Southside Bancshares Inc Q1 FY2022 Earnings Call

Thank you for joining us, and welcome to the Southside Bancshares, Inc. First Quarter 2022 Earnings Conference Call. As a reminder, this call is being recorded. I will now hand it over to your host, Ms. Lindsey Bailes, Vice President of Investor Relations. Please proceed.

Thank you, Valerie. Good morning everyone and welcome to Southside Bancshares First Quarter 2022 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.

Thank you. Good morning everyone and welcome to Southside Bancshares first quarter earnings call for 2022. This morning we reported strong financial results for the first quarter. I want to start by recognizing and thanking the entire Southside team for their continued contributions and efforts, without which these results would not have been possible. Highlights for the quarter included earnings per share of $0.77, a return on average tangible common equity of 15.2%, annualized linked quarter loan growth, net of PPP of 19%. Continued strong asset quality metrics and an efficiency ratio of 48.15%. Linked quarter, our net interest margin decreased one basis point due to a $780,000 decrease in PPP loan accretion, which resulted in a 9 basis point decrease in the average yield on loans, partially offset by a 2 basis point increase due to the increase in interest rates. Linked quarter, the average yield on securities increased 30 basis points and the average rate on our interest-bearing liabilities decreased 2 basis points. During the quarter, as interest rates increased, we sold $168 million of AFS securities and realized a loss of $1.5 million. In addition, during March and subsequent quarter-end on April 1, 2022 we transferred longer duration securities with the fair value of $662 million from AFS to HTM. With the flattening of the yield curve, reduced Fed purchasing, and higher current coupons, agency mortgage-backed securities are once again beginning to look attractive from a risk-reward perspective. We were extremely pleased with our annualized linked quarter loan growth of 19%. Our loan pipeline remains strong and we are encouraged about second quarter loan prospects despite a few expected loan payoffs. 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 for most if not all of 2022. For now, we are maintaining our anticipated 2022 loan growth estimate, net of PPP loans, at 9%. We plan to reconsider this estimate after the second quarter. During the first quarter, we continued to benefit from the increase in our average non-maturity deposits over the last 24 months. At March 31, 85% of our $676 million of brokered deposits were hedged with $575 million of fixed rate swaps. FHLB borrowings decreased to $3.9 million during the quarter. 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 performing 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 are pleased to report a strong start to 2022 with net income of $25 million in diluted earnings per common share of $0.77 for the first quarter. Net income decreased $3.7 million from the fourth quarter of 2021, driven by the provision for credit losses of $294,000 compared to the $3.4 million reversal of provision last quarter, and a net loss on the sale of AFS securities of $1.5 million compared to a net gain of $463,000. Linked quarter net had a $17.1 million decrease in PPP loans. Our loan portfolio increased $172.9 million to $3.79 billion, driven by strong growth within our real estate portfolio. Our CRE loans increased $124.4 million, construction loans increased $42.3 million, and we also experienced an increase in municipal loans of $12.1 million on a linked quarter basis. The weighted average rate of new loans funded during the first quarter was approximately 3.6%. As of March 31, our PPP loans included in the commercial loan category totaled $13.9 million, down from $31 million at year-end. The average balance of PPP loans was approximately $20.9 million for the first quarter. Currently, our remaining PPP loans are approximately $13 million. We continue to experience very strong asset quality metrics with non-performing assets of $11.5 million or 0.16% of total assets at March 31, consistent with year-end. Linked quarter, our allowance for loan loss increased $251,000 or 0.7% due to the provision for credit losses on loans of $294,000 recorded in the first quarter. As of March 31, our allowance for loan losses as a percentage of total loans was 0.93% and 0.94% when excluding PPP loans. Our allowance for off-balance sheet credit exposures remains consistent on a linked quarter basis at $2.4 million. As of March 31, our loans with oil and gas industry exposure were $85.9 million or 2.3% of total loans. Our securities portfolio decreased $314.8 million or 11% on a linked quarter basis. The decrease was driven by an increase in the unrealized loss in the portfolio, sales of securities, and principal payments. When combined, these exceeded purchased securities during the quarter. The sales consisted of U.S. Treasury securities of $68 million and mortgage-backed securities of approximately $99 million. In March, we transferred available-for-sale securities with fair values of $385.8 million to held to maturity. Subsequent to quarter-end on April 1, we transferred AFS tax-free municipal and U.S. agency mortgage-backed securities with fair values of $276 million to held to maturity. We recognized $1.5 million in net security losses on the sale of AFS securities during the quarter, a decrease from the net gains of $463,000 reported last quarter. At quarter-end, we had a net unrealized loss in the securities portfolio of $103.7 million compared to the unrealized gain of $111.7 million at the end of the year. As of March 31, the duration of the entire securities portfolio was 8.1 years, an increase from 5.9 years on a linked quarter basis. The duration of the AFS portfolio at March 31 was 6.9 years. Our mix of loans and securities at March 31 was 60% and 40% respectively, shifting from 56% and 44% on a linked quarter basis, due both to the increase in the loan portfolio and the decrease in the securities portfolio. Our deposits increased $348.1 million or 6.1% compared to year-end. This increase was driven by an increase in brokered deposits of $380.8 million. To obtain lower-cost funding, we utilized an additional $310 million of brokered deposits, included in the $380 million for funding our cash flow hedge swaps and reduced FHLB advances. During the first quarter, our Board approved a new stock repurchase plan with an authorization to purchase up to 1 million shares. As of March 31, we had purchased 82,285 shares at an average price of $40.81. Since quarter-end into April 2022, we have repurchased 139,737 shares at an average price of $39.67 per share. Our net interest margin decreased slightly on a linked quarter basis to 3.22% and net interest spread remained consistent at 3.09%, approximately 3 basis points of the net interest margin related to fees earned on PPP loans compared to 8 basis points last quarter. For the three months ended March 31, net interest income decreased $495,000 or 1% when compared to the linked quarter. We recorded approximately $569,000 in net fees related to the PPP loans, included in interest income this quarter compared to $1.4 million last quarter. As of March 31, 2022, we had net deferred fees of approximately $368,000 remaining to be recognized as a yield adjustment over the terms of these loans. Additionally, we recorded $345,000 in purchase loan accretion this quarter. For the three months ended March 31, 2022, non-interest income excluding net loss on the sale of AFS securities increased $720,000 or 6.2% for the linked quarter, which was driven by net gains recorded on other investments of $837,000. Mortgage servicing fee income and swap fee income were partially offset by a decrease in deposit services interest fees. For the first quarter, non-interest expense was $31.2 million, a slight decrease of $139,000 on a linked quarter basis. For the remainder of 2022, we expect quarterly non-interest expense to be approximately $32.5 million. Our fully taxable equivalent efficiency ratio increased slightly to 48.15% from 47.61% for the previous quarter. Income tax expense decreased $1.7 million or 34.6% compared to the three months ended December 31, 2021. Our effective tax rate decreased to 11.2% from 14.4% for the fourth quarter. At this time, we are estimating an annual effective tax rate of 11.3% 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 Bradley Bailey Jr. of KBW. Your line is open.

Yes, this is Brady Gailey. Good morning guys.

Good morning, Brady.

I wanted to start just with what you did with bringing on brokered deposits to reduce FHLB. Can you just talk more about the details there and how that's going to impact spread income going forward, especially as the Fed continues to push rates higher?

Sure. The brokered deposits we just basically replaced our cash flow hedge and replaced short-term borrowings at the Home Loan Bank with short-term borrowings from brokered deposits. We received a special deal from one of the brokered deposit groups at an extremely low rate that they guaranteed for 90 days. I think it was an all-in rate of around 3 basis points, which was probably 8 to 9 basis points below what the Home Loan Bank was offering at that time, and they weren't guaranteeing it for 90 days. So that's the whole reason we switched there. And going forward, we'll just have to determine whether it's the Home Loan Bank or the brokered market that provides us the cheaper funding.

Okay. And then just thoughts on the bond book going forward; I mean, the balance is there, at least on an average point of view, has been fairly consistent for the last few quarters. We're now reinvestment yields are heading a lot higher, so do you start growing the bond portfolio more from here? What's the outlook on balances in the bond book?

During the first quarter, as interest rates rose more quickly than expected and the curve flattened, we sold a substantial amount of shorter-term securities along with some longer-term ones, primarily those we could exit without significant impact. Although we incurred a loss of $1.5 million, it was relatively minor in percentage terms. We are looking for opportunities to reinvest those funds in the future. If we become more confident that rates have peaked, or at least are no longer rising as steeply, we might consider expanding our securities portfolio.

Okay. And then just finally for me, that's good to see some activity with the buyback last quarter and then here in this month. Do you think that you will execute on the full 1 million share buyback this year or is it too hard to know if you'll be able to do all of it?

Yes, it's really difficult to determine, and we hope that the price doesn't reach a point where we want to buy it back and it goes beyond that. But it's just too early to make a judgment on this right now.

Thank you. Our next question comes from Brett Rabatin of Hovde Group. Your line is open.

I wanted to first discuss the loan growth guidance of 9%. The first quarter was exceptionally strong, and you mentioned you expect some payoffs may impact growth moving forward. Can you elaborate on the extent of those payoffs and whether they are the reason behind your expectation for growth to decelerate? Specifically, do you believe high originations remain consistent and that payoffs are influencing this, or could you provide more detail on the factors affecting the loan growth outlook?

Sure. Right now, we have a couple of loans that we know we are going to pay off. But the loans in the pipeline and things we have set for closing well exceed those anticipated payoffs at this point in time. The only reason we haven't changed the 9% is that it's just the first quarter, and while we can kind of look forward and get a pretty good gauge on the second quarter, we don't want to be overly optimistic about the third and fourth quarter until we have a better feel for it. If our loan growth continues like it's been, then yes, we're going to take a look at it after the second quarter and readjust that. It's not that we're anticipating slower growth; we just don't want to overpromise at this point in time based just on the first quarter loan growth. But right now the pipeline is as strong as we've seen it, it looks good; and where we do have a couple of payoffs coming, but they're not of the magnitude that it should impede loan growth at this point in time based on what we know today.

Okay. And then on the securities portfolio wanted to make sure if I understood some of the thoughts around that with the extension of the duration during the quarter. Is there essentially an implicit statement that you think the market rates have kind of topped out, and the Fed catches up as much as they can? Or let's say we’ll see how far they go in terms of raising rates, but it sounds likely you’re essentially saying that you think the longer-term rates have moved up enough that they're not going to move up much from here and you kind of make a bed on that. We've talked out from a rate perspective, or is there some other thesis at play?

I think the extension in the bond portfolio is on the muni side. Some of the lower coupon munis extended. They basically went from yield to call to yield to maturity, not the yield portion, but the maturity, because some of them now trade at a discount. So that, plus the fact that we sold some shorter duration securities knowing that they would quickly be underwater significantly if we didn't get out of them and rates kept rising, we had a pretty good idea that short-term rates are definitely going up with what the Fed's going to do. Combined to see that extension out there. We're not saying rates are at the top by any means; that's why I said that if it looks like we're beginning to think that they are near the top or not going to be trending up quite as fast, we plan to redeploy some of the money that we gathered as a result of selling securities. Does that kind of help you?

Yes, that's a great color. That helps explain it. And then just lastly, I want to make sure I understood the expense guidance going forward. The $32.5 million, was that specifically for Q2? I didn't quite catch whether it was for the average for the year?

Yes, Brett, that was an average for the year, while we expect for the next three quarters individually. We had guided toward that as well for the first quarter, and of course we didn't get to that point. Looking over some of that guidance, we basically just did not hit in some of the expense categories, the budgeted amounts we had hit; the biggest area was personnel, with relationship to health insurance expense. We budgeted some inflation over last year's amount and we did not incur that. But of course that's a very volatile item and can change from quarter to quarter. So that was one of the biggest items for why we did not hit the $32.5 million; and then just some other various items. Also, we are putting several software platforms in place along with new things we are doing. That's why I'm holding to that $32.5 million.

Okay.

Does that help?

Yes, that's great. Thanks. Thanks for all the color.

Sure.

Sure, Brett.

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

Thank you for taking my question. You have covered most topics, but I wanted to follow up on the brokered funds you mentioned. According to the release, the cost of interest-bearing demand accounts increased from about 20 basis points to 31. I believe you indicated that the cost of that funding was around 3 basis points. I'm trying to understand if that was the main factor behind the increase or if there are LIBOR-linked funds involved as well. I would like to know how you expect that to reprice in the future.

Yes. We made a shift to fixed rates. The funding cost was 3 basis points; we are receiving LIBOR, and our total cost for fixed funding was 83 basis points.

Okay. So that's showing up...

Does that make sense?

Yes.

Yes, that is correct.

There is brokered money markets are non-maturity, if you will, as opposed to brokered CDs, so that...

We're actually getting some benefit, in that we were getting a floating rate of LIBOR receiving a greater than what we were paying for that 90-day period.

Thank you. Our next question comes from Matt Olney of Stephens Inc. Your line is open.

Yes. Thanks for taking the question. Just a few follow-ups here. On the allowance ratio, I think we're now at 93 basis points; is there any more room to move this lower or should we anticipate this to flatten out?

That's a good question. With CECL, you never know exactly what is going to happen. It really comes down to the economic forecast moving forward. If they start factoring in. We used the Moody's economic forecast, kind of a mix of their different forecasts. If they start forecasting in a more optimistic scenario than the others, there is a real possibility that it could go down as they start factoring in recession or something like that. I think you're going to see that among all the banks; it really is just kind of coming down to that economic forecast. This time we did take a look at the forecast and decided to go kind of with a 50-50, mostly their base case and then their, I think it was the S3 case, which is somewhat bearish, in order to come up with a scenario that we felt comfortable with, in terms of an economic forecast.

Okay.

I don't know if that helps you or not, but the asset quality is right now as strong as we've seen it. And 93 basis points, I can see where we get that simply because our municipal portfolio has a very low rate CECL reserve. Then the mortgages have a reserve, the one-four family mortgages have reserve less than 0.93%. So those two parts of the portfolio drag it down, which is certainly justified, and then the rest of the portfolio is above that 1%.

Yes. That's helpful. Lee, thanks for that. And then...

Okay.

Julie, on the impact of the NII in this quarter, I wrote down the PPP fees, but I missed what you said around the accretion income. Can you go over that again, please?

Yes, the accretion we recorded was $345,000 for the quarter, and we are seeing that, of course, starting to decline; it can vary, obviously with early payoffs of those purchase loans that we are typically seeing, it start to decline for the most part. On the fees on PPP, they were $569,000 and they had a 3 basis point impact on the NIM. Did that answer your question?

Yup. That's it. Thank you for that.

Okay. Sure.

We are actively looking and we're not seeing a lot of sellers at this point in time that are in geographic locations that we would be interested in acquiring. But we are hopeful that sometime this year we're going to find a partner for us to acquire.

Thank you. Our next question comes from Michael Young of Truist Securities. Your line is open.

Thank you for the question. I would like to explore further the growth in commercial real estate and construction and the overall outlook. Where are you observing the highest demand, perhaps by sector or type of commercial real estate? Additionally, are there any factors in the current market, such as underwriting or competition, that you believe could potentially threaten growth in the future?

The biggest part of the increase in the construction portfolio has to do with multifamily. A lot of the projects that we put on last year are just now beginning to fund, and there is multifamily in a lot of these metropolitan areas, which is still a sure supply and badly needed, especially with the affordability of housing decreasing. That's the biggest part of the construction bucket. And then the second part of your question was, can you help me out again?

Yes, just anything in sort of the competitive landscape that you're seeing that might cause you guys to kind of see a change in growth, i.e. getting too competitive or pricing too skinny, etc.

Yes. What we're seeing on the competition front is, we're not really seeing people give on credit. Where we're seeing competition is on pricing, especially the fixed-rate pricing. Some folks are just pricing things at levels we don't believe are appropriate for our balance sheet. But we're able to get our pricing on more deals than not, but there are a few loans that we would have liked to make that we weren't able to because the rate was considerably too skinny, given the fixed-rate environment that we're in at this point.

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to Lee Gibson, President and CEO, for any closing 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 loan pipeline, balance sheet, core earnings, and asset quality, we're excited about the prospects for the remainder of 2022 and look forward to reporting second quarter results to you during our next earnings call in July. This concludes the call. Thank you again.

Thank you. Ladies and gentlemen, that concludes today's conference. Thank you all for participating, you may now disconnect. Have a great day.