Origin Bancorp, Inc. Q3 FY2024 Earnings Call

Ladies and gentlemen, good morning and welcome to the Origin Bancorp, Inc. Third Quarter Earnings Conference Call. My name is David, and I will be your Evercall coordinator. The format of this call includes prepared remarks from the company, followed by a question-and-answer session. Please note that all attendees will be on listen-only mode until the Q&A portion of the call. Also, please note that this event is being recorded. I would now like to turn the conference over to Chris Reigelman, Director of Investor Relations. Please go ahead.

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 call. Please refer to Page 2 of our slide presentation, which includes our safe harbor statements regarding forward-looking statements and use of non-GAAP financial measures. For those joining by phone, please note the slide presentation is available on our website at www.ir.origin.bank. Please also note that our safe harbor statements are available on Page 5 of our earnings release filed with the SEC yesterday. All comments made during today's call are subject to the safe harbor statements in our slide presentation and earnings release. I'm joined this morning by Origin Bancorp's Chairman, President and CEO, Drake Mills; President and CEO of Origin Bank, Lance Hall; Chief Financial Officer, Wally Wallace; Chief Risk Officer, Jim Crotwell; Chief Accounting Officer, Steve Brolly; and our Chief Credit and Banking Officer, Preston Moore. After the presentation, we'll be happy to address any questions you may have. Drake, the call is yours.

Thanks, Chris, and thanks for being on the call. I'd like to believe that I've developed a reputation for being transparent and direct. We have accomplished a great deal since we went public in 2018 when we were $4.2 billion in assets. We've expanded our presence in Texas, grown market share in Louisiana and Mississippi, entered new markets in South Alabama and the Florida Panhandle, built an award-winning culture that attracts talented bankers, and we have diligently prepared to cross $10 billion in assets. Even with these successes, we clearly understand the work in front of us to create upper quartile profitability. We've been very strategic in how we prepare for crossing $10 billion in assets. We've made significant investments in people and processes that we knew would impact short-term profitability, but would prepare us to drive long-term value. While this preparation and rate environment have pressured our profitability, I am confident we've made the right decisions to lay the foundation to build long-term value. We strengthened our management team. We've invested in technology. We've enhanced our ability to gather and analyze data to drive strategic decision-making, and we have improved our risk management capabilities to name a few. Now it's time to sharpen our focus on near-term profitability. We are laser-focused on a strategic initiative to return to acceptable profitability levels by the end of next year. We will provide detailed metrics around this initiative when we report our full-year results in January. We are well into the process and are actively working with a third party to benchmark us at a granular level to our peers. We have also begun outlining specific revenue and expense opportunities to achieve our profitability goals. In the near term, we need to operate at levels in line with our peers with a defined path to outperform them. Now, I'll turn it over to Lance and the team to talk through the quarterly results.

Thanks and good morning. Over the past several quarters, I've talked about our bankers' consistent focus on driving core deposit growth and expanding relationships. While the rate environment has put pressure on deposits across the banking industry, I'm pleased with the balance sheet trends we showed in the third quarter. I'm confident these trends will continue and our bankers will capitalize on opportunities, particularly in our metro Texas markets and our new Southeast market. Total deposits, excluding brokered, were up 2.3% quarter-over-quarter, which is the strongest growth we've seen in two years. Non-interest-bearing deposits were also up, growing 1.5% for the quarter. Also, our NIB mix as a percent to total deposits remained stable at 22%. I want to speak directly to the success we're having in our Texas markets. Our teams throughout the state continue to drive meaningful growth. Year-to-date, our Texas bankers have grown deposits by $241 million and grown loans by $154 million. We see tremendous opportunity in Texas, and we have the infrastructure in place to continue to grow that business. While we look forward to detailing the profitability initiative that Drake mentioned next quarter, improving operating efficiencies is always a focus. As an example, one area we have had success in building efficiencies is in our Robotics Process Automation platform. Our RPA team continues to add value to the bank by saving approximately 3,356 hours of manual work in the third quarter. Year-to-date, this team has saved more than 9,600 hours of manual work, equivalent to just over seven full-time equivalents. I'm optimistic about the momentum that we're seeing within our markets and how our bankers are focused on growing profitable relationships. Now I'll turn it over to Jim.

Thanks, Lance. As we discussed over the past several quarters, we continue to experience normalization within our loan portfolio. With that said, we are pleased to report decreases in past dues, classified loans, as well as nonperforming loans for the quarter. While we did experience an increase in net charge-offs for the quarter, year-to-date net charge-offs continue to be in line with expectations. Past due loans held for investment came in at 0.49% as of September 30, decreasing from 0.83% as of June 30 and in line with past due levels of 0.42% as of the end of the first quarter. As you will recall, the increase in past dues as of June 30 was attributed to relationships identified as part of the questioned activity of a former banker in our East Texas market. We continue to work through this issue with our customers, including those relationships subject to the ongoing dispute. Classified loans decreased $10.8 million to 1.35% of loans as of September 30, down from 1.49% as of June 30, while nonperforming loans decreased $12 million to 0.81% as of quarter end, down from 0.95% as of the prior quarter end. The decrease in both classified and nonperforming loans was primarily driven by the $10.4 million write-down in three acquired loans as well as the settlement payment of $3.3 million on one of these loans. As to classified loans, these reductions were partially offset by downgrades of four relationships totaling $7 million, three of which were acquired loans. Net charge-offs for the quarter totaled $9.5 million, up from $2.9 million from the prior quarter. While net charge-offs for Q3 were 0.48%, year-to-date net charge-offs were 0.26% and are in line with expectations. Our credit provision expense was $4.6 million for the quarter compared to $5.4 million for the prior quarter and after considering net charge-offs resulted in a $4.9 million decrease in the allowance to $96 million. The reduction in the reserve was primarily driven by the utilization of previously established reserves. On a percentage basis, our allowance decreased from 1.27% to 1.21% as a percentage of total loans held for investments and from 1.34% to 1.28% net of mortgage warehouse. During the quarter, we completed our external loan review, which covered approximately 55% of loans net of consumer and one to four family residential loans. The results of the review were positive, resulting in no recommended downgrades to criticized or classified loans. As discussed last quarter, we continue to focus on client selection. And during Q3, we saw an additional $42 million in desired reductions. We will continue to closely monitor and manage our portfolio. With the market's continued focus on non-owner-occupied CRE office, we continue to provide added detail on slide 13, which shows the resiliency and performance of this sector within our portfolio. As of quarter end, this segment totaled $364.7 million, average loan size of only $2.4 million, a weighted average debt service coverage of 1.34 times and a weighted average loan-to-value of 59.01%. We had no past dues, minimal classifieds, and no non-performing loans and no charge-offs within this segment. As to total ADC and CRE, we continue to closely monitor our overall exposure and reflected total funded ADC and CRE of total risk-based capital at quarter end of 72% and 239%, which positions Origin with the flexibility to support our customers and provide strategic growth. I'll now turn it over to Wally.

Thanks, Jim, and good morning, everyone. Turning to the financials. In Q3, we reported diluted earnings per share of $0.60. As you can see on slide 24, the combined financial impact of notable items during the quarter equated to a net expense of $627,000, equivalent to $0.02 in EPS pressure. On the balance sheet side, I will start with a discussion on deposits, which were down 0.3% during the quarter. Excluding brokered though, deposits grew 2.3% linked quarter, a strong quarter, as Lance mentioned. Furthermore, non-interest-bearing deposits grew 1.5% linked quarter, the first quarter of growth in NIBs since 2022. We continue to see mix stabilization in our deposits with non-interest-bearing deposits remaining flat at 22% of total deposits. On the loan side, growth in gross loans held for investment and growth excluding mortgage warehouse were both essentially flat during the quarter as our strategic focus on client selection continues to result in some planned reductions, as Jim discussed. As a result, our loan-to-deposit ratio ex-mortgage warehouse remains below our 90% target at 87.9%. We anticipate our client selection process could add some continued pressure to growth in Q4, but we continue to expect loan growth in the low single digits for the year with deposit growth essentially matching. Moving to the income statement. Net interest margin expanded one basis point during the quarter to 3.18%, below our guidance, which was for mid-single-digit expansion from an adjusted base of 3.22% in 2Q. The primary driver of this shortfall relative to our expectations was deposit costs that were higher than we anticipated as pricing pressures for new deposits did not ease as much as forecasted across our markets. While we anticipated margin expansion despite potential pressures from Fed rate cuts, our prior models considered a measured cadence of 25 basis point cuts versus our current model, which now includes the already announced 50 basis point cut in September and additional 25 basis point cuts in November and December of this year. This scenario results in a brief period of NIM compression of roughly 10 basis points, as the benefits from asset repricing lag the pressures from our floating rate loan portfolio. Assuming the Fed slows or stops easing, we still anticipate asset repricing benefits to drive NIM expansion in line with our previous expectations. Shifting to non-interest income. We reported $16.0 million in Q3. The quarter included a $221,000 gain on the sale of securities. Excluding this notable item and the $6.1 million net benefit of notable items in Q2, non-interest income declined to $15.8 million from $16.4 million in Q2, due primarily to normal seasonality in our mortgage business. In Q4, we expect normal seasonal pressures in both our mortgage and insurance businesses to drive Q4 fee income to levels similar to Q4 2023. Our non-interest expense declined to $62.5 million in Q3 from $64.4 million in Q2. Excluding $848,000 of notable items in Q3 and $1.5 million in Q2, non-interest expense declined to $61.7 million from $62.9 million. While Q3 levels were better than anticipated, we still expect Q4 expense will remain at levels similar to Q2, which includes an expectation of legal and accounting-related professional services expense associated with the activity Jim discussed earlier. As such, our 2024 full-year expense growth, when excluding the notable items mentioned, is still expected to be in the mid-single digits. Lastly, turning to capital. We note that our TCE ratio ended Q3 at 10.0%, up from 9.5% in Q2. Also, due to continued easing of AOCI pressures and the contribution from earnings, we were pleased to report growth in our tangible book value per share of 5% quarter-over-quarter and 17% year-over-year. Furthermore, as shown on Slide 23 of our investor presentation, all of our regulatory capital levels at both the bank and holding company remain above levels considered well capitalized. As such, we remain confident that we have the capital flexibility to take advantage of any potential future deployment opportunities to drive value for our shareholders. With that, I'll now turn it back to Drake.

Thanks, Wally. As I mentioned earlier, while I'm not satisfied with where we are from a performance standpoint, I'm extremely confident in our ability to take the necessary steps to be an elite financial performer. Origin has a strong history of delivering for our shareholders, employees, customers, and communities. I have spent my career building this organization, and I have every intention of ensuring our success. Origin has a strong culture that has attracted best-in-class bankers, a geographic footprint that serves some of the most dynamic growth markets in the country, and our management team is deeply committed to doing what it takes to increase value for this company. Thank you for being on the call. We'll open it up for questions.

Thank you, team. Ladies and gentlemen, we will now begin the question-and-answer session. Our first question comes from Matt at Stephens Inc. Your line is open, Matt.

Hi. Thanks. Good morning, everybody. I want to start on the net interest margin. It sounds like the loan repricing story is intact, no real change there, but it's the deposit costs that were stubbornly high in the third quarter. I just want to drill down more into that. Did you get more pushback than you expected on exception pricing? Or was there other pushback with specific deposit categories? Just trying to appreciate the drivers there. And then part two, kind of moving forward, does it give you pause for your assumptions around deposit betas with down rates? Thanks.

Matt, thank you. Regarding the deposit beta question, we didn't encounter any significant negative surprises. Our deposit balances have grown more than we expected, especially in interest-bearing accounts, which impacts our overall deposit costs. Pricing trends have remained consistent with our previous observations. Before the Fed's actions, we would have predicted continued stabilization and possibly even reductions in overall costs. We are committed to continuing our deposit gathering efforts. We view the quarter's deposit growth, which exceeded our expectations, positively, as it is crucial for our ability to expand loans, and we aim to resume growing our loan portfolio. We believe this pressure is temporary. Additionally, considering the Fed's rate cuts, we've been modeling a conservative zero beta. Following the September 50 basis point cut, our deposit betas on non-maturity interest-bearing deposits are approximately 40%, which aligns with historical performance and exceeds our models. This reassures us that we can maintain our deposit performance if the Fed continues to lower rates.

Thank you for that, Wally. To clarify the margin outlook moving forward, you mentioned a margin compression of about 10 basis points in the fourth quarter. This is based on an expectation of another 25 basis point cut from the Fed in November and December, in addition to what we experienced in September. There was also some mention about the potential for mid-single-digit margin expansion. Do you believe a pause from the Fed is necessary to achieve that, or could we start to see some of that expansion early next year?

We do not need a Fed pause, Matt. We've modeled this from anywhere from no more rate cuts to seven more rate cuts. In all scenarios, our margin expands to levels above where we have been so far year-to-date. What we need is a measured cadence of cuts, 25 basis points preferably. 49% of our loan portfolio floats. When the Fed cuts 50 basis points in one meeting, that 49% prices down essentially immediately. Our loans that are maturing, they're maturing throughout the quarter. So it takes time for the benefits of those repricing to offset the pressure that we see on day one of a 50 basis point cut. So if we continue to get 50 basis point cuts, then you would expect to see the following quarter continued pressure on our loan yields. But as soon as the Fed pauses or slows the cadence of cuts, then those asset repricing benefits kick in. And we end up at the same endpoint. It's just a matter of the short-term effect offsets because of the lagging of the repricing.

Okay. All right. Understood. Thanks for the commentary Wally. And if I could just sneak one more question in for Drake. Drake, your prepared remarks were interesting and helpful. I think you mentioned achieving peer profitability in the near term. And then there's also a mention of achieving upper quartile peer profitability at some point. It sounds like you're still working on these details and you'll have more for us next quarter. What specific metrics are you focused on? And is the Board focused on? Is this an ROA or efficiency? And within the peer levels, what do you consider peer and then upper quartile within those metrics?

Yes. Currently, we are evaluating all aspects of our expenses and revenues using internal metrics to achieve profitability similar to our peers. Right now, we are targeting a profitability range of 105 to 106. Our goal is to return to the profitability levels we had at the end of 2022 as we move into 2023. We plan to accomplish this in the coming quarters, which will help us not only align with our peers but also position us for growth when it returns. Historically, we've designed this company to grow by 8% to 10% annually, and while we are adjusting our expectations, achieving that growth again will enable us to reach upper quartile profitability.

Okay. Thanks for the color Drake. Thanks for taking my questions. I'll step back.

Thank you.

Thank you, Matt. Our next question comes from Tim at Raymond James. Your line is open.

Hey guys. This is Tim in for Michael. Good morning everyone.

Tim, good morning.

Just want to follow up on Matt's question around deposits and betas. Just understand you want to grow the portfolio as much as possible, but I just want to get a sense of where the relief could come from with down rates. Is there a certain mix of the portfolio that's indexed? Are there CDs repricing in the next few quarters? Is there kind of a big relief from the roll-off rate to what you're putting CDs on now at? Any color there would be appreciated.

Yes, we would anticipate relief across all of our deposit products. There's no magic bullet in the time deposit portfolio where it's going to be a really lumpy repricing benefit in any given quarter. It's really kind of measured throughout the pace of the year. We've seen our non-interest-bearing deposits pretty stable in that 22% range of total deposits. Right now, I think what we would do is use any continued deposit inflows to continue to allow our brokered deposits to roll off the balance sheet. That's our highest cost segment in the deposit portfolio. But I would really just kind of think about it as a measured cadence of deposit price improvements throughout the course of the year.

Understood.

This is Lance. I want to clarify that we are actively managing deposit pricing across all markets. We have collaborated with our treasury management and retail partners, as well as our presidents, and we have ongoing plans for interest-bearing accounts. We are evaluating each account in terms of profitability and understanding the competitive landscape. This approach is tailored and not a one-size-fits-all solution, but we believe it will effectively help us manage our deposit costs.

That's great. Appreciate it. And then back to the kind of strategic actions that you might lay out here in January. I just want to get a sense on the expense side. You hired a team earlier this year down in South Alabama. As you get over $10 billion in assets, you want to move past that number meaningfully, might be some more team lift outs, maybe some more technology spend on the horizon. Just want to get a sense where do you think those opportunities lie just as you look at the expense base right now?

As we navigate this process, I've been reflecting on the significant impact of our technology investments on our strategic planning and future directions. Our current use of data allows us to more accurately assess profitability and revenue streams across the entire organization. This provides us with a clearer understanding of how to create efficiencies while still pursuing meaningful expansions. I’m very satisfied with our growth in the Southeast, where Nate and his team are performing slightly above our expectations. We're in a strong position to accelerate our growth in 2025, particularly in credit and other key areas, as we prepare for a successful launch next year with our planning fully in place.

Yeah. And this is Lance again. Maybe to kind of add on to that to your question. I think part of the evolution of this company is the impact that Wally and his team have brought in, the ability to use data in a much more meaningful way. So as we launch our plan, I think the optimization of everything is on the table as we have looked deeply into banker profitability, product profitability, branch profitability, and business lines, all of that is consistently and deeply being analyzed at this point as we understand once we cross over the $10 billion threshold, and we kind of need to turn the jets on what that looks like from both a growth and a profitability perspective.

Okay. Great. And if I could piggyback one more on that. You talked about returning to that 8% to 10% growth range over time. And not asking for 2025 or 2026 guidance or anything. But just conceptually, what's it going to take? Is it just a matter of the macro environment improving at lower rates? Or is it more specific to you guys? I just want to get a sense of how you return to that posture.

This is Lance, and Drake might provide a different perspective to elaborate on this a bit more. For me, it has mainly revolved around our loan-to-deposit ratio and enhancing core liquidity. We have consistently indicated that this has been a controlling factor for us, leading us to exercise strict client selection throughout this process. It's primarily been about maintaining liquidity at the $10 billion mark for me. If we can remain below $10 billion for another quarter, it would push the impact of Durbin into 18 months ahead. I'm also proud of our deposit growth this quarter and our capability to reduce reliance on brokered deposits. Currently, we find ourselves with increasing liquidity, a solid loan-to-deposit ratio, and positive trends in commercial real estate and asset development and construction. We are positioning ourselves to cross over the $10 billion threshold early next year with robust liquidity. This development would free us up somewhat and enable us to focus on growth, particularly within our Texas and Southeast markets.

Great. Appreciate you taking my questions.

Thank you, Tim. Ladies and gentlemen, this concludes the question-and-answer session, handing it back to Drake Mills for any additional remarks.

Thank you all for being here. I want to address a comment about credit deterioration, which I disagree with. Looking back at the last quarter, we've managed to reduce past dues and non-performing loans, and our classified loans have also decreased. The charge-offs we experienced were due to a credit that was fully reserved. Many of our non-performers resulted from non-credit events related to questionable activities. Therefore, I'm very pleased with our credit position. We've gone through a process of client selection and have released an additional $41 million in credits this quarter that do not align with our criteria. This reflects our commitment to entering 2025 with a robust credit profile. Additionally, we've worked hard this year to prepare for growth in deposits. We have reduced brokered deposits, and our efforts aimed at remaining under the $10 billion threshold have been significant, as Lance mentioned. We're looking to push for a more favorable situation with Durbin in 2026. We're well-positioned for growth, with strong liquidity and a focused approach to client selection, which has allowed us to maintain a cleaner credit profile moving into 2025. I confidently believe our footprint is competitive nationwide, and the experience and teamwork we've demonstrated, particularly in the Southeast, set us up for a strong 2025. The efforts we've made over the past year are starting to yield results. Thank you again for joining the call, and I look forward to seeing many of you soon.

Ladies and gentlemen, this concludes today's earnings call. Thank you. And have a great day.