Southside Bancshares Inc Q2 FY2024 Earnings Call

Good day, and thank you for standing by, and welcome to Southside Bancshares, Inc. Second Quarter 2024 Earnings Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Suni Davis, Chief Risk Officer. Please go ahead.

Thank you, Justin. Good morning, everyone, and welcome to Southside Bancshares' second quarter 2024 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 Form 10-K. Joining me today are Lee Gibson, 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, Suni. Good morning, everyone. This morning, we reported second quarter net income of $24.7 million, earnings per share of $0.81, a return on average tangible common equity of 16.9% and continued strong asset quality metrics. Linked quarter, our net interest margin increased 1 basis point to 2.87%. During the quarter, we sold approximately $93 million of lower coupon municipal securities, unwound the related fair value swaps and reinvested most of the proceeds in higher-yielding agency mortgage-backed securities. We estimate the payback of the loss on the sale of securities will be less than one year. Linked quarter, loans increased an annualized 1.1% as we experienced a few payoffs. Our loan pipeline remains solid, and we continue to target 5% loan growth for 2024. Since the last quarter, we have continued implementing initiatives associated with our 5-year strategic plan. One of the initiatives is to carefully examine additional revenue as well as cost containment opportunities. Attrition and a slight reduction in workforce resulted in additional cost savings of approximately $600,000. Repricing of services in our wealth management and trust department will result in additional revenue of approximately $500,000. We are executing on an initiative to expand C&I lending in our metropolitan markets to further diversify our loan portfolio, increase revenue and grow deposits. We've hired a lead C&I relationship manager in the Houston area and expect to add additional C&I team members in the coming months. The $600,000 in cost savings and $500,000 in added revenue are estimated to more than cover the expense associated with this initial C&I expansion phase in the Houston area. We continue to evaluate expenses as well as revenue opportunities, and we'll update you on any further progress in future quarters. The markets we serve remain healthy and continue to grow and perform well. I look forward to answering your questions following Julie's remarks. I will now turn the call over to Julie.

Thank you, Lee. Good morning, everyone, and welcome to our second quarter call. We are pleased to report second quarter net income of $24.7 million, an increase of $3.2 million or 14.7% on a linked-quarter basis and diluted earnings per share of $0.81, an increase of 14.1% linked quarter. We had slot loan growth of $12 million or 0.3% linked quarter and 1.1% annualized. Our annualized year-to-date loan growth was 2.9%. The growth was driven by increases of $59.4 million in commercial real estate loans and $17.5 million of 1-4 family residential loans partially offset by decreases in construction loans of $53.4 million and municipal loans of $10.2 million. The average interest rate of loans funded during the quarter was approximately 8%. As of March 31, our loans with oil and gas industry exposure were $120.8 million or 2.6% of total loans. Our allowance for credit losses decreased $762,000 for the linked quarter to $45.6 million. Asset quality metrics remained strong. Nonperforming assets decreased to $6.9 million from $8 million or 0.08% of total assets on June 30 compared to 0.10% at March 31. On June 30, our allowance for loan losses as a percentage of total loans was 0.92% compared to 0.95% on March 31. Our securities portfolio was $2.71 billion at June 30, consistent with March 30. As Lee mentioned, we sold municipal securities and replaced them with higher-yielding agency mortgage-backed securities and to a lesser extent, U.S. treasury bills. In connection with the sale of the municipal securities, we unwound the fair value swaps associated with the hedged items, which resulted in a net loss in the second quarter of $563,000. There were no transfers of AFS securities during the second quarter. As of June 30, we had a net unrealized loss in the AFS securities portfolio of $48.3 million compared to $48.8 million last quarter. At March 31, the unrealized gain on the fair value hedges on municipal and mortgage-backed securities was approximately $18.6 million compared to $20.4 million linked quarter. This unrealized gain partially offset the unrealized losses in the AFS securities portfolio. Our AOCI on June 30, 2024, was a net loss of $111 million compared to a net loss of $110.9 million on March 31, 2024. The net loss was comprised of net losses on our securities and swap derivatives of $92.5 million and $18.5 million related to our retirement plans. As of June 30, the duration in the total securities portfolio was 8.9 years, and the duration of the AFS portfolio was 6.7 years, a slight increase from 9.1 years and 6.9 years, respectively, at March 31. At quarter end, our mix of loans and securities was 63% and 37%, respectively, with no change in the mix from March 31. Deposits decreased $49.8 million or 0.8% on a linked-quarter basis due to a decrease in public fund deposits of approximately $71 million and broker deposits of $100 million. These decreases were partially offset by an increase of approximately $121 million in deposits from an account that increases at this time each year for a short time and is expected to exit in the third quarter. This account enables us to reduce our brokered deposits during the same time, saving approximately 190 basis points. Our capital ratios remained strong with all capital ratios well above the capital adequacy and well-capitalized threshold. Liquidity resources remain solid with $2.24 billion in liquidity lines available as of June 30. During the second quarter, we purchased 57,966 shares of our common stock at an average price per share of $26.22. We have not purchased any shares subsequent to June 30, and we have approximately 583,000 authorized shares remaining for repurchase. Our tax equivalent net interest margin increased 1 basis point on a linked quarter basis to 2.87% from 2.86%. The tax equivalent net interest spread decreased for the same period by 3 basis points to 2.13% down from 2.16%. For the three months ended June 30, we experienced a slight increase in net interest income of $260,000 or 0.5% compared to the linked quarter. Noninterest income, excluding the net loss on the sales of AFS securities increased by $2.4 million or 24.4% for the linked quarter primarily due to the increase in BOLI income of approximately $1 million due to a death benefit on a former covered officer realized in the second quarter, a loss on sale of loans in the first quarter, an increase in deposit services income, and trust fees. Noninterest expense decreased $1.1 million on a linked-quarter basis to $35.8 million driven by decreases in salary and employee benefits, primarily due to approximately $618,000 recorded in the first quarter associated with future cost reductions. Based on the estimated cost savings reported last quarter, we are expecting quarterly expenses of $37 million for the remaining two quarters of 2024. Our fully taxable equivalent efficiency ratio decreased to 52.71% as of June 30 from 55.54% as of March 31. We recorded income tax expense of $5.2 million, an increase of $590,000 compared to the first quarter. The increase in tax expense was driven by an increase in pretax income. Our effective tax rate decreased slightly to 17.4% for the second quarter from 17.7% in the previous quarter. We currently estimate an annual effective tax rate of 17.6% for 2024. Thank you for joining us today. This concludes our comments, and we will open the line for your questions.

Our first question comes from Woody Lay from KBW. Your line is now open.

Hi, thanks for taking my question. I wanted to start on the NIM. Obviously, a couple of different moving pieces there. I think in the opening comments, you called out sort of a short term in nature of deposit account that benefited the NIM in the quarter. Any way to quantify how much of an impact that was on either the NIM or NII?

I can tell you that the account started accumulating money probably in early June and reached that high of around $120 million at June 30. So I don't know what the exact average was, but I'm going to guess it was $60 million for that one month. So one-sixth of the quarter, we experienced a benefit on that $60 million. I have not quantified it in basis points. But likely, it's probably going to leave sometime in August is what we estimate at this point in time. It is an account that does this every year, and they build up to a certain level. And then they take the money for the purposes that it was raised for.

Got it. And that account is listed in the interest-bearing bucket?

That is correct.

Okay. And then with the securities reposition, we've seen a pullback in longer-term rates over the past couple of months. Is there an opportunity for further repositionings from here?

It's possible that we'll continue to seek those opportunities. We've been doing this intermittently for about 18 to 24 months. Whenever we find opportunities, particularly with the fair value swaps we have, and we can achieve a reasonable payback, we'll pursue them. I don't have any specific examples at this moment, but as rates and spreads on various securities change, we are actively exploring those options.

Yes. And then maybe lastly on the loan growth front, any expectations for growth in the back half of the year? You've got the C&I initiative coming on board, but I would imagine that would take some time to contribute to the growth?

Yes, I think it will. We may see some growth occur as a result of that in the fourth quarter, but we believe it will be 2025 before it becomes significant. Therefore, most of the growth will likely come from continued funding for our construction portfolio and other full funders in the commercial real estate sector.

All right. Thanks for taking my question.

All right. Thank you.

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

Hi, good morning, everyone.

Good morning.

Wanted to ask, just staying on the margin. So it looks to me like the securities portfolio actions you've taken, if I look at it right, it didn't really affect the second quarter that much. Do those actions raise the margin in 3Q? Or does the cost of funds, is that going to be an offset in the back half of the year? Just any thoughts on the tenure of the margin in the back half?

Most of the transactions occurred in late May, with the majority happening in June. Therefore, we didn't see much impact in the second quarter. The main effects will be felt in the third quarter. I believe as long as the Fed funds rate remains steady, it will largely offset any potential impact from possible increases in deposits. The real change will happen when the Fed begins to lower rates, at which point the pressure will ease and trends will shift in the opposite direction.

Okay. And then on the expense guidance, if I heard you correct, Julie, was that $37 million for the back half of the year?

Yes, that's correct.

Okay. And so looking at 2Q versus the $37 million, I know you've obviously made some changes and done some things to improve efficiency. Is the growth in the back half because of the initiatives that you've added? Can you maybe give us some color on the growth in the back half of the year?

Originally, we had a budget of about $37.9 million. After implementing some cost containment measures in the first quarter, we projected that this would have an impact of around $700,000 to $900,000 on the third and fourth quarters. I am removing that from our projections. We want to be cautious regarding software expenses, which have remained stable. Overall, most categories have shown consistent results from quarter to quarter, except for salaries and employee benefits. I don't want to set a lower projection than our anticipated budget, as we have already been below that amount, but I prefer not to lower our expectations for the third and fourth quarters.

Yes, that's helpful. And then...

We are probably being conservative.

Yes. I mean, we are being conservative.

Okay. And then just lastly on credit. The results are really pristine, and you reduced the reserve with the negative provision. Any thoughts on, are criticized assets lower? Any color on if you guys just are basically just not seeing anything from a credit perspective at this point in terms of any pull over stress.

Yes. Once a month, we hold our watch list meeting to discuss any credits that are under scrutiny. After attending that meeting, I feel confident about our current situation. We do have one very minor credit that we anticipate will incur a small loss, but it now seems that this loss will be less than what we've set aside as a reserve. Overall, given the equity we had going into deals, there are no credits causing us significant concern right now. We monitor several accounts and receive monthly updates, but many are showing positive trends, which is encouraging.

Okay, great. Appreciate all the color.

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

Hi, thanks. Good morning.

Good morning.

I want to ask about the fees. Good quarter of fees even after I make a few adjustments that you noted. I would love to hear any commentary about expectations for fees for the back half of the year.

I think we mentioned that we did some repricing, and we needed to in the wealth management and trust area. So we anticipate those fees are going to go up in the last half of the year. Also, our brokerage is doing extremely well. So I think that's going to go up and then the deposit services fees have really done probably better than we originally budgeted and anticipated. So those are really the areas obviously, then we have the extra BOLI income, but that was a death benefit. So we are hopeful that doesn't reoccur in the third quarter. But overall fees, it's been encouraging this year to see the fees move in the direction they have.

Okay. Appreciate that. And then the Houston C&I hiring. Appreciate it may take some time to get some traction there. Would love to hear maybe kind of some longer-term plans. I guess it's early as far as the team. You're still looking for new employees, but maybe it's a longer-term strategy that you want to build out there.

Yes. Our plan, which will unfold over multiple quarters, is to first build out the Houston area. After that, we'll determine whether to expand to Dallas-Fort Worth or Austin next. These will be the three markets where we plan to establish additional C&I lending teams, focusing on small to midsize C&I lending in those regions. Our primary goal is to enhance our C&I lending in these metro areas, starting with the greater Houston area. We are optimistic that by the end of the year, a significant portion of the team will be in place in Houston.

Okay. And I guess your existing footings in some of those larger metro Texas markets, I assume at this point, those are mostly real estate based. So these new teams would kind of complement those existing teams?

That is correct. I mean we do have some C&I lenders in the various markets. But if you were to look at the concentration of the lenders we have, they're much more heavily focused in the CRE arena.

Right. Okay. Thanks for the commentary.

All right. Thank you.

And I'm showing no further questions. I would now like to turn the call back over to Lee Gibson, CEO, for closing remarks.

Thank you, everyone, for joining us today. We appreciate your interest in Southside Bancshares along with the opportunity to answer your questions. In closing, we're looking forward to our prospects during the second half of 2024 and reporting third quarter 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.