Southside Bancshares Inc Q4 FY2021 Earnings Call

Thank you, Jonathan. Good morning, everyone, and welcome to Southside Bancshares Fourth Quarter and Year-End 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, and then Julie will give an overview of our financial results. I will now turn the call over to Lee.

Good morning, everyone, and welcome to Southside Bancshares Fourth Quarter and Year-End Earnings Call for 2021. This morning, we reported exceptional results for the year and the fourth quarter. I want to start by recognizing and thanking the entire Southside team for their extraordinary contributions and efforts during 2021, without which these results would not have been possible. Highlights for the quarter included earnings per share of $0.88, an ROATCE of 16.8%, annualized linked quarter deposit growth of 29.1%, annualized linked quarter loan growth net of PPP of 3.8%, an increase in the net interest margin to 3.23%, and continued strong asset quality with nonperforming assets decreasing to 0.16% of total assets. Highlights for the full year included record net income of $113.4 million; record earnings per share of $3.47; an ROATCE of 17%; a 16% increase in deposits, a 5% increase in loans, net of PPP; an increase in the net interest margin of 9 basis points; and further improvement in our strong asset quality. The fourth quarter results included a reversal of provision for credit losses of $3.4 million. Linked quarter, our net interest margin increased 7 basis points. The average yield on securities increased 8 basis points. And the rate on our interest-bearing liabilities decreased 13 basis points, 11 basis points of which resulted from the decrease in subordinated debt expense. The average yield on loans decreased 12 basis points, largely due to the decrease in PPP loan accretion. We were extremely pleased with our annualized linked quarter loan growth, net of PPP of 3.8%, given the previously discussed anticipated large payoffs that occurred during the fourth quarter. As we begin 2022, our loan pipeline is extremely strong. What is especially encouraging is that the pipeline in each of our regions is very strong. Given the excellent outlook for the high-growth markets we serve, as well as the growth occurring in our other markets, we anticipate solid loan demand will continue well into 2022. We are projecting 2022 loan growth, net of PPP loans, of 9%. During the fourth quarter, we continued to experience an increase in our average nonmaturity deposits, which represent our lowest cost interest-bearing liabilities. Over the past 24 months, nonmaturity deposits have increased significantly, which has allowed us to strategically transform the funding base by significantly reducing dependence on higher cost and shorter duration CDs and unswapped FHLB and other wholesale borrowings. Currently, our swapped borrowings are $575 million, down $30 million since December 31. The economic conditions in our markets remain strong, bolstered by continued company relocations and existing company expansions combined with population growth resulting from continued migration 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 remarks, and I will now turn the call over to Julie.

Thank you, Lee. Good morning, everyone, and welcome to our call today. We ended 2021 with another strong quarter and record financial results for the year with annual net income of $113.4 million and diluted earnings per common share of $3.47, a 40.5% increase from $2.47 for 2020. We reported fourth quarter net income of $28.7 million, a linked quarter decrease of $619,000 or 2.1% due to a lower reversal of provision for credit losses and a decrease in gain on sale of AFS securities, partially offset by a decrease in interest expense. For the quarter ended December 31, 2021, our diluted earnings per common share were $0.88, a decrease of $0.02 or 2.2% on a linked-quarter basis. Linked quarter, net of the decrease in PPP loans of $36.5 million, our loan portfolio increased $34 million to $3.61 billion. Our construction loans increased $25.8 million. Commercial loans, excluding the PPP forgiveness, increased $11.7 million. And we also experienced an increase in municipal loans of $15.8 million on a linked quarter basis. We had increased payoffs in commercial real estate, including several large loans between $24 million and $30 million. The weighted average rate of new loans funded during the fourth quarter was approximately 3.4%. As of December 31, our PPP loans included in the commercial loan category totaled $31 million, down from $67.5 million at September 30, 2021. The average balance of PPP loans was approximately $53.6 million for the fourth quarter and $142.7 million for 2021. Currently, our remaining PPP loans are approximately $25 million. Our asset quality remains strong. Nonperforming assets decreased throughout 2021, with a total decrease of $5.9 million or 33.6% for 2021, 0.16% of total assets compared to 0.25% at December 31, 2020. On a linked-quarter basis, nonperforming assets decreased $815,000 or 6.6%. Linked quarter, our allowance for loan loss decreased $2.7 million or 7.2% to $35.3 million at December 31, due to recording a reversal of provision for credit losses on loans of $2.7 million in the fourth quarter of 2021. The reversal of provision for the fourth quarter was primarily due to an improved forecast for commercial real estate, as well as the impact of loan payoffs on the allowance. As of December 31, our allowance for loan losses as a percentage of total loans was 0.97% and 0.98% when excluding PPP loans. Our allowance for off-balance sheet credit exposures at December 31 decreased to $2.4 million when compared to $3.1 million at September 30, 2021, due to a reversal of provision of $706,000 in the fourth quarter. This, combined with the reversal of provision for credit losses on loans, meant the total reversal of provision for credit losses was $3.4 million for the 3 months ended December 31, 2021. As of December 31, our loans with oil and gas industry exposure were $69.7 million or 1.9% of total loans. Our securities portfolio increased $9.5 million or 0.3% on a linked quarter basis. We recognized $463,000 in net security gains on the sale of AFS securities during the quarter, a decrease from the net gains of $1.4 million reported last quarter. At year-end, we had a net unrealized gain in the securities portfolio of $111.7 million, and the duration of the portfolio was 5.9 years, up from 5.8 years linked quarter, and 4.7 years at the end of 2020. Our mix of loans and securities at December 31 was 56% and 44%, respectively, remaining consistent on a linked quarter basis with the shift from 58% loans and 42% securities for the prior year-end. Our deposits increased $390.7 million or 7.3% compared to September 30, 2021. This increase consisted of an increase in public fund deposits of $126.6 million or 14.7%. Public fund deposits normally increase in the fourth quarter each year. Additionally, brokered deposits increased $181.3 million or 159.8%. In December, in order to obtain lower-cost funding, we utilized $265 million in brokered deposits for funding our cash flow hedge swaps and reduced FHLB advances. During the first quarter of '22, we plan to utilize brokered deposits in place of FHLB advances on the remaining $310 million of cash flow hedge swaps. We expect this to reduce the overall funding cost on the swaps by approximately 10 basis points. Our net interest margin increased 7 basis points on a linked quarter basis to 3.23%. And the net interest spread increased 9 basis points to 3.09%. The reduction of our subordinated notes on September 30 impacted the average rate paid on our interest-bearing liabilities by approximately 11 basis points, for an impact of 9 basis points on the NIM. Approximately 8 basis points of the net interest margin related to fees earned on PPP loans compared to 18 basis points last quarter. For the 3 months ended December 31, net interest income increased $1.2 million or 2.5% when compared to the linked quarter. We recorded approximately $1.4 million in net fees related to the PPP loans included in interest income this quarter compared to $3.1 million last quarter. As of December 31, 2021, we had net deferred fees of approximately $935,000 remaining to be recognized as a yield adjustment over the terms of the loans. Additionally, we recorded $364,000 in purchased loan accretion this quarter, an increase of $168,000 from the prior quarter. For the 3 months ended December 31, 2021, noninterest income, excluding net gains on the sale of AFS securities, increased $160,000 or 1.4% for the linked quarter. For the fourth quarter, noninterest expense was $31.3 million. Excluding the loss on the redemption in the third quarter, noninterest expense increased $689,000 or 2.2% on a linked quarter basis. For 2022, we expect quarterly noninterest expense to be approximately $32.5 million. We are pleased to report our fully taxable equivalent efficiency ratio for the 3 and 12 months ended December 31 was 47.61% and 49.03%, respectively. Income tax expense decreased $165,000 or 3.3% compared to the 3 months ended September 30, 2021. Our effective tax rate decreased slightly to 14.4% for the fourth quarter. At this time, we are estimating an annual effective tax rate of 12% for 2022. Thank you for joining us today. This concludes our comments, and we will open the line for your questions.

Our first question comes from the line of Graham Dick from Piper Sandler.

Just wanted to start on the bond portfolio. Do you guys have any plans to grow it from here? I know you all talked about the addition of those brokered deposits. But it looks like there might have been some seasonal funds in there as well. Overall deposit growth is pretty strong. Just wondering if you guys are planning to grow it anymore from here?

No. I think for the year, we're budgeting just an ever so slight increase in the bond portfolio, $30 million or $40 million, somewhere in that range. But no, we're really not. And that growth in brokered deposits was due to us changing the funding of our swap hedge funding from a home loan bank to the brokered deposits so that we could save approximately 10 basis points.

Right. That sounded like a pretty good trade for you guys. And then I guess one last thing on the bond portfolio. I was just wondering if there's anything nonrecurring driving the improvement in the MBS yields this quarter?

I believe the increase was related to a decrease in amortization expense on the mortgage-backed securities. We are still experiencing some prepayment where there is yield maintenance on those securities. With rates slightly rising on the long end, I expect we might see a further slowdown in prepayment speeds, which could lead to a slight increase in mortgage yields.

Okay, that's what I expected. Moving on to asset sensitivity in a higher rate environment, could you provide some insights on your positioning? Specifically, I’m interested in your net interest income shock scenarios, the percentage of loans that repriced immediately, and what you anticipate regarding upfront deposit payments. That information would be very helpful.

Okay. I think over the last really since the pandemic began, deposits in all banks started growing. We basically utilized that deposit growth in nonmaturity deposits to become significantly less dependent on the CDs and to become significantly less dependent on unswapped wholesale funding, which right now we just don't have a lot of. So as the short-term interest rates increase, we don't feel like we're going to have to raise our funding costs anywhere near what those increases are. In fact, first increase on some of the nonmaturity deposits, there may not be any increase at all, but it'll be a very small percentage increase going forward, even throughout the year if it goes up the 4 rate increases that they're anticipating this year. On the loan side, I think just a little less than 50%, and Julie probably has the number, is in floating rate of that. Probably 60% to 70% reprices immediately, but most of it reprices within 6 months to a year. Some of it's based off a 3-month LIBOR, and some of it's 1 month, but a lot of it is overnight and immediate.

I appreciate that. Congrats on a pretty solid quarter.

Thank you.

Our next question comes from the line of Michael Young from Truist Securities.

Just wanted to touch on the loan growth outlook. You mentioned, I think, 9%. I assume that's kind of ex PPP, so just the core loan growth. And I was just curious what areas you're seeing the most strength in, if it's kind of the historical construction bucket, and what the new yields are on loans that you might be putting on. Are they a good bit higher at this point than kind of the back book of what's rolling off?

We are observing a significant number of construction loans, which are almost always variable rate. They are usually linked to either prime or 1-month LIBOR or SOFR at this time. As interest rates rise, these construction loans will also increase. What is particularly positive is that we are seeing many full funders, mainly in the commercial real estate sector. Additionally, we are expecting to see nice growth in municipal loans throughout the year. Does that address your question, Michael?

Yes. I guess I'm trying to get at, basically, are the new loans you're putting on, are they sort of at higher rates and higher yields than what's running off, and that it should be sort of accretive to loan yields? Or is it more in line or still kind of slightly dilutive?

I would say that the full funders, if we're adjusting them, are at slightly higher yields than what is rolling off. For the floating rates, they are likely at similar yields to what we have presently. However, in March, it's generally expected that there will be at least a 25 basis point increase. If that happens, it will be reflected in SOFR, LIBOR, and prime across the board. For those floating rate loans, let's say we have one at prime at 325, the real spread will likely increase beyond our cost of funds. It probably won't reach the full 25 basis points, but it should be in the range of 20 to 23 basis points.

Right. Okay. And then on the capital side, Lee, just sort of curious, you guys are going to have stronger loan growth. So wanted to just get your updated thoughts on capital returns, if share buyback is even still in the equation given where the stock is and then what the outlook is for M&A?

We do not have any stock buybacks currently in place, but we are considering it and expect that you might see something in the first half of this year. Regarding capital, I wanted to mention that.

M&A, dividends, yes.

We are currently engaged in some significant discussions with potential partners that we would be interested in acquiring. While I do not expect anything to happen immediately, I am hopeful that we may be able to announce something during the first half or within the first three quarters of 2022. However, there are no concrete plans on the table at this moment, just positive conversations.

Our next question comes from the line of Brady Gailey from KBW.

So when I look at your fee income, a lot of it is driven by service charges on deposits. Can you just talk about, now that industry is seeing some pressure on NSF fees and overdraft, maybe just, one, tell us how much NSF and overdraft within 2021? And then how you guys are thinking about that going forward?

Julie is grabbing the number for 2021. What I can tell you is that we're cognizant of that. And our budget for 2022, we basically have lowered it by 10% for the last 9 months of the year. Is that correct?

Yes, that's correct.

Yes. And the only reason we're doing that is because if we look to make a change today on something, it would take a while for that to filter through. And really some of our lower months of overdraft income occurs in the first quarter because of tax refunds and things of that nature. So we are cognizant of that, and I think Julie has that number for 2021.

Yes, Brady, the overdraft and return check charges together were about $9.2 million. The overdraft just by itself was $8.4 million. And that was some decline from 2020 as well, not significant, but some decline, mainly due to the abundance of deposits in probably in all institutions right now.

And then moving to the expense base, the guidance of $32.5 million, is that more kind of the run rate in the first quarter and you're going to see some growth beyond that? Or is that more kind of an average run rate for the full year?

It's probably closer to an average for the full year based on budgeting.

We have accounted for some additional loan officer hires that we expect to see in the second and third quarters, and possibly the fourth quarter.

It might run a little lower in Q1.

Run a little lower in Q1. I think you were guessing somewhere closer to $32 million in the first quarter. But on average, we think it's budgeting $32.5 million for the year per quarter.

Okay. And then, Lee, it sounds like you're a little more active on M&A now than you have been in the last couple of years. So just remind us what geographies do you like and kind of what's the sweet spot from a size point of view for a bank target for Southside?

We plan to remain primarily along Interstate 35 to the east, potentially extending 50 to 60 miles west of it, but not significantly beyond that. This area covers about 85% of the state's population and economy. Ideally, we're looking for acquisition sizes between $1 billion and $2 billion. If we go above $2 billion, we could approach $10 billion. Therefore, we aim to stay below that threshold unless a very large opportunity arises that exceeds $10 billion by at least $1 billion or $2 billion. The target size that suits us best is likely between $1 billion and $2 billion.

All right. And then just on that topic, Durbin, I know it sounds like you guys are going to stay under $10 billion for a while here, but if you do cost, remind us what the Durbin impact could be.

Our last estimate was around $8 million. It would probably seem to be refreshed, but that was, I think, last quarter or so.

Our next question comes from the line of Matt Olney from Stephens.

I want to ask about the loan growth guidance that you guys provided of 9% for the full year ex PPP. It implies a nice pickup versus what we've seen over the last few quarters. Any more color on that improvement? And I think you mentioned pay downs were heavier in the back half of 2021. So are you assuming a more moderate level of pay downs in 2022?

We are not expecting pay downs like that in the first half of the year. There was some uncertainty about tax laws that probably drove a few payoffs from sales that occurred in the fourth quarter. However, we're not anticipating that volume. Our pipeline looks strong; typically, December and January are slow months, but this time it’s been fast and furious. We haven't seen a start to the year like this in quite some time, which is very encouraging. It's not just limited to one or two regions; it's happening in all of our regions. The economy is performing extremely well, and growth is substantial, characterized by new jobs, people relocating, and companies moving in. It's remarkable what's happening. In Austin and the DFW area, for example, there are bidding wars for apartments similar to those for houses. This trend is related to housing and company relocations, as well as various warehouse-related activities. Overall, the current environment is very positive, and we are beginning to see a significant impact on our pipeline as a result.

That's helpful, Lee. And you also mentioned earlier optimism around hiring additional new producers for the year. Is loan production from those producers you expect later on this year, is that also embedded in that 9%? Or could that be potential upside even from the current guidance?

I believe there could be potential upside from the current guidance. We are actively engaging with various lenders and are optimistic that, especially in the first three quarters, we will secure some agreements. It typically takes about a month for new hires to acclimate and inform everyone of their transition. We are hopeful that we will see an increase in productivity from the loan officers we hire, but we are not factoring that into our 9% projection since it is not currently established.

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Lee Gibson for any further remarks.

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 pipeline, balance sheet, capital position, core earnings, and asset quality, we're excited about the prospects for 2022 and look forward to reporting first quarter results to you during our next earnings call in April. This concludes the call. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.