Southside Bancshares Inc Q2 FY2021 Earnings Call

Good day, and thank you for being with us. Welcome to the Southside Bancshares, Inc. Second Quarter 2021 Earnings Call. I would now like to introduce your speaker today, Ms. Lindsey Bailes, Vice President of Investor Relations. Please proceed.

Thank you, Roche. Good morning, everyone, and welcome to Southside Bancshares' Second 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 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 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' Second Quarter Earnings Call for 2021. This morning, I am pleased to report we had another solid quarter with net income of $21.3 million, earnings per share of $0.65, and an annualized ROA of 1.2% and an annualized return on average tangible common equity of 13.13%. Our quarterly results included continued linked quarter deposit and loan growth, net of PPP loans, and continued strong asset quality metrics. The second quarter results included a provision for credit losses of $1.7 million due to a decline in the downside component of the economic forecast and its effects on macroeconomic factors used in the CECL model. Our strong asset quality metrics included nonaccruing loans to total loans of 0.14% and nonperforming assets to total assets of 0.21%. Our linked quarter loan growth, net of PPP loans, of $14.5 million was partially offset by earlier-than-anticipated loan payoffs due to recently completed construction projects selling prior to stabilization at very low cap rates. A year ago, we were seeing construction projects typically sold post-stabilization. Annualized loan growth as of June 30, 2021, was 4%. We continue to believe 7% loan growth for 2021, net of PPP loans, is achievable as our loan pipeline remains very healthy, a trend we anticipate will continue throughout the year, given the outlook for the high-growth markets we serve. The $656,000 decrease in our net interest income linked quarter was due entirely to the decrease in PPP loan accretion during the quarter. Linked quarter, our net interest margin and spread decreased 14 basis points, primarily due to an 18-basis-point increase in the yield on earning assets. The average yield on loans decreased 16 basis points, half of which was due to the decrease in the combined PPP and purchase loan accretion. The average yield on securities decreased 18 basis points linked quarter, largely due to a 42-basis-point decrease in the yield on mortgage-backed securities, primarily a result of higher prepayments, and a 23-basis-point decrease in the yield on taxable securities primarily due to an increase in the average balance of a treasury position during the second quarter. The mortgage-backed securities position continues to decrease as a percentage of the overall securities portfolio. In addition, during July, we sold approximately $57 million of our lower-yielding mortgage-backed securities. On September 30, we anticipate the redemption of our 5.5% coupon $100 million sub debt issue pending regulatory approval, which will have a positive impact on both net interest income and the net interest margin beginning in the fourth quarter. For the six months ended June 30, 2021, our net interest margin has increased 11 basis points when compared to the prior year. During the second quarter, we continued to see a nice increase in non-maturity deposits, which represent our lowest-cost interest-bearing liabilities. Over the past 15 months, we have experienced significant growth in non-maturity deposits, which has allowed us to strategically lower our higher-cost funding sources, CDs, and FHLB borrowings. Economic conditions in our market areas remained strong, bolstered by company relocations and expansions combined with population growth as the Texas economy continues to benefit from individuals and companies migrating from other states. The DFW and Austin markets that we serve 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 reported net income of $21.3 million, a linked-quarter decrease of $12.8 million or 37.5% due primarily to an increase in provision expenses of $11.8 million and a decrease in net security gains of $2 million. Net income decreased $237,000 or 1.1% compared to the same period in 2020. For the quarter ended June 30, 2021, our diluted earnings per share were $0.65, unchanged when compared to the same period in 2020 and a decrease of $0.39 or 37.5% on a linked-quarter basis. Linked quarter, net of the decrease in PPP loans of $88.8 million, our loan portfolio increased $14.5 million to $3.64 billion. Our commercial real estate loans increased $82.3 million, partially offset by a decrease in construction loans of $77.5 million. Construction loans decreased due to several large unexpected early payoffs in the second quarter, and commercial loans, excluding the PPP forgiveness, increased approximately $21 million during the second quarter. As of June 30, our PPP loans, included in the commercial loan category, totaled $132.1 million, down from $220.9 million at March 31, 2021. The average balance of our PPP loans for the three months ended June 30, 2021, was approximately $200.6 million. Our asset quality remains strong as nonperforming assets decreased slightly by $98,000 down to 0.21% of total assets compared to 0.22% at March 31, 2021. Linked quarter, our allowance for loan loss increased approximately $1.5 million or 3.5% to $42.9 million at June 30 due to recording a provision for credit losses on loans of $1.5 million in the second quarter of 2021, an increase of $8.9 million compared to the reversal of provision in the first quarter. The increase in the provision for the second quarter was primarily due to a decline in the S3 Downside Scenario in the Moody's economic forecast at June 30, 2021, and its effect on macroeconomic factors used in the CECL model. On June 30, our allowance for loan losses as a percentage of total loans was 1.18%. And when excluding PPP loans, 1.22%. Our allowance for off-balance sheet credit exposures at June 30 increased slightly to $3.8 million compared to March 31, 2021, due entirely to provision expense of $157,000, again compared to a reversal of provision of $2.8 million in the previous quarter. Combined with the provision expense for credit losses on loans, the provision for credit losses totaled $1.7 million for the three months ended June 30, 2021. Our COVID-19-related deferrals have decreased to one remaining mortgage loan with an approximate balance of $158,000. As of June 30, our loans with oil and gas industry exposure were $94.3 million or 2.7% of total loans. Our securities portfolio increased $215.8 million or 8.2% on a linked-quarter basis. We recognized $15,000 in net security gains on the sale of AFS securities during the quarter, a decrease of $2 million from the net gains reported last quarter. As of June 30, 2021, we had a net unrealized gain in the securities portfolio of $136.4 million, and the duration in the portfolio increased slightly to 5.4 years from 5.3 years at the end of the first quarter. Our mix of loans and securities at June 30 shifted to 56% loans and 44% securities, from 58% and 42%, respectively, at March 31 due to the purchases in the securities portfolio. Our net interest margin and spread were 3.06% and 2.89%, respectively, with a linked-quarter decrease in both of 14 basis points, a result of the decrease in yield on interest-earning assets. Consistent with last quarter, approximately 10 basis points of the net interest margin related to interest and fees earned on the PPP loans. For the three months ended June 30, net interest income decreased $656,000 or 1.4%. We recorded approximately $1.7 million in net fees related to the PPP loans included in interest income this quarter compared to $2.6 million linked quarter. As of June 30, 2021, we had net deferred fees of approximately $5.3 million remaining to be recognized as a yield adjustment over the terms of the loans. Additionally, we recorded $649,000 in purchased loan accretion this quarter, an increase of $234,000 from the prior period. For the three months ended June 30, 2021, noninterest income, excluding net gains on the sale of AFS securities, decreased $702,000 or 6% for the linked quarter, which was primarily driven by a decrease in other noninterest income, partially offset by an increase in deposit services income. Our other noninterest income decreased primarily due to a decrease in swap fee income and a decrease in the fair value of mortgage servicing rights. An increase in debit card income was the primary driver of the increase in deposit services income. Additionally, we have experienced consistent increases in our trust fees and brokerage services income over each of the five linked quarters since June 30, 2020, resulting in increases of 51% in brokerage services income and 14% in Trust fees for the six months ended June 30, 2021, when compared to the same period in 2020. Linked quarter noninterest expense decreased $535,000 or 1.7% to $30.7 million. For the third quarter of 2021, we expect noninterest expense to be approximately $31 million. Our fully taxable equivalent efficiency ratio decreased to 50.31% compared to 50.44% linked quarter. The decrease in the fully taxable equivalent efficiency ratio was due to the decrease in noninterest expense for the quarter. Income tax expense decreased $1.9 million or 39.2% compared to the three months ended March 31, 2021, a result of the decrease in pretax income. Our effective tax rate decreased slightly to 11.9% for the second quarter from 12.2% last quarter due to an increase in tax-exempt income as a percentage of pretax income. Additionally, we recorded $115,000 of discrete tax benefit in connection with equity award transactions during the second quarter. At this time, we are estimating an annualized effective tax rate of 12.5%. Thank you for joining us today. This concludes our comments, and we will open the line for questions.

Your first question comes from Brad Milsaps from Piper Sandler.

Lee, I wanted to start with the bond portfolio. It seems that the average bond portfolio finished the year at around $2.6 billion during the quarter, while you were closer to $2.9 billion at the end of the period. I believe you mentioned you sold some assets, but I'm curious about what categories you decided to invest in. It appears you're allowing MBS to run off. Did you buy more tax-exempt securities, or are they part of the taxable book? Additionally, what implications does this have for your margin going forward?

Primarily, we focused on purchasing municipals, mainly tax-free municipals with some taxable as well. We acquired a few bank sub-debt deals, but our main activity has been in the municipal sector. Currently, we are not finding any value in the mortgage sector. Regarding the margin ahead, the treasury position on the taxable side has affected that yield, but we are not increasing our treasury position right now, so I don't anticipate it being a problem. For other taxable purchases, they have generally been in the range of 2.50% to 2.70%. On the tax-free side, it really depends on the maturity and the call, but for the high-quality options, any additions will likely result in a slight reduction in the rate.

Okay. Great. It seems like you are feeling more positive about loan growth picking up in the second half. Do you think that the net interest margin can stabilize above 3%, or are you expecting more significant compression?

I don't expect to see a 14 basis point decrease in the net interest margin going forward, particularly in the third quarter. However, I do anticipate some slight compression. Several factors have contributed to the lower NIM. We expect to start seeing forgiveness of some round two PPP loans within the next six to nine months, which will bring in additional income. Additionally, pending regulatory approval for the sub-debt deal will alleviate some pressure on the NIM, likely leading to an improvement.

Great. And just one housekeeping question. Julie, do you have now the average number of PPP loans in the quarter?

You want the average number or the average balance?

I'm sorry, the balance. I apologize. The balance.

Okay. Well, that's what I thought you meant. It's yes, it's $200.6 million.

Your next question comes from the line of Brett Rabatin with Hovde Group.

I wanted to ask the Securities question in a different way. Lee, how much cash flow do you anticipate having that needs to be reinvested in the coming quarters? What would be the average rate? I'm trying to understand what you need to replace in relation to the current portfolio moving forward.

The cash flow we are receiving is primarily from the mortgage-backed securities portfolio, averaging around $30 million per month. While the sale of some of these securities may lead to a slight decrease in this figure, I anticipate we will see close to $90 million in redemptions for the third quarter. The average yield on these securities is 2.2%, and we are seeing prepayments mainly from lower rate securities. Overall, we should be able to invest in securities with similar yields, although this could create some additional pressure on the overall yield of the securities portfolio.

Okay. That's good information. Regarding the payoffs in the construction portfolio, it appears those were unexpected. Essentially, there were projects that, even before the occupancy letter was filed, were refinanced away from us. What might have contributed to the unexpected decline in construction?

Yes. We were expecting these to sell, but typically, what we've seen is that the project, say, it's a multifamily, it will reach stabilization, which means it may be 90%, 95% occupied. What we were starting to see in the second quarter was they were able to sell these projects prior to stabilization. So, they weren't leased up to stabilization. And so, they were prepaying anywhere from 3 to 9 months faster than we originally anticipated that they would pay off.

And then a last question for me. I've had some contacts in the state tell me that the talks are picking up, and I know you've been thinking about doing M&A. I was just curious to get your tea leaf read on M&A for you, and if you were seeing some opportunities and you're hearing or having conversations with folks these days.

We are hearing more opportunities out there and having additional conversations, and some of the opportunities that are out there are ones that we may not be interested in. But yes, we are definitely seeing an uptick in opportunities to have conversations surrounding M&A.

Your next question comes from Will Jones with KBW.

I wanted to return to the topic of loans and loan growth. It's unfortunate you had to reduce your growth this quarter, especially after the strong performance in the first quarter. However, it seems you're still hopeful for the latter half of the year. What are you observing in your markets right now, and where do you expect most of the growth to originate? I understand you're working on expanding your presence in Houston and are also recruiting lenders in the Dallas market, so I’m interested in your thoughts on loan growth.

We're seeing a number of opportunities in our current pipeline. There are several full funders that we are evaluating right now, which gives us some encouragement regarding the 7% loan growth. Additionally, our construction projects initiated last year are beginning to fund. We anticipate that there may be a few more early payoffs, which we were expecting in the latter half of this year or early next year. Given what we observe in our pipeline and the types of loans we are seeing, along with the presence of several full funders, we are confident that barring any unexpected large payoffs, we should be able to achieve close to that 7% growth.

Got you. That's great to hear. And then just on the hiring front, are you guys still active in seeking new lenders? Are you guys still active in building out in different markets or maybe hoping to do some lending count within certain portfolio segments? Just curious on the commentary around your hiring efforts and what you guys are seeing out there.

We are definitely interested in hiring additional revenue producers, especially in our higher-growth markets, and we're actively looking for some. We did bring on three in the first quarter that have worked out extremely well. And we're just being very selective in what we do. But yes, we are continuing to look for additional revenue producers in those market areas.

Great. Just for my reference, what would you consider your highest growth markets?

The Dallas-Fort Worth area, the Austin market, and Houston, while it may not be as high-growth as the other two, is still a growing market. And for us, we're just scratching the surface there. So there seems to be a lot of opportunity there for us even with maybe a little slower growth than we're seeing in some of the other markets.

Awesome. That's great. And just lastly for me, I know that just looking at it, it looks like in the period shares, roughly flat quarter-over-quarter. But I know you guys were active on the buyback last quarter. Did you guys buy back any shares this quarter? And how is your appetite for the buyback as you go into this upcoming quarter? I know same stocks were kind of pulled back a little bit. Is it possible to see you guys engage pretty heavily?

In terms of the future, yes, we're definitely looking to repurchase shares moving forward, especially at these prices. And in terms of what we purchased during the quarter, I'm going to let Julie answer that.

Yes. We purchased right at 91,000 shares in the first quarter. It was very early on in April at an average price of $38.49. And like Lee said, we do plan to be pay back in there.

Next question with Michael Young with Truist Securities.

I wanted to ask just about interest rate sensitivity. You guys have historically been a little bit liability sensitive. But just wanted to kind of get your thoughts or any proactive measures that you may be taking to maybe be a little more neutral if we think we're moving towards a higher rate environment or extending duration or shrinking duration as the case may be.

Yes, great question. Over the past 15 months, we've capitalized on the significant growth in non-maturity deposits. While there might be some decline in these deposits, it seems that most of them will remain quite stable. These deposits are typically longer-duration liabilities compared to those that we allowed to decrease, like CDs and FHLB borrowings. As a result, we believe our overall liabilities have lengthened nicely in duration due to the increase in non-maturity deposits. Additionally, we have a substantial number of floating-rate loans. On the loan side, we are receiving considerable cash flow from mortgages. Currently, I feel we are almost neutral because of the growth in non-maturity deposits.

Okay. That's helpful. I have a broader question about the bank's expense structure. You have managed to reduce expenses effectively to maintain an appealing efficiency ratio. Looking back at the pandemic and the brief period when branches were closed, along with the sales activity during that time, are you now more confident in continuing to optimize the branch network or shifting it towards higher-growth metropolitan areas? Any insights on this would be appreciated.

Yes, in the past 12 months, we have closed six branches. Specifically, in the last nine months, we've also closed six branches. I'm trying to recall if we closed any in the third quarter of last year. Additionally, we have opened two new branches, one of which was initially a loan production office and is now a full-service branch. The other new branch is located in Houston, and we have opened one in the Dallas-Fort Worth area as well. We are considering more branches in higher-growth markets while ensuring we maintain a sufficient number of branches in other areas that generate a lot of low-cost deposits. It’s essential that these regions are adequately serviced by our branches.

I will now turn the call back over to Mr. Gibson.

All right. Thank you for joining us today. We appreciate the opportunity to answer your questions and your interest in Southside Bancshares. In closing, given the positive economic conditions in our markets, our strong balance sheet, capital position, asset quality, and core earnings, we are very encouraged and look forward to reporting results to you during our next earnings call in October. This concludes the call.

This concludes today's conference call. Thank you for participating. You may now disconnect. Goodbye.