunities, both organic and M&A. It also keeps our real estate concentration levels well below regulatory guidelines, and it provides additional flexibility in our stock buyback analysis.

As most of you would probably agree, COVID has taught us that scale is becoming more and more important. Being able to spread our expense on a larger asset base only makes sense, not to mention our focus on building and maintaining a positive operating leverage. It has certainly been a challenging seven months, but in the midst of challenge is opportunity, and that is where we are looking, when the situation does turn back positive, we want to be prepared and fully equipped to serve the needs of our markets.

Jesse, I'd now open the line for any questions.

Questions and Answers:

Operator

Thank you presenters. Participants, we will now begin the question and answer session [Operator Instructions] First question is from the line of Michael Rose from Raymond James. Sir your line is now open.

Michael Rose -- Raymond James -- Analyst

Hey, good morning, guys. How are you?

Malcolm Holland -- Chief Executive Officer

Good.

Terry Earley -- Chief Financial Officer

Hey, Michael.

Michael Rose -- Raymond James -- Analyst

Hey, maybe we could just start on the buyback. Good to see that you guys extended it a quarter. It does seem, based on the language, that you guys are probably going to be active and use the rest of it. You obviously raised some more sub debt above the remaining authorization. What's the appetite for share repurchases beyond the current authorization? And would you expect to be active with the stock at these levels if you finish up the program?

Terry Earley -- Chief Financial Officer

Thanks, Michael, it's a great question. Obviously, it was important to extend the deadline out for a quarter on the current authorization, as you said, just to give us time. I mean I think we will -- I think it depends on valuations. And if capital and credit behave as we think they will, and if the equity prices are weak, then it's certainly something we would consider. We certainly wouldn't rule it out today. But I wouldn't say we're necessarily ready to -- I think it depends on strategic things that could come up, but it's there. We have -- I think we're in a place where we have the most flexibility.

And I think that's what we really want heading into 2021 with the proceeds from the sub-debt and thinking about organic growth, strategic growth, credit and buybacks. And they're all very much in the mix. So we've been active over '19 and the early part of '20. And we believe it's -- the buyback is an important tool to manage capital to optimize the capital stack and to help enhance earnings per share. So...

Malcolm Holland -- Chief Executive Officer

Yes, and let me just add one other thing. It's not a huge number, as you know. It's $31 million, so we can move the needle a little bit. But Terry is right, we got to evaluate a whole bunch of different potential opportunities and then make sure our credit and capital stay in good stead, which they are. But I would guess that you'll see us do a little bit of it. But again, it's not a big number, so it's -- it can't move the needle a whole bunch.

Michael Rose -- Raymond James -- Analyst

Yes, I completely understand. Thanks for the color. Moving on, the next thing I wanted to kind of address was another deep dive in the portfolio this quarter. A little bit smaller in terms of the dollar amount of credits that you covered, but we did see the increase in NPAs, despite the other credit metrics kind of moving in the right direction. Is this -- is the way to read this that you guys are trying to get ahead of the curve and maybe getting ahead on some properties and property types and credits that could face some issues, some greater issues, if we do go into more of a lockdown scenario, if COVID case pick up? And with the expectation that we could see a flood of properties begin to hit the market in the earlier part of next year, is this your guys' effort -- best effort to try and get ahead of this? Is that the way we should read it? Thanks.

Malcolm Holland -- Chief Executive Officer

Yes. I mean our efforts since day one of this thing back in late March when it started was OK, let's be as conservative as we can. It's all about capital preservation, and that's been our philosophy since the start. I think what you see in the NPA movement is our effort to be as conservative as possible.

The one thing Clay said that you may not have picked up on is 46% of those NPAs were current at the end of the quarter. You don't usually find a current loan in a non-performing category. But we feel like that right now, prudence would have us just be super, super conservative.

And so you mentioned something about a second closure, and I know the cases are getting higher. That would be a game changer for all of us if everything gets shut down again. We don't see that in Texas, but then again we don't control all of that. So I don't think that we, as management, are surprised by any of these movements. In fact, this is kind of what we had anticipated.

Michael Rose -- Raymond James -- Analyst

Okay. And then maybe finally for me, the warehouse has been pretty strong. Can you talk about some of the trends there? And it does seem like the NPAs origination data at least is fairly strong into the other part of next year. Should we expect average balances to kind of hover around these levels? Thanks.

Malcolm Holland -- Chief Executive Officer

Yes. I think this is a fair assessment of where we think we should keep our balances.

Clay Riebe -- Chief Credit Officer

Yes. I mean we're seeing a lot of opportunities. Amy Satsky, who's been with us about 1.5 years, has done a great job in leading that business. And in our view, it's got some of the best risk-adjusted spreads right now that you can see. The turn times are great and the market production -- the mortgage world is so strong, let's take advantage of this. And we don't want to let it get outsized, but right now we like what we see. And we're not opposed to letting it drift up a little or stay steady. It's just it's a good place to park liquidity.

Michael Rose -- Raymond James -- Analyst

Thanks, for taking my question.

Malcolm Holland -- Chief Executive Officer

Yeah, thanks, Michael.

Operator

Our next question is from the line of Mr. Brad Milsaps of Piper Sandler. Sir, your line is now open.

Brad Milsaps -- Piper Sandler -- Analyst

Hey, good morning, guys.

Malcolm Holland -- Chief Executive Officer

Hey, Brad.

Brad Milsaps -- Piper Sandler -- Analyst

Just a follow-up on Michael's question regarding the loan review -- loan reviews, I guess, just -- I know it's probably hard to make this a blanket statement. But just kind of curious sort of what you mentioned there were more upgrades than downgrades. What were sort of the criteria to see an upgrade versus a downgrade? I know that might be tough given all the different categories. But just getting back to the point of maybe how stringent you were kind of as you walked through this?

Clay Riebe -- Chief Credit Officer

Sure. Thanks, Brad, for the question. So the criteria that we use is really just based upon how we expected the borrower to be performing. And it was done with interviews not only with the lending managers, but with the lenders themselves on specific credits. And so we looked at whether or not the borrower's performing as we expected or not.

And so -- and another thing that I think is important to note that the upgrades came in some instances for credits that we had downgraded in the first quarter based upon industry types. And so as we looked at those credits that had been automatically downgraded because they were in an at-risk industry, and we looked at the performance and saw well, they're actually performing fine through this, we upgraded them. And so that's where a lot of the upgrades came from.

Brad Milsaps -- Piper Sandler -- Analyst

Okay. Great. And then if I'm looking at slide -- the slide that you disclosed around the allowance this quarter, I guess if there are no more -- a lot more negative migration where you need specific reserves, one could assume that your provisioning -- your most significant provisioning is pretty well behind you at this point, if not -- could be pretty minimal, if not 0 or negative. Is that a fair assessment?

Malcolm Holland -- Chief Executive Officer

Yes. I mean that's -- we kind of think it's a high-water mark on the reserve side today. Obviously, there's a lot of unknowns, things that could happen. But yes, I think you're thinking the way we're thinking.

Brad Milsaps -- Piper Sandler -- Analyst

Okay, and then just one final follow-up for Terry. I appreciate all the color around new loan yields and deposits. You guys have done a great job of holding the yield on the bond portfolio fairly flat for it looks like basically four consecutive quarters. Can you talk a little bit about kind of what we should be seeing there? Is there some risk that we do see a reset lower there? Or based on the duration you have and some of the mix, you feel like you can continue to hang on to that?

Terry Earley -- Chief Financial Officer

Well, it has performed very well, and that's -- I appreciate the question. Will and his team have done an excellent job in getting the portfolio positioned for down rates. I mean sometimes it's just good to be lucky. And we were positioning for down rates, but had no idea that they would fall off. And we started that process in the second quarter of '19. And so when the -- not only have we got a good yield, but the amount of cash flow coming off the portfolio is substantially less than you would expect, and the convexity in the portfolio is flat to positive.

So it's going to trend lower. That's just because of the payoffs and the reinvestment rates. But I don't think -- I think it's going to be a bright spot for us continuing pretty well as I look forward into the rest of this year and next year. And so -- but it's definitely going to -- it's going to trend off a little bit, Brad, but it's not -- I'm not -- we don't have huge premium risk. We don't have huge prepayment risk. And so I think it's going to continue to perform well for us.

Brad Milsaps -- Piper Sandler -- Analyst

Thanks, Terry, that's helpful. I appreciate it.

Operator

Our next question is from the line of Matt Olney of Stephens. Sir, your line is now open.

Matt Olney -- Stephens -- Analyst

Hey, thanks and good morning, guys. Hey,I want to go back.

Malcolm Holland -- Chief Executive Officer

Hey, there.

Matt Olney -- Stephens -- Analyst

Thanks, I want to go back to Slide 18 and those 10 largest NPLs. I appreciate the breakdown. That's very helpful. I didn't see any hotels within this top 10 list, and it sounds like it's just too early to see the migration, still lots of stimulus money out there. Can you talk just more about the timing of when any potential migration of hotels could occur beyond kind of where the current loan grades are? Thanks.

Malcolm Holland -- Chief Executive Officer

Yes. I think you're right, it is a little bit early with the deferrals that have been going on. But we're not seeing many on second deferrals, as you can see there in our deck. And as those wind down, then we're going to naturally see some winners and losers that emerge, and we'll call those out as we see.

Terry Earley -- Chief Financial Officer

And hotels are just improving their performance. I mean, you guys were all over it, and their performance is just trending the right way. And some of these occupancy levels are even capped based on percentage occupancy the government said they can't go over that's allowed. So...

Matt Olney -- Stephens -- Analyst

Okay. Appreciate that. And then circling back on the mortgage warehouse, it sounds like you expect some -- this strength to maintain. Any commentary on how much this is from just current customer base, which is higher volumes, versus adding newer customers from just dislocations?

Malcolm Holland -- Chief Executive Officer

Yes. So I mean really, we've done kind of a revamp of our customer base over the last 1.5 years since Amy was here. And we've upgraded client, just the credit quality of our clients. We've also increased our usage capacity on the lines that we do have. And candidly the market is a little fragmented right now down here for a bunch of different reasons.

And we've been able to obtain some really, really high-quality clients. And so not only is our book bigger, but it's stronger and the usage is better. And the turn times are way quicker. So I mean it's just positive, positive, positive, not to mention the return on this book is as good as we've ever seen it.

Matt Olney -- Stephens -- Analyst

Okay. Thank you, guys.

Malcolm Holland -- Chief Executive Officer

Thanks, Matt.

Terry Earley -- Chief Financial Officer

Thanks, Matt.

Operator

Our next question is from the line of Woody Lay from KBW. Your line is now open.

Woody Lay -- KBW -- Analyst

Hey, good morning guys.

Malcolm Holland -- Chief Executive Officer

Good morning.

Terry Earley -- Chief Financial Officer

Good morning.

Woody Lay -- KBW -- Analyst

I wanted to touch on the loan growth front. Excluding any impacts of PPP and the mortgage warehouse, you sort of noted that the pipelines were getting stronger into the fourth quarter. Do you think it's reasonable to expect loan growth to occur in the fourth quarter?

Terry Earley -- Chief Financial Officer

Yes, yes, I think it will be positive. It's -- obviously the pipelines are a clear forecaster of the future. The one that you can't -- is harder to forecast is the payoff side. But we've talked long and hard, and with our portfolio at $6 billion, just round numbers, we're going to pay off 25% to 30% of that every year. We got about a 4-year-life book. And so you got to do a fair amount of new business to keep up with those payoffs. But it looks right now like the fourth quarter will be another positive quarter. We are very pleased with 4.4% annualized last quarter and hope to do that in the fourth quarter. But things are better.

Woody Lay -- KBW -- Analyst

Got it. That's helpful. And then I appreciate the breakout on Slide 21 of the top 10 hospitality relationships. I was just curious about it's sort of surprising to see the two hotels with 30% occupancy rates, not on deferral, at least around two deferral status. Do you think in the hotel portfolio, there's a chance we see deferrals increase in that portfolio?

Clay Riebe -- Chief Credit Officer

We may see some additional deferrals. I don't think it's going to be widespread, but we may see some additional. Overall as Terry pointed out, we feel like the trends are -- that all of these properties are trending in the right direction. And we feel pretty good overall about the performance but all of that's really going to be dependent upon travel hesitancy and business travel as it returns.

Terry Earley -- Chief Financial Officer

And just to begin to that third one though, that's got a really strong, strong ownership base with massive, massive deep pockets. So capital calls for those guys are no-brainers, just specific to number three.

Woody Lay -- KBW -- Analyst

Got it, that's helpful. that's all for me, thanks, guys.

Malcolm Holland -- Chief Executive Officer

Thank you.

Operator

Our next question is from the line of Gary Tenner of D.A. Davidson. Your line is now open.

Gary Tenner -- D.A. Davidson -- Analyst

Thanks, guys, good morning.

Malcolm Holland -- Chief Executive Officer

Good morning.

Gary Tenner -- D.A. Davidson -- Analyst

A couple of questions, I guess first on loan growth for the quarter. The commercial segment obviously drove a good bit of that growth separate for mortgage warehouse. Just wondering were you seeing that show itself in new business or some leveling up of utilization rates after the drop we saw in the second quarter?

Malcolm Holland -- Chief Executive Officer

Most of it is new business and not necessarily new clients. Although I would tell you, our Houston market is picking up new clients quite a bit. But it's a new business, Gary. Utilization is really, I'm going to guess now, but it's down from -- I mean people paid back their lines a lot in the second and third quarters. But it's -- we see a lot of business. I mean our loan committees are pretty darn full.

Gary Tenner -- D.A. Davidson -- Analyst

Thank you. And then in terms of -- just to clarify, the government guaranteed loan income in the quarter, the 2.3 million, that's pretty exclusively SBA gain on sale for the quarter, nothing related to the valuation allowance related to the PPP?

Terry Earley -- Chief Financial Officer

There would have been a little bit of the PPP trail, if you will, that's in there. But that's something like 10% at most, somewhere in that range. So it's really driven by -- we did -- it's not like we brought in all the valuation allowance to show that income. Trust me, we did not. We just had a really good quarter selling USDA SBA 7(a). And on the 7(a) front, it's predominantly 25-year real estate secured. And so that's where we're really focusing that business. And again, gain of sale premiums are good, and we just -- we had a really good quarter. And hopefully that momentum is going to continue.

Gary Tenner -- D.A. Davidson -- Analyst

Okay. Great. And then just one last question for me, I think you mentioned in the restaurant portfolio the support that a lot of those SBA loans have gotten over the last six months. With SBA payments now expired, what are your thoughts about the kind of the residual risk within that portfolio?

Clay Riebe -- Chief Credit Officer

Yes. So once those have expired, Gary, that we are considering deferrals on those. The SBA is a proponent of working with these borrowers to provide them every opportunity to succeed. And so we'll be considering some deferrals in that SBA book. And as those deferrals play out, as business returns, we'll see how they migrate going forward, but that's what you can expect in that.

Gary Tenner -- D.A. Davidson -- Analyst

Thank you.

Terry Earley -- Chief Financial Officer

Thanks, Gary.

Operator

[Operator Instructions]

Malcolm Holland -- Chief Executive Officer

Looks like there are no questions Jessey.

Operator

No further questions on queue, speakers.

Malcolm Holland -- Chief Executive Officer

Great. Appreciate it very much. And anybody with specific questions today, you're more than welcome to contact us directly. Thanks. Have a good day.

Operator

[Operator Closing Remarks]

Duration: 42 minutes

Call participants:

Susan Caudle -- Investor Relations and Secretary to the Board

Malcolm Holland -- Chief Executive Officer

Terry Earley -- Chief Financial Officer

Clay Riebe -- Chief Credit Officer

Michael Rose -- Raymond James -- Analyst

Brad Milsaps -- Piper Sandler -- Analyst

Matt Olney -- Stephens -- Analyst

Woody Lay -- KBW -- Analyst

Gary Tenner -- D.A. Davidson -- Analyst

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