Origin Bancorp, Inc. Q2 FY2021 Earnings Call

Good morning and thank you for joining us today. We issued our earnings press release yesterday afternoon, a copy of which is available on our website, along with the slide presentation that we will refer to during this presentation.

Thanks, Chris, and good morning. This quarter marks three years of reporting as a public company. We'll get into the details of our performance over the period later, but first, I am pleased that our investment thesis that we introduced to the market during our roadshow has and continues to drive shareholder value. Our goals from our IPO are on target as we maintain a long-term value creation strategy. This quarter's results are a great example of maintaining a focus on our long-term objectives as we took advantage of opportunities to strengthen our balance sheet and credit profile at the expense of reporting short-term growth. We have included a couple of slides that present the value being created for our shareholders, which continues to show a positive trajectory and double-digit compounded annual growth rate since our IPO. Through the first half of 2021, we focused on efficiency as we continue to experience positive operating leverage while improving our credit metrics. I'm proud of our results and the strategic focus we have as we move forward. Looking at the results for the quarter. Our diluted earnings per share were $1.17 for the second quarter, with net income over $27.7 million. Net interest income was $54.3 million and noninterest income was $12.4 million. Noninterest expense was $37.8 million, and our efficiency ratio for the quarter came in at 56.7%. We had a provision release of $5.6 million, with total assets ending at $7.27 billion, with loans of $5.4 billion and deposits of $6.03 billion. Lance, Jim, and Steve will dive into the numbers, but I think about these performance metrics for the quarter and what we have accomplished this year, I'm extremely proud of how our company has managed expenses while we continue to invest in growing the bank and enhancing the customer experience. Our bankers are consistently communicating with our customers, and I'm excited about the pipelines that are being built throughout our footprint.

Thanks, Drake. In Q2, we were successful in continuing to set ourselves up for long-term success in growing profitable loan relationships, improving our credit profile and building out our production teams. On Slide 10, you can see an update on our PPP metrics. We have nearly 55% of our PPP loans forgiven at this point, with another 12% of the loans in the forgiveness process at June 30. We've collected over $26 million in fees through the PPP process and still have over $9.2 million of those fees left to earn. On Slide 11, you'll see we remain focused on the way we're using technology within our company. Our customers' post-COVID adoption rates of banking technology still continue to be extremely positive. And we're having ongoing conversations with fintech partners on streamlining processes and continuing to add value and enhance the customer experience. On Slide 12, you'll see an overview of deposit trends. Our average deposits for the quarter were $6.2 billion, an increase of $374 million over the first quarter of 2021. During the quarter, we reduced our broker deposits, as you can see on the top left, and ended the quarter with no brokered funding. Our total loans this quarter ended just shy of $5.4 billion, which was a decline from the prior quarter but up year-over-year. During the quarter, and as we expected, we saw warehouse and PPP balances decline quarter-over-quarter. Absent those two drivers in our loan portfolio, our total loans held for investment were down $14 million in Q2 as compared to Q1.

Thanks, Lance. We are extremely pleased with the performance of our loan portfolio through the pandemic. I firmly believe that the resiliency of our portfolio is a direct result of our focus on relationship banking and sound client selection resulting in the well-diversified loan portfolio that we have. During the quarter, we experienced stable levels of past due loans at 0.61% net of PPP loans as well as stable levels of nonperforming loans also at 0.61% net of PPP loans. I am pleased with our stable level of charge-offs of only 0.23% annualized for the quarter and the $11.9 million reduction in classified loans during the quarter, resulting in total classified loans of 1.66% of average loans held for investment net of PPP loans. As Lance mentioned, during the quarter, we proactively reduced a total of $47 million of outstanding loan balances and credits that no longer fit our client selection criteria. As such, we feel that we significantly enhanced our overall portfolio strength during the quarter. Based on improving credit metrics and forecasted economic conditions, our allowance for loan credit losses declined by $8 million to $77.1 million, which represents 1.43% of loans held for investment and 1.84% net of PPP and mortgage warehouse loans. We will continue to closely monitor economic forecasts, keeping a close watch on the impact of recent increases in COVID cases as well as inflationary and labor pressures and continued supply chain disruptions. Again, we are extremely pleased with the performance and resiliency of our loan portfolio.

Thanks, Jim. On Slide 15, you can see trending information for our yields and costs. After more significant declines in loan yields in prior quarters, this quarter, our yield on loans held for investment, both with and without PPP, have stabilized. During the second quarter, we saw costs of total deposits declined by four basis points with the quarterly cost of total deposits and borrowings at 38 basis points. With a weighted average rate of 72 basis points, our CD book still provides an opportunity to lower our cost of deposits even more. On Slide 16, our quarterly net interest income was $54.3 million, slightly lower than Q1 driven by anticipated declines in mortgage warehouse volumes. NIM for the quarter on a fully tax equivalent basis came in at 3.12%, down from 3.22% in Q1. The main contributor to our decreased NIM, as you can see on the bottom right, was an increase in average cash balances. During the second quarter, we reduced more than $500 million of brokered deposit balances to offset the anticipated declines in mortgage warehouse and PPP balances. Our bankers continue to do a great job with core deposit growth, and we believe we are well positioned to fund future loan growth. Slide 17 shows a longer-term trend of our net revenue distribution. For Q2 2021, we generated over $12.4 million of noninterest income or about 19% of total net revenue for the quarter. When you look at the longer-term trend since early 2018, the year of our IPO, we have seen a consistent increase in noninterest revenue dollars. In Q2 2020, as mentioned earlier, we recorded historically high mortgage banking revenues with the second quarter 2021 results lower than that historic high. The community banking mortgage model we built has done a great job protecting our earnings as interest rates declined in 2020. Moving to Slide 18. Our noninterest expense for the quarter was $37.8 million, down $1.6 million from Q1. The driver of this decline was because of the $1.6 million prepayment penalty from the Federal Home Loan Bank advance from the prior quarter and prudent expense management. Slide 19 shows our continued strong trends with capital, ending the quarter with a total capital ratio of 14.85%. Our strong earnings continue to be a significant driver of capital enhancement and will support future loan growth. Now I'll turn it back to Drake.

Thanks, Steve. We had a solid quarter with record net income, improving credit trends, excellent expense control, impressive core deposit growth, a strong loan pipeline, and our capital is in a good position to support further growth. We continue to make purposeful and strategic decisions in building this company to put us in a strong position to capitalize on opportunities.

Lance, I think it was you that mentioned that the bank exited around $47 million of loans this quarter. Would love to hear more about these credits. And what was it that ultimately drove the decision to exit these? And are there other credits that could fit this profile that could be exited in the future?

Yes. Thanks, Matt. For us, we've really focused, and Drake's used this term in the last couple of quarters, around client selection. And so for us, it's not necessarily around credit all the time. There are other factors about deposit balances and secondary repayment sources and succession in these companies and some things like that. So this particular for us was concerns about the future operation capacity of this company and where they were going. It wasn't purely a short-term credit issue. And I think for the long-term benefit of us, we made a really good decision.

Okay. And then, Drake, based on your commentary, it sounds like you brought over seven producers recently. Would love to hear more about those producers, what markets they're focused on and kind of what's their sweet spot for loan production.

Yes. Matt, I want to talk just for a second about this client selection process because I think for this institution, as we look at the liquidity in the markets and we see some of the opportunities that we're passing on and the reach that maybe the industry is making for loan volume, we are going to stay focused on client selection and what's best for this organization from a long-term growth perspective. So when you think about our Texas move, I'm excited about where our pipelines are right now and the direction things are going. So the seven new lenders, four are in DFW, three are in Houston. Two of them come from Wells, one from BofA, one from Capital One, and one from Comerica. And then we also picked up the next market president in Houston. That is a big-time name that is going to really do some good things for us. So we're excited about those. And they're focused on private banking, C&I and some owner-occupied real estate and some other real estate. But just really pleased with the size of these portfolios they have. I've met with a couple of their clients, both in Fort Worth and Dallas, and then last week, a few in Houston. I've been extremely pleased with how quickly I think these portfolios will come over.

Okay. Perfect. And then on the credit front, we saw the negative provision expense in Q2, but the reserve ratio is still relatively high. I think we're still well above day one levels. What are the updated thoughts around provision expense these next few quarters? And do you expect to get back towards day one levels in the near term? Or could it be a while?

Yes. I will let Jim Crotwell discuss that further as we are actively addressing the Delta variant and its implications for COVID. We remain positive about our situation and believe it will take about three to four quarters to return to initial levels. Jim, please elaborate on the initiatives we are undertaking and what our current outlook is.

Thank you, Drake. I agree with that. I believe we will carefully analyze our reserves based on ongoing thorough assessments of the economic outlook in the coming quarters. Ideally, as we evaluate our situation, our reserves will adjust in line with how they were built during the pandemic. However, there's still a lot of uncertainty, especially regarding the effects of the resurgence of the Delta variant. As we approach the end of this year, we should have a clearer understanding of the inflationary pressures we're experiencing right now, which we hope will ease in the latter half of the year. We are monitoring developments closely. I believe our current reserve strategy is conservative, and our strong balance sheet puts us in a good position. Nonetheless, I anticipate a continued reduction in the level of reserves we'll need.

So we saw mortgage start to normalize, which is no surprise. We're seeing that across everywhere. But $2.7 million of fees in the second quarter, how are we thinking about the outlook there? Do you think you could see a little more slippage? Or is that kind of a new normalized run rate?

No, I don't think you'll see any further decline in the mortgage sector. When examining the overall mortgage situation and our pipeline for the third quarter, I feel optimistic about the stabilization of that business. This relates to the pretax pre-provision miss we experienced, which was significantly influenced by pipeline valuation. In the fourth quarter, we originated $160 million and sold $125 million, which had no effect on valuation in the first quarter. We recorded $138 million in origination with $185 million in sales, resulting in a negative adjustment to the pipeline valuation. This trend surprisingly continued in the second quarter with $122 million of origination and $140 million in sales, leading to a $2 million pipeline adjustment that was unexpected and certainly contributed to the pretax, pre-provision miss. However, looking at the third quarter, we see origination and sales nearly identical, so we do not anticipate experiencing that type of adjustment going into the third quarter.

So if you add that $2 million mark back, you're back up at $4.7 million, which is kind of in line with the first quarter. So could we see that $4 million to $4.5 million level in the third quarter assuming there's no marks that go against you?

We could.

All right. And then, Drake, what's the latest on M&A? I know you guys have a pretty strong organic growth pipeline. I know the back half of the year is looking up. But like recently, you've kind of downplayed M&A, saying, 'Hey, we really don't need it.' But what's the latest on how you're thinking about M&A at this point?

Yes, I still view this as an organic growth story. You may wonder about our second-quarter performance. We did make decisions regarding some of our credits that I believe were beneficial for growth. Any chance to improve our credit profile will be taken. We could have retained those credits, but we've decided to allow others to report that growth this quarter while we focus on our core activities. From an M&A standpoint, we're engaged in valuable discussions. Although it's not essential, we're looking for a cultural fit with potential partners who want to be integral to our operations. Such opportunities are available, and we are having productive conversations. Although I can't promise any announcements in the coming quarters, we are optimistic about the prospects we are exploring.

Great. Good luck with that. The last question I have is just on the PPP benefit. I know you have about $9.3 million of fees left to be realized. Now how should we think about the timing there? Will most of those be recaptured in the back half of the year? Or does some of that slip into 2022?

Most of it will be recaptured in the third and fourth quarters, but some may extend into 2022. Based on our projections, which fluctuate daily, we might have about $150 million remaining as of December 31. Once those are forgiven, they will be reflected in the next quarter. To answer your question, I would estimate that out of the $9 million, around 50% will likely be recognized in the next quarter. Of the remaining 50%, perhaps 30% will be realized in the fourth quarter and the rest going forward. That’s our current outlook.

Drake, I just wanted to ask on new loan yields. It looks like you guys saw quite a bit of stability in the quarter. Just kind of wondering if you think you'd turn the corner there. Is that something that you think can stabilize going forward? I just want to kind of get a sense of where new loan yields are coming on and what that might mean for the NIM going forward?

Yes. I think when you look at the reduction in NIM with a basis point contributed to loan yields, we feel very good about stabilization of the loan yields and feel like we can move forward with that. So we've had a lot of discussion of a couple of opportunities to put some liquidity to work in some markets, and we're going to kick that off here this next week and feel like we're going to be able to pull out some nice relationships out of some of these new lenders that we picked up. So feel very good about turning the corner. And a stabilization at this point, I'm going to report, and hopefully, that we see some upside. But at least stabilization.

Okay. Great. And then just to follow up on the mortgage discussion. Just wanted to ask Lance. You guys have picked up a lot of new customers on the mortgage warehouse side of the business. Do you think you're sort of nearing a trough in those balances? Obviously, subject to what happens in the overall market. But just kind of curious kind of what your crystal ball might say on mortgage warehouse.

Yes. No, we actually met with our group the other day forecasting balances. And you're right. If you think back over the last 12 months or so, we've gone from 23 clients in that business to 47, and we're actually still onboarding maybe one at this moment. That being said, balances, we think at the end of Q3, will probably drop to about $750 million. And then by the end of Q4, we're projecting $600 million. And those are kind of quarter-end balances.

Sorry, I was on mute. I didn't think I was going to get in. I had some technical difficulties this morning, but glad I could get in the queue. I had one follow-up question to the questions you just answered. I believe Steve had said not only are yields stabilizing, but you continue to lower deposit costs. So I assume it's fair to assume, especially if loan growth is reaccelerating, that net interest margin you anticipate will be up in the second half.

We believe that the second half will likely remain flat. While there might be a slight increase, we must remember that we have both securities and cash. We plan to use the cash for loans instead of securities. Right now, our securities book is approximately 215, and we are not aiming for 150 as that would be too much of a stretch. This does create some pressure related to securities. However, if we focus on core net interest margin, we expect loans to remain stable while deposits might decrease slightly. The decline in deposits will not be drastic, possibly around 20 basis points. We do anticipate a drop in CD balances, which may affect interest-bearing accounts even further. Overall, I think the core will be fine, but we may experience some pressure from securities and cash.

Okay. All right. And then just clarify, if you will, the loan growth guidance because I think I heard two different things. So the high single digits guide, is that anticipated to be what you're run rating in the second half? Or should I look at full year on a core basis, take out the PPP noise and be thinking that you'll get high single for the full year on a core basis?

Well, that's high single for the full year. We said that at the beginning of the first quarter. And when you look at the growth engine being intact and when you say reestablish or reignite loan growth, we actually had positive momentum in loan growth, especially when you look at Q2 '21 versus Q2 '19. We went back and looked at how we were doing from the standpoint of the growth engine. And it was pretty significant. It was 40-some odd percent between those quarters. And so that showed that we were making significant growth. Also, when you look at the utilization, our line utilization, where it's down to a low of about 42% where it's generally running at 48%, 49%, we saw significant growth in lines added to that utilization in the second quarter. So about a 7.5% increase in lines added. So we are going to start seeing a ramp-up in that line utilization on top of the loan growth we have from new originations. So we're pretty excited about where we are, and that's why we're so positive about what looks like in the pipeline. We've already had a very strong July and expect that to continue through the third quarter.

I've been looking at the full year loan guidance, but what does that mean for the second half of the year considering loans decreased? Is that guidance regarding total loans or adjusted for warehouse and PPP? I'm trying to understand if it suggests mid- to high single-digit growth for the latter part of the year or something greater.

Yes. The projections for loan growth exclude mortgage warehouse and PPP. This pertains to our core portfolio. We anticipate this growth to be slightly above single digits in the third quarter. Overall, we're aiming for high single-digit loan growth for the year. You can estimate the second, third, and fourth quarter figures to reach that target.

Okay. Great.

Yes. You all didn't remember everything. I give you some numbers.

On the new hires, do you think that opportunity has stabilized for a while, or is there still potential for more growth? I remember you mentioned a quarter or two ago that your previous focus was on growth and achieving scale in the market. Now, there's a shift towards enhancing core bottom line profitability. With new hires, expenses start immediately, but it takes time for revenues to begin. I'm curious about how you're balancing growth opportunities with the aim of improving core profitability.

We are working diligently on the back end to manage and reduce expenses as we onboard new hires. We intend to capitalize on the current disruptions in the marketplace, which we are already observing. Our company has been built on this principle, ensuring that new team members align with our culture and that their portfolios complement ours. Client selection remains crucial for us, and we have opted to forgo certain deals last quarter that did not meet our standards. While I have concerns about this, I am committed to improving our credit profile, particularly as liquidity shifts in the market and we potentially face a weaker credit cycle. We are actively seeking opportunities to bring on individuals who fit our model, share our cultural values, and have compatible portfolios. In the last quarter, we brought on seven new hires, and we feel optimistic about continuing this trend, although perhaps not at the same pace. We are also exploring some unique opportunities that could integrate well with these teams.

And Drake, just one add-on on that client selection point, the loans that you guys proactively offloaded. Was that all one client? Was it a number of relationships? Just trying to get a gauge on whether it's a handful or just one big client.

No, it was a handful. One client contributed about $28 million of that total through a couple of loans and a piece of real estate in a different deal. It was a small number of clients that were due for renewal, and it was time to either negotiate rates or address those types of issues. However, when we evaluate our client selection profile and the deposits related to it, considering the nature of the businesses and their succession—which was a significant concern—they simply did not align with our model. I would say, Kevin, it would have been easy for us to say, 'We need to report loan growth, so let's keep this on.' I don't believe that would have led to any losses, but these clients would have been in a potentially stressed state in a downturn, and we had the option to avoid that. As I mentioned earlier, this is a long-term value strategy. We are committed for the long haul, and I believe these decisions are beneficial for us.

I believe another important takeaway is that you felt confident enough to let go of those clients because you likely identified new clients that were a better fit.

Absolutely.

On Slide 15, you included some good details around variable rate loans and how much of those are currently on their floors. I think it’s around $1.67 billion. Any commentary you can provide as far as how many Fed fund increases we'll need to see to get above those floors?

Yes. On the prime rate loans, one increase takes us to where we pretty much will enjoy the next full increase at a 25 basis point consideration. And on the LIBOR side, one increase pretty much puts us there. So we're set up well, Matt, to enjoy a rising interest rate environment.

Okay. And then as far as the tax rate from here, for the back half of the year, Steve, any color on the tax rate?

Unless something is enacted, it should be about the same that we have year-to-date.

Okay. Good. Can you provide any insights regarding the production mix of purchased versus refinance mortgages? Also, looking back a few years, there was some wholesale production, but it seems to have decreased significantly. Can you update us on the current percentage of retail versus wholesale production?

Yes. Let me return to the initial part of your question. In our mortgage group for the last quarter, we experienced a split of 48% refinance and 52% origination, which was quite interesting since our mortgage warehouse recorded a 43% refinance and 57% origination. Despite the recent drop in rates, we have noticed a slight increase in originations. This trend will likely remain close to the 48-52 ratio, but I would estimate it to be around 45-55 for refinance and origination. Currently, we are achieving approximately 91% to 92% origination within our footprint compared to wholesale. Additionally, our wholesale production is largely from an individual in the Dallas-Fort Worth area who sells exclusively to us. When considering that, we are nearly at 100% origination in our footprint now.

Well, sir, no further questions at this time. We will conclude today's question-and-answer session. I would now like to turn the conference call back over to Mr. Drake Mills for any closing remarks. Sir?

Yes. Thank you, each and every one, for giving us time today and the interest in this company. And I will tell you that I've never been in a better place as far as the quality of this organization, our growth opportunities and our opportunity as a partner. We do have a couple of insurance acquisitions in the pipeline that we continue to work on. We'll close one of those before the end of this year and possibly even two. But I'm excited about where we are. I'm excited about the quality of this company overall, and I just appreciate your interest and your investment, and look forward to any questions and calls. Each one of you have my cell number, and I look forward to hearing from you. Thank you for your time and hope to see you soon.

And we thank you also, sir, to you and to the rest of the management team for your time. Again, the conference call has now concluded. At this time, you may disconnect your lines. Thank you, everyone, and have a great day.