Southside Bancshares Inc Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Southside Bancshares' Incorporation's First Quarter 2020 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Lindsey Bibby, Vice President-Investor Relations. Thank you. Please go ahead, madam.

Thank you, Hadi. Good morning, everyone and welcome to Southside Bancshares' First Quarter 2020 Earnings Call. A transcript of today's call will be posted on southside.com under Investor Relations. During today's call and other disclosures and presentations, I will remind you that any forward-looking statements are subject to risks and uncertainties. Factors that could materially change our current forward-looking assumptions are described in our earnings release and our Form 10-K. Joining me today are Lee Gibson, President and CEO and Julie Shamburger, CFO. First, Lee will share his comments around the COVID-19 pandemic and an update on our securities portfolio. Then Julie will give an overview of our financial results. I will now turn the call over to Lee.

Thank you, Lindsey. I'd like to welcome everyone. And thank you for listening to our First Quarter 2020 Call. Like everyone else on this call, when COVID-19 became a reality in the United States, it quickly changed our daily routines, commerce, methods of conducting business and the economic forecast. We feel very fortunate that we entered this crisis from a position of strength, with strong asset quality, capital, liquidity, and a low level of nonperforming assets. In addition, Southside has a deep experienced management team, adept at navigating challenges. For the first quarter ended March 31st, 2020, we reported net income of $4 million and earnings per share of $0.12, after recording a $25.2 million provision for credit losses. During the quarter, we adopted the accounting standard often referred to as CECL, which resulted in an increase in Southside's allowance for loan losses, to $53.6 million from $24.8 million at the end of the fourth quarter 2019. We believe this significantly higher allowance further enhances our position to successfully navigate through potential unexpected outcomes. One of the assumptions that heavily impacts CECL results for a given quarter is the economic forecast. We utilize the Moody's economic forecast, with their recommended scenario allocations, all of which at quarter end anticipated a significant economic downturn resulting from the pandemic. Our provision for credit losses recorded this quarter was largely a result of these negative economic forecasts. On a linked-quarter basis, non-performing assets as a percent of total assets decreased to 0.24%. And our tax equivalent net interest margin improved five basis points. During the first quarter, we had solid loan growth of $32.8 million. However, given the negative economic forecast and uncertainty surrounding when the economy may begin to recover, other than short-term PPP loan growth, we do not anticipate meaningful loan growth for the remainder of the year. Due to the significant declines in short- and long-term interest rates, we entered into an additional $400 million of swaps to lock in longer-term interest rates on funding. At March 31st, 2020 these interest rate swap contracts had an average interest rate of 32 basis points, with an average weighted maturity of 5.2 years. During March, as volatility in equity markets persisted, U.S. agency, mortgage-backed securities and highly rated municipal bonds also began to experience volatility, primarily due to illiquidity. When this occurred, given our reduced expectations for loan growth, we increased our securities portfolio of approximately $450 million by purchasing $490 million of largely AAA-rated municipal bonds, of which $8 million were taxable. Due to the timing of these transactions, the full impact on interest income and interest expense will be reflected in future quarters. During the first quarter, Southside also repurchased 869,723 shares of its common stock, at an average weighted price of $29.71. I want to thank all of the Southside team members for their outstanding attitudes and continued dedication to Southside during this challenging time. They eagerly adapted to changes in operational methods and delivery channels, while continuing to deliver the high level of quality service our customers expect and deserve. When the Paycheck Protection Program was announced, our lending and credit teams, together with assistance from team members from several additional departments in the bank, began processing over 2,000 PPP loans, providing over $300 million in much needed funding to small businesses. Over the last 60 years, we've seen growth not only in the balance sheet and capital position, but also in the relationships we formed in the communities we serve. We still believe the underpinnings of the Texas markets we serve are sound and will recover once this economic downturn caused by COVID-19 subsides. As a result, we believe we are well positioned to navigate these difficult times and emerge ready to help our customers achieve their financial goals. I will now turn the call over to Julie.

Thank you, Lee. Good morning, everyone, and welcome to our call this morning. Despite the adoption of CECL and the COVID-19 pandemic-related disruptions beginning in March, we reported net income of $4 million for the first quarter, which includes the $25.2 million in provision for credit losses, primarily in response to the economic uncertainties surrounding COVID-19. We reported diluted earnings per share of $0.12 per share, as of March 31st, 2020, a decrease of $0.39 per share or 76.5% on a linked-quarter basis. We implemented CECL during the first quarter, resulting in a day-one cumulative effect adjustment that decreased retained earnings by $7.8 million, net of tax. The adjustment was the result of a $5.3 million increase in the allowance for loan losses, from $24.8 million at December 31, 2019 to $30.1 million upon adoption, including $231,000 for purchased loans with credit deterioration. And $4.8 million increase to the allowance for off-balance sheet credit exposures reported in other liabilities in our consolidated balance sheet. With the implementation of CECL and expected impacts resulting from COVID-19, the allowance for loan losses increased by $28.8 million to 1.49% of total loans as of the first quarter compared to 0.69% of total loans at December 31, 2019. Our nonperforming assets were $17.4 million, essentially flat linked quarter with just a $46,000 decrease. However, due to the increase in our balance sheet, our nonperforming assets to total assets decreased to 0.24% compared to 0.26% at year-end. As mentioned in our earnings release earlier today, we began originating loans to qualified small businesses through the Payroll Protection Program or PPP in April under the provisions of the CARES Act. These PPP loans may be eligible for loan forgiveness for certain costs incurred related to payroll, group healthcare benefit costs, and qualifying mortgage, rent, and utility payments. The remaining loan balance after forgiveness is fully guaranteed by the SBA. The SBA will pay participating lenders a processing fee tiered by the size of the loan. We are pleased to report that as of April 30th, we had submitted and received approval on approximately 2,000 loans for a total of just over $300 million. We expect to recognize approximately $10 million in PPP loan-related fees as a yield adjustment over the terms of these loans. The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and increased unemployment levels. The resulting temporary closure of many businesses and the implementation of social distancing and sheltering-in-place policies may impact many of our customers. In addition to participation in the Paycheck Protection Program, we are also assisting our borrowers that may be experiencing financial hardship due to COVID-19 related challenges with payment deferrals. Generally, these deferrals are for up to three months. As of April 30, 2020, we have granted deferrals totaling approximately $176.7 million of outstanding balances. The largest categories include commercial real estate of $112.7 million and 1-4 family residential loans of $47.2 million and together make up approximately 90% of the total. Additionally, of these deferrals approximately 29% consists of private households, primarily the 1-4 family residential, 22% in hotels, 17% retail commercial real estate and 5% restaurants. At March 31, 2020, our loans with oil and gas industry exposure were approximately $103 million or 2.86% of our total loan portfolio and deferrals granted from this category approximate 0.43% of all deferrals granted. We began the year with loan growth, reporting a $32.8 million or 0.9% increase on a linked-quarter basis to $3.6 billion. The increase was driven by growth in our commercial real estate portfolio of $100.6 million and partially offset with decreases primarily in construction loans and commercial loans of $41 million and $17.5 million, respectively. Certainly as a result of our participation in the Paycheck Protection Program, we will see a significant increase in loans during the second quarter. However, we expect that most of this increase will have paid off by the end of the third quarter. Due to the uncertainty of the full economic impact of COVID-19, we do not believe additional loan growth is likely for 2020. As Lee mentioned in his remarks, our securities portfolio increased by $454.1 million or 18.2% for the quarter ended March 31, 2020. We recognized approximately $5.5 million in net securities gains on the sales of AFS securities during the first quarter. At March 31, 2020, we had a net unrealized gain in the securities portfolio of $114 million and a duration of 5.9 years, an increase from 4.4 years at the end of 2019. Our mix of loans and securities shifted to 55% loans and 45% securities compared to a mix of 59% loans and 41% securities at year-end. The shift was driven by our strategic purchases in the securities portfolio during the quarter. Net interest income increased $1.5 million driven by lower interest expense directly related to the decrease in interest rates on interest-bearing liabilities. Linked quarter, our net interest margin increased five basis points to 3.03% from 2.98%. The margin benefited from lower deposit and funding costs, which more than offset negative impacts on lower rates on interest-earning assets. We had a 10 basis point increase in the net spread linked quarter to 2.76% as a result of the lower deposit and funding costs. We recorded $437,000 in loan accretion this quarter, an increase of $100,000 or 30% from the prior quarter. Non-interest income excluding net gain on available for sale securities decreased $466,000 or 4.5% for the linked quarter, primarily due to decreases in deposit services and trust fees. For the three months ended March 31, 2020, our non-interest expense decreased $424,000 or 1.4% for the linked quarter, primarily due to a $600,000 loss on disposition of certain assets recognized last quarter offset with a small increase in salaries and employee benefits of $237,000. We used additional FDIC credits in the amount of $439,000 in the first quarter and we had $327,000 in remaining credits. Our efficiency ratio decreased to 51.91% compared to 53.87% on a linked-quarter basis, primarily due to the increase in net interest income. Income tax expense decreased $2.4 million, or 83.2% linked quarter, driven primarily by the decrease in pre-tax income and the linked quarter increase in tax-free municipal income. Our effective tax rate decreased to 10.8% from 14.1% for the first quarter, primarily due to higher tax exempt income as a percentage of pre-tax income than the prior quarter. Additionally, we recorded a discrete tax benefit of $52,000 or 1.2%, a more significant impact on the effective tax rate than usual due to the lower pre-tax income. Regarding our estimate on non-interest expense absent COVID-19, we were estimating non-interest expense of approximately $30.5 million. However, at this time we expect it maybe in the $31 million range for the second quarter. We do expect some additional overtime pay as a result of processing the PPP loans. At this time, we are estimating an effective tax rate of 12%. During the first quarter, we increased our stock repurchase plan authorization by an additional one million shares for a total authorization of two million shares, and purchased approximately 870,000 shares of our stock bringing our total purchase to approximately 895,000 shares at an average price of $29.82. We have not purchased any shares subsequent to March 31 and approximately 1.1 million shares remain authorized for purchase.

The first question comes from Brad Milsaps with Piper Sandler.

Hi. Good morning, guys.

Good morning.

Hi, Brad.

Julie, when you were discussing some of the loan portfolio statistics, I was writing quickly. I would appreciate it if you could clarify the exposure to hotel, restaurant, and energy sectors. Is that related to the percentage of the deferrals you granted? I'm interested in understanding the total exposure to those higher-risk categories such as hotel, restaurant, retail CRE, and energy.

Sure. Okay. To be clear, in what I was stating in my script was referring to the deferrals. So did you get all of those percentages?

Would you mind going over those again, and also providing the composition?

Okay, sure. Okay. Specifically to the deferrals, 29% private households, 22% hotels, 17% commercial real estate and 5% restaurants. And then, with respect to the portfolio...

Here Brad, I can give you that.

I've got it.

Okay. Go ahead.

Retail investment real estate is 9%; and hotels are at 2%; retail trade 2%; and foods and restaurants at 2%; for a total with oil and gas of 17%.

Okay, great. Thank you. That's very helpful. And then Lee, maybe just moving to the balance sheet. Obviously, a lot of movement at the end of the quarter that wasn't necessarily reflected in kind of what you earned in the first quarter. Is it fair to say you would expect a pretty big boost in NII in the second quarter even excluding PPP, but your margin will see some contraction? Just kind of curious kind of what yield were the bonds that you bought that came on during the quarter? Just trying to get a sense of kind of what's going to go on in the margin.

The bonds we issued in March had a tax equivalent yield of 3.22%. We secured funding of $400 million at 32 basis points, resulting in a spread of approximately 2.9%. Most of this activity occurred in the last 15 to 20 days of March.

Great. I understand that some of your existing borrowings are swapped with LIBOR. Are there any significant amounts coming due in the near term that could benefit from a lower rate?

Yes, we have some public funds that are connected to Tex pool. The Tex pool rate in March averaged around 1%, and for April, it's expected to be about 45 basis points. The balances are approximately $250 million to $300 million. Additionally, many of the brokerage CDs that are maturing are going to the Home Loan Bank. We are also borrowing from the Fed on the PPP loans at 25 basis points. Overall, our retail deposits have decreased, with the higher tiers seeing a significant drop.

Okay. So in the meantime, you'll allow the higher-cost items to run off and possibly rely on the wholesale Federal Home Loan Bank advances until things stabilize?

That is correct.

Okay. Great. I’ll hop back in queue. Thank you.

Yeah.

Your next question comes from the line of Michael Young with SunTrust.

Hey. Good morning.

Good morning, Michael.

I wanted to start by discussing capital. You mentioned that you authorized a share buyback late in the first quarter, which you were active with, but then you paused after the quarter ended. How should we consider that going forward? What factors are you monitoring to decide whether to continue with the remainder of that buyback or not?

I think we'll keep an eye on the stock price, and we have that option available. Our overall capital levels, particularly from a risk-based perspective, are very strong. We have that option ready, and if it seems appropriate, we'll consider repurchasing some shares again.

Okay. And maybe just overall margin this quarter, were there any significant prepayment fees or anything else running through the margin that aided it further this quarter that we shouldn't expect to recur going forward on a core basis?

No. No, there was really nothing unusual in the quarter other than interest rates just dropping significantly short-term down close to zero.

Okay. And then the last one for me maybe just on the specific portfolios you mentioned specifically CRE or construction and some of the more at-risk areas. Could you give us a sense for, sort of, the underwriting criteria that you all stick to and what maybe some of the LTVs or debt service coverage ratios would be in those books if you have that available?

You know, the equity we typically look for in CRE is at least 30% if not 40% and it really depends on if there's a guarantor or not, and the strength of the guarantor. We do have some that have more equity than that but that's not the typical thing. On the debt service coverage for the most part it has to have a 125% debt service coverage ratio. And those are basically the things that we look for. And we stress them to make sure that under different stress scenarios they're able to meet certain things.

Okay. Thanks.

Our next question comes from the line of Brady Gailey with SunTrust.

Yeah, it's actually Brady Gailey with KBW. Good morning, guys.

Good morning, Brady.

Good morning.

So on the bond purchases it sounds like you saw an opportunity with the dislocation in the bond market and took advantage. How do you think about additional bond purchases from here?

Everything is quite constrained at the moment. We opted for municipal bonds because they provide us with the advantage of locking in a bond without the concern of prepayment due to call protection. We'll keep an eye out for further opportunities, but it's quite tight currently. Municipal bonds have tightened significantly since mid-March. Mortgages are extremely narrow right now, particularly with the Federal Reserve purchasing heavily. That's primarily why we decided to invest and achieve the asset growth we were targeting for the year.

All right. And then you mentioned the $10 million of pre-tax earnings from the PPP loans. That looks like about 330 basis points of fees or gains. When would you expect to realize that? It seems like most of those loans will be forgiven within the next quarter or two. So is it right to think about that $10 million will flow through spread income in the next call it two quarters?

I think we don't know exactly how much will occur, but we're estimating that close to 90% will. If it does happen this quarter, it will likely be in the last 15 days. However, the majority may depend on the processes related to the SBA and if loan approvals are slow, it could extend into July for prepayments.

Okay. Great. Thanks, guys.

If that's helpful, I mean, we're thinking that whatever is going to be prepaid probably 95% of it's going to happen by the end of July. There'll be very little that trickles past that I would guess.

There are no further questions at this time. Would you like to make closing remarks?

Yes. Well, thank you for being on the call today. And given Southside's experienced management team along with having entered the crisis with strong asset quality, capital liquidity, and low levels of non-performing assets, we believe we're well-positioned to deal with the challenges ahead. Thank you for joining us today. We look forward to reporting second quarter results in July. This concludes our comments.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.