Southside Bancshares Inc Q2 FY2023 Earnings Call

Good day, and thank you for standing by. And welcome to Southside Bancshares, Inc. Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to introduce your host for today's call, Lindsey Bailes, Vice President of Investor Relations. Please go ahead.

Thank you, Justin. Good morning, everyone, and welcome to Southside Bancshares' second quarter 2023 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 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, Lindsey. Good morning, everyone, and welcome to Southside Bancshares' 2023 second quarter earnings call. This morning, we reported net income of $24.9 million, earnings per share of $0.81, a return on average assets of 1.29%; a return on average tangible common equity of 18.59%; and continued strong asset quality metrics. During the quarter, we experienced strong loan growth, 80% of which occurred during June. In fact, approximately 52% of the second quarter loan growth occurred in the last two weeks of June. Our loan pipeline remains strong, and we are projecting healthy construction loan advances for the remainder of the year. We are continuing to budget for overall loan growth for 2023 in the high single-digits. Our net interest margin held in well during the quarter, contracting only 4 basis points. Late second quarter loan growth, along with our interest rate swaps, fair value hedges and Fed term funding should help mitigate most, if not all, of any further net interest margin compression during the third quarter. Linked quarter deposits, net of brokered and public fund deposits, increased $73 million or 1.6%. In July, we began offering additional options to deposit customers with deposit insurance concerns. We anticipate this will assist with deposit growth in the coming quarters. We are glad to report that the markets we serve remain healthy and continue to grow and perform well. 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. Welcome to our call today. We are pleased to report second quarter net income of $24.9 million, a decrease of $1.1 million on a linked-quarter basis, and diluted earnings per common share of $0.81, a decrease of $0.02 or 2.4% linked quarter. We had strong loan growth in our loan portfolio this quarter with an increase of $176.4 million or 4.2% linked quarter, driven by our real estate portfolio with an increase in commercial real estate of $109.5 million and a $65.5 million increase in construction loans. The interest rate of loans funded during the quarter was on average approximately 7.5%. Asset quality metrics remained strong with nonperforming assets of $3.1 million or 0.04% of total assets at June 30th. At June 30th, our allowance for loan losses as a percentage of total loans was 0.84%, a slight decrease compared to 0.87% on March 31st due to second quarter loan growth. Our allowance for credit losses decreased $381,000 for the linked quarter to $39.5 million. As of June 30th, our loans with oil and gas industry exposure were $108.5 million or 2.5% of total loans. Our securities portfolio decreased $97.4 million or 3.5% on a link-quarter basis. The second quarter decrease was driven primarily by sales of available-for-sale securities, which resulted in a net realized loss of $3.5 million. Additionally, in the second quarter, we recognized a net gain of $2.6 million on the sale of correspondent bank stock. There were no transfers of available-for-sale securities during the second quarter. As of June 30th, we had a net unrealized loss in the available-for-sale securities portfolio of $69.7 million, compared to $61.9 million last quarter, an increase of $7.8 million. As of June 30th, the unrealized gain on the fair value hedges in municipal securities was approximately $27.9 million compared to $9.8 million linked quarter, which partially offset the unrealized losses in the available-for-sale securities portfolio. As of June 30th, the duration in the entire securities portfolio was nine years and the duration of the available-for-sale portfolio was 6.7 years. Our mix of loans and securities shifted to 62% and 38%, respectively, compared to 60% and 40% on March 31st. Deposits increased $279.5 million or 4.8% on a linked-quarter basis, driven by an increase in broker deposits. Our capital ratios remained strong, with all capital ratios well above the capital adequacy and well-capitalized thresholds. Liquidity resources remained solid with $2.5 billion in liquidity lines available as of June 30th. During the second quarter, we completed the purchase of all the remaining authorized shares of our common stock in our stock repurchase plan, a total of 618,831 shares at an average price of $30.27. In our earnings release this morning, we reported that our Board of Directors approved a stock repurchase plan on July 20th, authorizing a repurchase of up to one million shares of the company's outstanding common stock. As of today, no shares have been purchased under this recently approved stock repurchase plan. Our tax equivalent net interest margin decreased four basis points on a linked-quarter basis to 3.17% from 3.21% primarily due to larger average rate and balance increases on our interest-bearing liabilities when compared to the interest-earning assets. The tax equivalent net interest spread decreased for the same period by seven basis points to 2.55%, down from 2.62%. For the three months ended June 30th, net interest income increased $563,000 or 1.1% compared to the linked quarter. We also recorded $81,000 in purchased loan accretion this quarter. Non-interest income, excluding the net loss on the sales of the available-for-sale securities and equity securities decreased $486,000 or 4.1% for the linked quarter. The result of bank-owned life insurance (BOLI) income related to death benefits of $950,000 realized in the first quarter, partially offset by increases in brokerage services and other non-interest income. Non-interest expense increased $144,000 on a linked-quarter basis to $35 million. For 2023, we have budgeted approximately $35.5 million in non-interest expense each quarter. Our fully taxable equivalent efficiency ratio increased to 51.06% as of June 30th from 50.99% as of March 31st. Income tax expense increased slightly to $4.6 million, and our effective tax rate increased to 15.5% for the second quarter from 14.9% in the previous quarter. At this time, we estimate an annual effective tax rate of 15.5% for 2023. Thank you for joining us today. This concludes our comments, and we will open the line for your questions.

Thank you. And our first question comes from Brady Gailey from KBW. Your line is now open.

Thanks. Good morning, guys.

Good morning.

Good morning.

So it was great to see the margin hold in so well. It's only down four basis points, linked quarter, a lot better than some of your peers. And it sounds like you expect the margin to be stable going forward. Is that the right way to think about the margin? And can you just talk about any impact? I know you have some hedges, any impact from those hedges over time on the margin?

We believe the margin will remain stable, particularly in the third quarter. Currently, we have about $760 million in interest rate hedges, with none set to expire for the rest of the year, and an average rate of 3.19%. Additionally, we have $296 million in Fed term funding at an average rate of 4.46% at quarter end, bringing our total locked funds to just over $1 billion. When we factor in our non-interest-bearing deposits, we have a strong funding base. Therefore, we are optimistic about maintaining the margin, especially considering the loans we have placed.

All right. And then I heard the expectation for high single-digit loan growth this year. So, if you look at deposits, they've been kind of flat, if not down a smidge year-to-date. So, how do you think about deposit growth going forward? And your loan-to-deposit ratio is 7%, which is pretty low. How high would you be willing to allow that to go?

Yes. If our loan-to-deposit ratio increases, as long as it stays below 90%, we would be comfortable, and we're quite far from that. Regarding deposit growth for the remainder of the year, we don't expect it to be strong since raising deposits is currently costly, but we believe we can manage some increase in deposits. We funded nearly $100 million of our loan growth during the quarter by decreasing our securities. This is an option we can explore in the upcoming quarters as well. Overall, if we can maintain the loan growth we anticipate, then reallocating some of those assets from lower investment categories to higher loan categories, combined with some deposit growth, should enable us to comfortably finance those loans.

All right. And then finally for me, it was good to see the new buyback authorization and the completion of the prior one. You guys have been pretty consistently buying back your stock at least the last three quarters; is there any reason to think that that would slow in the back half of this year?

We'll just have to see what price the stock is at, and we're going to buy as we feel like it makes sense based on where the price is. I don't anticipate it will slow. It just really is going to depend on market conditions.

Okay. All right, great. Thanks for the color, guys.

All right. Thank you, Brady.

And thank you. And our next question comes from Graham Dick from Piper Sandler. Your line is now open.

Hey, good morning everybody.

Good morning, Graham.

I wanted to elaborate a bit more on the deposit situation as it relates to the future mix. I understand you believe there is potential for deposit growth. Can you share your perspective on the non-interest-bearing deposits? Additionally, where do you see opportunities for growth? It seems that most of this quarter's gains came from brokered deposits. I'm curious about when you expect non-interest-bearing outflows to slow down, allowing core deposit growth to pick up and take over from brokered deposits.

We believe that core deposits grew by approximately $73 million during the quarter. The rise in broker deposits has corresponded with a decrease in borrowings from the Fed and home loan banks. We needed to fund our interest rate swaps totaling $760 million with some type of wholesale funding. We found that funding these swaps through the brokered CD market was cheaper than using the Fed discount window. Essentially, the funds have shifted from one source to another, depending on where the more affordable financing is available. This funding is secured at a fixed term rate. We aim to continue increasing our core deposits, with a portion expected to come from non-interest-bearing deposits as we establish new loan relationships. Our goal is to expand our core deposits across all categories.

Okay. All right. Would it be safe to assume then that we're getting closer to the bottom of non-interest-bearing kind of remixing into some higher-cost stuff? I mean it sounds like you're bringing on a lot of relationships right now. So if you bring on the full relationship with the non-interest-bearing piece, it could help slow things down on that front. Is that fair to assume?

That is correct. And some of the non-interest-bearing on the commercial side are tied to analysis, and some of that decrease you've seen is the fact that they don't need to carry as many balances in order to pay their analysis fees. So in higher interest rate environments, you typically see some deterioration in the non-interest-bearing deposits on the commercial side.

Right. Okay. Thanks. And then I guess just shifting bigger picture. As we look at the balance sheet as a whole, I know you said there is obviously a shift toward the loan book out of the securities book this quarter. Do you guys have any near-term or medium-term targets for the percentage of assets you would like in loans?

Our target for a long time has been to get to a 70% asset at 70% loans and 30% securities. I think we moved to 62% and 38% this quarter. So I think we've moved the needle about 2% in each direction toward getting there, but that would be our goal. For us to do that in an orderly fashion, it would probably take another 1.5 years to two years to do that, assuming we continue to have the loan growth we've had.

Okay. You mentioned a good point, but regarding loan growth, I understand a significant portion occurred at the very end of the quarter. Was that due to one or two larger relationships, or was it a more detailed amount of growth that happened in those last two weeks? I'm trying to understand the loan growth outlook for the third and fourth quarters of 2023.

There were some larger loans that came in, but everything seemed to settle and close in June for some reason. We had some closings in the first two months that were carryovers from the first quarter, and even some of the loans that closed in June were also carryovers from the first quarter. It was just one of those unusual situations where many loan closings occurred in June, and a few of them were larger loans that closed.

Okay. That’s helpful. Thank you, guys. I appreciate it.

And thank you. And one moment for our next question. Our next question comes from Brett Rabatin from Hovde Group. Your line is now open.

Hey, good morning. Thanks for the question. I wanted to, I guess, first start with the taxable portfolio. The 45 basis point increase in that linked quarter. I know there's some hedges. I don't know if that flows through that line item. Can you talk maybe about the improvement in that piece of the securities book?

The tax exempt that went from 3.95% to 4.15% is that what you're talking about on a linked-quarter basis?

Well, I guess…

Oh, you're referring to the taxable aspect, which relates to the $300 million in T-bills we have. You can observe the increase there, and we were in T-bills that yielded a little over 5%.

Okay. And then I was hoping you could talk about the construction portfolio, what's the makeup of the construction book and what you were funding here this quarter in that piece of the loan portfolio?

The largest component is multifamily. We also funded some industrial projects, and I would say the homebuilder construction portfolio has remained quite similar to what we saw in the first quarter. Therefore, the largest part is multifamily, followed by industrial.

Okay. And then I wanted to make sure I understood the reconciliation non-GAAP last page of the press release. You've got the net of the nonrecurring income at $226,000, but it would seem like you had the securities losses of $34.55 million and the gain of $26.42 million. I don't know if there's a strange tax rate on one of those things, but it would seem like that would have netted to a bigger number? Any color on that, Lee?

Brett, I'll give you some color on that. During the quarter, we had an opportunity to purchase a piece of our subordinated debt, a $5 million piece, and we did so at a discount of about $587,000. For the purpose of the efficiency ratio, we did exclude it from nonrecurring income. So that was the missing piece that you don't have, the $587,000.

Okay. That's helpful. And then when I look at the linked quarter improvement in the FHLB funding costs. Is that just due to the duration of those being short-term, and you've re-upped them, or any color around that line item?

Okay. Just can we me get down here.

So linked quarter went from…

Right, that has to do with the hedges. We basically weren't borrowing overnight as much from the home loan bank, and we were borrowing overnight from the Fed discount window.

Okay, I'm sorry, please continue.

Go ahead. No, go ahead.

I was going to ask if I have it right, the duration of all of the borrowings is less than six months, and you don't have any longer-dated borrowings at this point on the balance sheet?

We have longer-term funding through swaps, which we have to renew every 30 to 90 days, depending on the specific swaps involved. With a swap, we pay a fixed rate while receiving a floating rate on the swap, and we also pay out a floating rate on our borrowings. Overall, it balances out; there may be a few basis points involved, but it effectively results in our cost reflecting the fixed rate we are paying on the swap.

Okay, that’s helpful.

And those swaps have about a two and a half year duration.

Okay, great. That’s what I was looking for. Thanks so much for the color.

All right.

And thank you. And our next question comes from Matt Olney from Stephens. Your line is now open.

Hey, good morning everybody.

Good morning, Matt.

I want to revisit the commentary on loan growth, specifically noting that the closing rates were particularly strong during the last few weeks of the quarter. Are there any additional themes or insights regarding loan growth in relation to borrowers? Would you say there is more optimism, or is it primarily about the closing timelines? Additionally, was any of the growth in the second quarter attributable to taking market share from other banks that may have reduced their activities in recent months?

Answer to the last question, I would think so because there are some less banks out there pursuing loan growth at this point in time. In terms of the borrowers, there seems to be optimism. It's requiring a lot more equity going into these projects; 50% equity is not uncommon. In some cases, we have as much as 60% or 62% equity going into some of these deals. So, my guess is that they're extremely optimistic if they're willing to put that much equity into a project at this point.

What can you share about loan paydowns, particularly regarding any trends you're seeing now that some of these construction loans are reaching completion?

We have around three or four construction projects expected to be completed later this year, likely in the late third quarter or during the fourth quarter. We anticipate that at least a couple of these might be prepaid, and it's possible that all four could be paid off before the year's end. Typically, these projects need to reach stabilization before any payoffs occur, and that process usually takes some time. Unlike during the pandemic when earlier payoffs were common, now they generally need to achieve stabilization first. So, while we might see a couple of payoffs, I would expect that to be the limit.

And those projects you mentioned, are those multifamily projects?

Yes, they are.

Okay. That's helpful. And then, I guess, switching over to fees. Anything notable there? I think you called out some one-time items. Anything else notable from the core fees or any kind of outlook there you can share?

No, I don't think there were any other notable fees this quarter.

Okay, go ahead.

No, I was just going to say, last quarter, we also had the death benefits on our BOLI that did obviously not reoccur again this quarter. So that was part of the decrease on that.

Okay. Got it. That's helpful. And then I think one of the comments I made earlier was as far as kind of funding loan growth that perhaps securities can help fund the loan growth, just want to dig in there, would that be more security maturities that are upcoming, or would you look to sell some securities in the back half of the year to help fund that loan growth?

We've got short-term T-bills of around $300 million that we could let go of any time we wanted. We sold a fair number of securities in the first half of this year. We wouldn't be bashful about selling some of those in the back half of the year if it made sense.

Okay. And then I think you disclosed that the unrealized loss position of the available-for-sale securities portfolio was around $70 million. Did I capture that right? And I guess...

That is correct.

Okay. And I guess, how do I just think about kind of the recapture of that over the next several years? Is there any guidepost you can give us to think about recapturing that?

The recapture would come either through maturity or through a change in interest rates down. In addition, on that, we do have on our fair value hedges, a $27 million unrealized gain that helps offset that $70 million. So when we look to sell securities, we're able to take that into consideration as well.

Okay. So what's the, I guess, the total AOCI mark at this point? It was probably disclosed; I just didn't see it in there.

You're going to have to ask. Julie is looking for it.

Okay.

At June 30, the AOCI is a debit of $115,693 on loss, I should say. $125.9 million is unrealized also on securities, and that includes transferred and then a gain of $29.4 million on derivatives, and AOCI to the negative $19.2 related to the retirement plan.

Okay. Got it. All right. That’s all for me. Thanks for taking my questions.

All right. Thanks, Matt.

And thank you. And one moment please. And we have a follow-up question, one moment please. And we have a follow-up question from Brett Rabatin from Hovde Group.

Hi. Julie, just one clarification on the expense guidance for the full year. I think you said $35.5 million per quarter. Does that mean you add those up to $142 million for the full year, or is that $35.5 million for the back half of the year, each quarter?

I think it's just for the remaining part of the year.

Okay. Not necessarily for the full year, okay.

Yeah. Basically, we're looking at $71 million for the remainder of the year.

Okay. Thanks for that clarification.

And thank you. And I am showing no further questions. I would now like to turn the call back over to Lee Gibson, President and CEO, for closing remarks.

Thank you, everyone, for joining us today. We appreciate the opportunity to answer your questions along with your interest in Southside Bancshares. In closing, we're excited about our prospects for the remainder of 2023 and look forward to reporting third quarter results to you during our next earnings call in October. Thank you.

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