Southside Bancshares Inc Q1 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the Southside Bancshares, Inc. First quarter 2021 Earnings Call. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to Lindsey Bailes. Please go ahead.

Thank you, Ashley. Good morning, everyone, and welcome to Southside Bancshares' first quarter 2021 earnings call. A transcript of today's call will be posted on southside.com under Investor Relations. During today's call and in other disclosures and presentations, I will remind you that any forward-looking statements are subject to risk 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 on the quarter, then Julie will give an overview of our financial results. I will now turn the call over to Lee.

Good morning, and welcome to Southside Bancshares' first quarter earnings call for 2021. This morning, we reported that we had an excellent first quarter, highlighted by record net income and earnings per share. Beginning the year on a strong note, the first quarter results included a partial reversal of provision for credit losses of $10.1 million. Our asset quality metrics remain strong as the ratio of nonaccruing loans to total loans linked quarter decreased to 0.14% from 0.21% and nonperforming assets to total assets decreased to 0.22% from 0.25%. Linked quarter, we did see a decrease in net interest income. Approximately half of this was due to a decrease in interest and accretion income related to PPP loans with the rest due to the $200 million decrease in average earning assets. To give you a little more color about our first quarter average earning assets, there are three things I want to point out. First, during the quarter, annualized loan growth net of PPP loans and payoffs increased 6.2%. A large percentage of the payoffs occurred during the first half of the quarter and approximately $97 million of the loan growth net of PPP occurred during March. Second, we are actively participating in the second round of PPP and as of April 21st, we've originated a little over 1,000 loans, totaling $105 million. Approximately $70 million of these PPP originations occurred after mid-February. Third, our net interest margin linked quarter was unchanged, while our net interest spread increased 1 basis point. As for the rest of 2021, our loan pipeline remains very healthy, a trend we currently anticipate will continue throughout the year, given the outlook for the high growth markets we serve. We continue to anticipate 7% loan growth for 2021 net of PPP loans. During the first quarter, we added three experienced commercial lenders, two in the DFW area and one in Austin that have hit the ground running, originating loans and bringing new relationships to Southside. In addition, on April 12th, we opened our Houston LPO near the Galleria and this group of commercial lenders have been active originating loans and introducing new relationships to us as well. We continued to see a very healthy increase in our non-maturity deposits during the first quarter due in part to the stimulus payments received by our customers combined with PPP loan funds being deposited into Southside accounts. These deposits allowed us to further reduce higher-cost wholesale funding and time deposits. We previously disclosed plans to close three branches, two in East Texas that were in close proximity to other Southside branches and one lease branch in North Texas. These closures were completed in mid-March. During the second quarter, we will realize the full savings associated with these closures. Economic conditions in our market areas continue to improve, bolstered by company relocations and population growth due to individuals moving to Texas from other states. The DFW and Austin markets continue to be among the highest growth markets in the country. I look forward to answering your questions following Julie's presentation, and I will now turn the call over to Julie.

Thank you, Lee. Good morning, everyone, and welcome to our call today. We are pleased with the solid start to 2021, with net income of $34.1 million, an increase of $4.5 million or 15.3% on a linked quarter basis and our diluted earnings per share increased $0.15 or 16.9% to $1.04 per share on a linked quarter basis. Linked quarter, our loan portfolio increased $58.8 million or 1.6% to $3.72 billion driven primarily by an increase in commercial real estate loans of $52.8 million and construction loans of $23.7 million, partially offset by a decrease in 1-4 family residential loans of $19.5 million. As Lee mentioned in his remarks earlier, we are encouraged by the activity in our loan pipeline at this time. As of March 31st, our PPP loans included in the commercial loan category totaled $220.9 million, including approximately $88 million net fees originated in connection with the second round of the program. New originations net of forgiveness payments resulted in the $6 million increase in PPP loans for the linked quarter. Our credit quality metrics remained strong with nonperforming assets as a percentage of total assets decreasing to 0.22% at March 31st compared to 0.25% at December 31, 2020. On a linked quarter basis, total nonperforming assets decreased $2.1 million or 12.1% to $15.4 million. Linked quarter, our allowance for loan loss decreased $7.6 million or 15.4% to $41.5 million at March 31st due to a reversal of provision for credit losses on loans of $7.4 million in the first quarter, the result of an improvement in the economic forecast. In addition, our allowance for off-balance sheet credit exposures at March 31, 2021, was $3.6 million, a decrease from $6.4 million at December 31, 2021, due to a reversal of provision for credit losses on off-balance sheet exposures. Combined, these provision reversals totaled $10.1 million. At March 31st, we reported our allowance for loan losses as a percentage of total loans at 1.12% and when excluding PPP loans 1.19%. As of April 22nd, our COVID-19 related deferrals had decreased to $1.4 million, consisting primarily of mortgages. As of March 31st, our loans with oil and gas industry exposure were $104.8 million or 2.82% of total loans. There are no COVID-19 modifications in this category. Our securities portfolio decreased $51.2 million or 1.9% on a linked quarter basis. We recognized approximately $2 million in net security gains on the sale of AFS securities during the quarter, resulting from sales of municipal securities. At quarter end, we had a net unrealized gain in the securities portfolio of $102.4 million and the duration in the portfolio was 5.3 years, an increase from 4.7 years at the end of 2020. Our mix of loans and securities at March 31st remained consistent with December 2020 at 58% loans and 42% in securities. As of March 31, 2021, our treasury stock increased by 301,000 shares. Purchases of 427,000 shares of our stock at an average price of $35.60 were partially offset by 126,000 shares issued from treasury shares in connection with equity award transactions during the quarter. Year-to-date through April 22nd, we have purchased 518,000 shares at an average price of $36.10. Approximately 420,000 authorized shares remain under our current stock repurchase plan. Our net interest margin remained consistent at 3.20% on a linked quarter basis, approximately 10 basis points of the net interest margin related to interest and fees earned on the PPP loans. The net interest spread increased to 3.03% for the first quarter of 2021 compared to 3.02% in the previous quarter. For the three months ended March 31st, net interest income decreased $2.4 million or 4.9%. We recorded $415,000 in purchase loan accretion this quarter, a decrease of $38,000 from the prior period. Additionally, we recorded approximately $2.6 million in net fees related to the PPP loans included in interest income this quarter, of which $2.5 million was related to round one of the program. As of March 31, 2021, we had net deferred fees of approximately $5.25 million remaining, consisting of $1.75 million on round one and $3.5 million on round two of the PPP loans. As of April 21st and based on approximately $105 million originated on the second round, we expect to recognize approximately $5.1 million in total fees on round two as a yield adjustment over the terms of the loans. For the three months ended March 31st, non-interest income, excluding net gains on the sale of available-for-sale securities increased $696,000 or 6.4% for the linked quarter, which was primarily driven by an increase in brokerage services and other noninterest income. These increases were partially offset with decreases in deposit services and gain on sale of loans. Our other noninterest income increased primarily due to an increase in swap fee income of $588,000 and increases in the fair value of Mortgage Servicing Rights and mortgage rate locks. The decrease in overdraft income was the primary driver of the decrease in deposit services income, a result of stimulus check deposits during the quarter. For the three months ended March 31st, noninterest expense was consistent with the fourth quarter of 2020, with a slight decrease of $81,000. For the second quarter of 2021, we expect noninterest expense to be consistent with this quarter at approximately $31 million. Our fully taxable equivalent efficiency ratio increased to 50.44% compared to 47.36% on a linked quarter basis. The increase in the fully taxable equivalent efficiency ratio was due to the decrease in net interest income as well as a decrease in non-recurring branch closure expense compared to the prior quarter. Income tax expense increased to $485,000 or 11.4% compared to the three months ended December 31st, driven by the increase in pre-tax income. Our effective tax rate decreased slightly to 12.2% for the first quarter from 12.6% last quarter due to $124,000 of discrete tax benefit recorded in connection with the equity award transactions during the first quarter. At this time, we are estimating an annualized effective tax rate of 12.6%. Thank you for joining us today. This concludes our comments and we will open the line for questions.

Your first question comes from the line of Brett Rabatin with Hovde Group. Your line is now open.

Good morning, everyone. This is Ben Gerlinger filling in for Brett. I'd like to start by discussing overall loan growth. The guidance of 7% for core loan growth is quite impressive. I understand that the banking sector anticipates significant growth in the second half of the year. Given that you're based in Texas, where there's a lot of population and business influx, I'm interested in how you view the rest of the year. Will it be more focused on the first half or is it expected to be back-weighted? Additionally, with the new team members, do you anticipate they will be fully operational within 12 months, or could this process extend into 2022?

In terms of the new lenders, they are highly experienced and have effectively ramped up their operations. Some began earlier this quarter, and we had anticipated their participation in the projected 7% loan growth. I do expect to see more contributions in 2022, especially since they will be involved for a full 12 months, and I believe they will play a significant role in our loan growth this year. Regarding the loan growth, I expect it to be steady, supported by a strong pipeline. However, the timing of loan closures, particularly for commercial real estate, will depend on various factors like appraisals. My expectation is that growth will not be evenly spread across the three remaining quarters, but we should still see positive growth in each of those quarters. My optimism comes from operating in markets that are experiencing substantial growth, where demand for housing is high, and the challenges of finding available properties are indicative of a strong market.

That's insightful. When considering the various regions within Texas, there are multiple metropolitan areas experiencing different types of growth, whether in business or technology. Are there specific areas where you feel you might want to strengthen your position, perhaps through mergers and acquisitions, adding more lenders, or addressing certain regions within the state where you may not have the capacity you desire?

I'll say that Houston, DFW, and Austin are massive markets. I don't know that we could hire enough lenders to fully cover those markets, so I think, those three markets will continue to explore additional opportunities. And then, there are a lot of good smaller markets throughout the state that if we're not in, we might, through M&A, explore entering some of those markets.

That's helpful. Regarding the expense guidance of approximately 31, is it reasonable to think that this represents a new core trend, or do you expect it to increase beyond the second quarter levels as we progress through the latter half of the year? Considering the various factors like branch closures, from that core viewpoint, should we consider 31 as a new good run rate, or is it somewhat low before we begin to see an upward trend again?

I don’t expect us to reach 32 at this point, so I believe we should see numbers in the range of 31 to 31.5 for the rest of the year based on our observations over the last couple of quarters. While we may experience some fluctuations, particularly in advertising and travel, we haven't fully returned to our previous activity levels.

Okay, great. That's really helpful color. Appreciate it. Congrats on a great start to the year.

Thank you.

Your next question comes from Brady Gailey with KBW. Your line is now open.

Thank you. Good morning, guys.

Morning.

Good morning.

When you look at the bond portfolio and if you look at it over the last five quarters, it has not been dramatic but the bond portfolio just continues to tick down kind of a little-by-little every quarter. When do you make the decision to stabilize, if not kind of grow the size of the buyback? Do you need a higher long end of the curve to do that or is this planned and you're really focusing on loan growth, so we should continue to expect the bond book to tick down and loans to tick up?

We anticipate an increase in loans. Regarding the decline in the bond portfolio during the first half, approximately 60% of that was due to the unexpected sale of some municipal bonds linked to various cities and their electric power companies. Following significant events, including the power grid crisis in February caused by the weather, we decided that, from a credit perspective, the bonds had dropped by a couple of points, but the potential upside was limited. This decision contributed to about 60% of the decrease. You're right about the rates; they increased during the quarter, particularly in the latter half. We have become more active in our purchases and have continued this trend into April. This isn't a planned strategy; it's more about responding to the current interest rate environment and assessing the risk-reward balance for making these investments.

Yes. All right. That makes sense. And it was good to hear about the three lender hires. Lee, how active do you expect to be going forward on hiring lenders? It sounds like you're making more and more of an investment in Houston, which is great to hear but what should we expect, continued LPO/branches in Houston and continued lender hires or are you going to kind of stick with what you got, let that mature and kind of slow play it in Houston?

I expect that we will start looking for more lenders in Houston. The LPO we opened has the capacity to accommodate more people, so I'm not planning on opening another LPO there right now since they are well positioned. However, it could be a real possibility in the future, perhaps in 2022 or 2023. If we can find experienced lenders who have had success in other places, we will attempt to recruit them from their current banks to join Southside.

And sticking with Houston. I know you just started there, so it's probably small, but what's your loan base right now in Houston? And then, how big do you think you could get that over time? What's the goal as far as the Houston loan portfolio?

Let's wait as they are providing me with some numbers. Regarding Houston, I know we initially started with approximately $250 million to $300 million in loans there, and Julie is currently looking for the exact number, so we'll have that for you shortly. As for the potential growth, I believe we can easily double or even triple that amount over time, given the size of the market area, although this significant growth will not occur this year.

Yes, it seems like activity is increasing in Texas now that the state is fully open for business. We've recently witnessed a significant transaction involving BancorpSouth and Cadence, which suggests more deals may occur later this year. How do you see Southside fitting into this landscape? Do you anticipate that you'll be active in mergers and acquisitions, particularly in acquiring smaller banks in Texas?

Yes. Those discussions have definitely picked up, and I do anticipate that sometime within the next 12 months, I would hope we're definitely active in that arena and we are beginning to have additional discussions along those lines. So, I think, on the sales side, there are more people interested in talking about that and so we are definitely interested. Our focus continues to be basically east of I-35, going down the state with maybe going out 40 or 50 miles to the west of 35.

And Lee, just remind us from a size point of view, I mean, you guys are $7 billion, so you're getting somewhat close to the $10 billion mark, but from a size point of view, what would the ideal target look like?

An ideal target would probably be at least $1 billion, up to $2 billion, getting much above $2.5 billion. We could adjust our balance sheet by reducing securities if we wanted to, but if we get much above $2.5 billion, we're right at $10 billion. And while we're preparing to get there, I think it's probably going to be the end of the year before the portfolio is ready to be able to go over that $10 billion mark.

Yeah. Great. Thank you for the color guys.

All right. Thank you, and we'll get you the number on Houston.

Your next question comes from Brad Milsaps with Piper Sandler. Your line is now open.

Hey guys. Good morning.

Good morning.

Good morning.

Hey, Lee, just wanted to follow up on the bond portfolio discussion, maybe a different direction in the size, but looks like the yield has actually stayed fairly stable year-over-year. Just kind of curious, if you can kind of talk about that, anything sort of out of the ordinary affecting the yield of weight or is that just your typical working the bond portfolio really hard like you've done over time. Just I think, it's very impressive that that's been able to stay relatively stable yet. We've seen obviously rates collapse around us. Just any additional color there would be helpful.

Sure. Basically, the stuff that's been rolling off, we really haven't had a lot of municipals roll off other than in those that we sold. And with stuff that's been rolling off is in the mortgage-backed arena and say, probably they've been paying much faster up in that 35 to 45 CPR range. And they tend to have some of the lower yields in the portfolio as a result of those higher prepayment speeds and we own those at premium. So I think, we can largely attribute it to the lower stuff rolling off, and yes, we're not putting on it. I'd love to say we're putting on everything at 3% or higher but we're not. But what we are putting on is higher than what's rolling off, so I think that's what you're seeing.

Okay. Thank you. That's helpful and then just on the other side of the equation. You guys had a lot of run-off in the time deposit category this quarter. I think, averages were down almost $300 million. Just kind of curious how much more run off you think you have to go there? You think that's getting close to a pretty steady state? And then, we have the same of the Federal Home Loan Bank advances. I think, most of what you have left is swap, so that may preclude you from kind of taking that new lower, but just any color on those two categories would be helpful.

You're right about the Home Loan Bank advances; we've nearly completed our swaps. We do have a $20 million swap that matures in June, but it's unlikely we will replace it concerning the time deposits. Most of the reduction in time deposits has come from public fund customers and brokered CDs. I’m not sure if we've completely eliminated brokered CDs, but we've decreased to $45 million, and we expect that to continue to decline given our excess funding. On the public fund side, we're approaching what I consider a core level as our institution's depository. Therefore, I expect a significant slowdown in that area over the next several quarters.

Great. And then just a couple of final ones. Curious, where new loan yields are coming on the books? And then, Julie, not sure, if you have average PPP loans for the quarter and then the contribution in dollars from the purchase accounting this quarter, also be helpful. Thank you, guys.

Okay. The average yield on loans going on the books without the PPP loans for the first quarter was 3.32%. We do anticipate with the rates having moved up some that we may see a little higher rate in future quarters, but that was the average rate excluding PPP loans. If you put the PPP loans in there, it was right around 2.90%.

The average balance on the PPP loans was $215,061,000.

And then the purchase accretion was $415,000. It was down about $38,000 from last quarter.

Excellent. Thank you, guys. Really appreciate it.

There are no further questions at this time. I will now turn the call back to Lee Gibson, CEO and President for your closing remarks.

Okay. As for Brady's question on total loans in Houston, right now, in the Houston area, we have right around approximately $400 million in loans in Houston. Our new loan group has provided new loans of about $70 million of that $400 million. Closing remarks. Thank you for joining us today. Given the positive outlook for our markets, our strong balance sheet, capital position, asset quality, and core earnings, we are very encouraged about 2021 and look forward to reporting results to you during our next earnings call in July. Thank you for attending and this concludes the call.

Thank you for joining us today. We have approximately $400 million in loans in Houston, with our new loan group contributing around $70 million of that total. Given the positive outlook for our markets, strong balance sheet, capital position, asset quality, and core earnings, we are very encouraged about 2021 and look forward to reporting our results during the next earnings call in July. Thank you for attending, and this concludes the call.