Earnings Call Transcript - SBSI Q4 2022

Operator, Operator

Good day and thank you for standing by and welcome to Southside Bancshares, Inc. Fourth Quarter and Year End 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker for today, Lindsey Bailes, Vice President, Investor Relations. Please go ahead.

Lindsey Bailes, Vice President, Investor Relations

Thank you, Justin. Good morning everyone and welcome to Southside Bancshares' fourth quarter and year end 2022 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.

Lee Gibson, President and CEO

Good morning everyone and welcome to Southside Bancshares' fourth quarter and year-end earnings call for 2022. This morning, we reported excellent fourth quarter and annual results for 2022. Highlights for the quarter included earnings per share of $0.87, a return on average assets of 1.47%, a return on average tangible common equity of 21.35%, annualized linked quarter loan growth of 8.2%, a linked quarter four basis point increase in our net interest margin, an efficiency ratio of 46.38%, and continued strong asset quality metrics. During 2022, loans net of PPP loans increased 14.8% or $533.5 million. The net interest margin increased 16 basis points and the efficiency ratio decreased to 47.39%. I want to thank the entire Southside team for their continued contributions and efforts, which made these results possible. We're extremely pleased with our continued solid loan growth during the fourth quarter of 2022. Our loan pipeline, while not currently as strong as it was this time last year, remains solid and we are encouraged by the loan growth prospects for 2023. In addition, we are seeing advances in our construction portfolio increasing as loans that closed several quarters ago are now beginning to fund. Given the outlook for the markets we serve, we are budgeting for 9% loan growth during 2023. As previously mentioned, approximately $743 million of our available-for-sale municipal securities are hedged to the call date, with fair value swaps designed to reduce the overall fair value volatility of these securities. During the fourth quarter, this $743 million of fair value swaps began producing net interest income as the overnight SOFR rate we received increased above the average fixed rate we pay. This was largely responsible for the linked quarter 31 basis point increase in the average yield on our tax-exempt municipal securities. In the month of December, we recorded approximately $645,000 of net interest income related to these swaps. During January 2023, we expect the net interest income associated with these swaps will increase to reflect the full effect of the mid-December increase in overnight SOFR, resulting from the increase in the federal funds rate. Should the Federal Reserve further increase the Fed funds rate, we anticipate a further increase in net interest income from these fair value swaps. Conversely, should the Federal Reserve at some point decrease the federal funds rate, net interest income associated with these fair value swaps would decline, at which time we would likely unwind some or all of these fair value swaps. The economic conditions in our markets remain solid, bolstered by continued company relocations and existing company expansions combined with population growth as a result of continued migration from other states. The combination of increased mortgage rates and high building costs has resulted in reduced housing starts and decreased margins, moving this market closer to pre-pandemic levels. We look forward to successfully executing on our business model in what we consider to be the best state in the country in which to operate. I look forward to answering your questions following Julie's remarks, and I will now turn the call over to Julie.

Julie Shamburger, CFO

Thank you, Lee. Good morning, everyone, and welcome to our call today. We are pleased to report a solid fourth quarter to end a strong year with 2022 net income of $105 million and diluted earnings per common share of $3.26. For the fourth quarter, we reported net income of $27.7 million, an increase of $717,000 from the previous quarter, and diluted earnings per common share of $0.87, which is a $0.03 increase from the previous quarter. For 2022, we reported record organic loan growth of $533.5 million, excluding PPP loans, reflecting a 14.8% increase from 2021. This growth was driven by our real estate portfolio, with increases of $389.5 million in commercial real estate, $11.8 million in construction, and $12.4 million in 1-4 family residential loans. Additionally, we saw a $24 million increase in commercial loans, also excluding PPP. Our loan portfolio increased by $84.2 million to $4.15 billion from the previous quarter. The increase was mainly due to strong growth in our commercial real estate loan portfolio, which saw an increase of $85.8 million from the previous quarter. The weighted average rate of new loans funded during the quarter stood at approximately 6.4%. We continue to maintain strong asset quality metrics, with non-performing assets of $10.9 million or 0.14% of total assets as of December 31st, a decrease of $855,000 from the previous quarter. Our allowance for loan losses as a percentage of total loans was 0.88% compared to 0.90% at September 30th. Additionally, our allowance for off-balance sheet credit exposures increased to $3.7 million from the previous quarter due to a provision of $1.6 million, compared to $200,000 last quarter. As of December 31st, our loans with exposure to the oil and gas industry totaled $111.3 million or 2.7% of total loans. Our securities portfolio increased by $50 million or 1.9% from the previous quarter, mainly due to a reduction in unrealized losses and, to a lesser extent, purchases of securities. During the fourth quarter, we transferred more available for sale securities worth $175.8 million to held to maturity. As of December 31st, we recorded a net unrealized loss in the available for sale securities portfolio of $88.9 million, down from $168.3 million last quarter, a reduction of $79.5 million. Furthermore, the unrealized gain on the hedged securities amounted to approximately $21.6 million, partially offsetting the unrealized losses in the available for sale securities portfolio. The overall duration of the securities portfolio was 10.7 years, while the duration of the available for sale portfolio was 9.3 years. The mix of loans and securities remained consistent from the previous quarter, at 61% and 39%, respectively. Our deposits rose by $16.9 million or 0.3% from the previous quarter, mainly due to an increase in public fund deposits, though this was partially offset by a decrease in broker deposits. In the fourth quarter, we boosted our stock repurchase plan authorization by 1 million shares, purchasing shares at an average price of $35.03 during the quarter. Since year-end and through January 24th, 2023, we have acquired 141,053 shares at an average price of $35.73. Our tax equivalent net interest margin increased to 3.40% from 3.36% quarter-over-quarter, driven by a rise in the average yield on loans of 54 basis points and a 21 basis point increase in the securities portfolio, though this was partially offset by a 56 basis point increase in the average yield on interest-bearing liabilities. The tax equivalent net interest spread decreased to $2.95 from $3.08. For the three months ending December 31st, net interest income rose by $1.3 million or 2.4% compared to the previous quarter. We also recorded $55,000 in purchased loan accretion this quarter. For the same three-month period, non-interest income, excluding net loss on the sale of available for sale securities, increased by $398,000 or 3.8% quarter-over-quarter. This increase was mainly due to rises in deposit services income, trust income, and other non-interest income from swap fees. In the same period, non-interest expense totaled $33.6 million, a slight increase from the prior quarter. For 2023, we have planned approximately $35.5 million in non-interest expense per quarter, mainly due to increases in salary and software expenses as well as the non-service component of our frozen retirement and restoration plan expense. Our fully taxable equivalent efficiency ratio as of December 31st improved to 46.8% from 47.42% as of September 30th, driven by an uptick in net interest income. Income tax expense rose to $4.3 million, compared to $3.9 million for the three months ending September 30th. Our effective tax rate increased to 13.4% for the fourth quarter, up from 12.6% in the prior quarter. We now estimate an annual effective tax rate of 12.8% for 2023. Thank you for joining us today. This concludes our comments, and we will open the line for your questions.

Operator, Operator

And our first question comes from Will Jones from KBW. Your line is now open.

Will Jones, Analyst

Hey, great. thanks. Good afternoon.

Lee Gibson, President and CEO

Afternoon. How are you doing?

Will Jones, Analyst

Hey, we're doing well. So, Lee, I just wanted to unpack this swap contract you guys have that's coming on and going to start benefiting you guys. So, you’re receiving variable but paying fixed. What is the fixed rate that you guys are paying? Or I guess the better question is, what is like the net pickup in yield that you received from this favorable swap contract?

Lee Gibson, President and CEO

I'm not entirely sure I grasp that part of your question, but we have around 20 to 30 of these swaps, totaling 84 in total. We began implementing them in April 2022, with the last one done in early October. Each swap has a different fixed rate, with the latest ones possessing the highest rates. Currently, nearly all of them are in a positive position. In November, we first noticed a positive turn with net interest income, which rose to $645,000 in December. The 50 basis point increase in SOFR came alongside the rise in Fed funds in mid-December, so we expect the remainder of the net interest income increase to happen in January. If the Fed raises rates by 25 basis points in February, we anticipate further increases. At this point, a significant portion of our tax-free municipal securities functions similarly to a floating rate security. For the quarter, we experienced a 31 basis point increase in the yield on our tax-free municipal securities.

Will Jones, Analyst

Yes. No, that very helpful. Yes. No, thank you for walking through that. And I'd imagine just with the majority of those being in a positive position that you would have a relatively sizable gain if you were to sell the swaps?

Lee Gibson, President and CEO

We currently have a gain in the swaps, which was $21 million at year-end. The outcome may change based on the longer-term rates because these are swapped to the call date of the municipal securities. The average fixed rate of our coupon that we are paying is 3.21.

Will Jones, Analyst

Okay, great. That's perfect. Yes, that's what I was looking for really. Great. That's very helpful. Okay. So, then as we think about just the story of the margin as we move into 2023, you still saw a little bit of expansion this quarter. I mean the deposit costs are ticking up a little bit. Do you feel like you still have leverage on the asset pricing side, maybe to some of this accelerated or continuing deposit pressure? So, maybe we see the margin flat out and just hold the line for the remainder of the year. There's an expansion left. Do you feel like this quarter was a peak, just any commentary around the margin would be great?

Lee Gibson, President and CEO

On loans, we have a significant portion of floating rate loans, around 46%. Most of the new fixed rate loans we’re adding are about $6 million, closer to $6.5 million. Additionally, we have nearly $0.75 billion in tax-exempt investment securities that will help offset some of the pressures we’re experiencing on the deposit side and overall funding. We anticipate that the beta will likely be between 30% and 35% moving forward. As for the margin, we expect it to remain relatively stable, fluctuating by about five to six basis points. If future Fed funds increases are not in 75 basis point increments, we believe there will be less upward pressure on rates compared to when those increases were at 75 basis points. However, we will continue to face significant pricing pressure for deposits, which is quite competitive, and this is true for us at Southside as well.

Will Jones, Analyst

You definitely not alone there. Just to clarify, that 30% to 35% deposit beta, is that interest-bearing deposits or total deposits?

Lee Gibson, President and CEO

I'm thinking it's interest-bearing deposits that we're focusing on at this moment.

Will Jones, Analyst

Awesome, great. And then last one, if I could just sneak one last one in here. Just what's the messaging on the buyback going forward? I mean it's been notable for you guys this past quarter. What's your further appetite here?

Lee Gibson, President and CEO

At this point, we'll assess how we manage the current allocation. If the price reaches a level we find suitable for expanding the buyback, we will do so then.

Will Jones, Analyst

Okay, very helpful. Thank you so much.

Lee Gibson, President and CEO

All right.

Operator, Operator

And thank you. And our next question comes from Brad Milsaps from Piper Sandler. Your line is open.

Brad Milsaps, Analyst

Hey, good afternoon.

Lee Gibson, President and CEO

Hey, how are you Brad.

Brad Milsaps, Analyst

Hey Lee, how are you doing?

Lee Gibson, President and CEO

Good.

Brad Milsaps, Analyst

Good, thanks for taking my question. I'm curious, similar to some other banks, it appears that the period-end balance of Federal Home Loan Bank advances increased significantly compared to the average. Are those primarily overnight advances? Would you consider relying on them more if deposit funding doesn't meet your needs? I'm trying to understand how you plan to support your 9% loan growth target. Do you intend to maintain your leverage and keep the bond portfolio as it is? Ideally, you would grow deposits to achieve both objectives, but any insights you could share would be appreciated.

Lee Gibson, President and CEO

Last year, in 2022, we secured favorable pricing in the broker deposits and money market environment, allowing us to replace our cash flow swaps and much of the home loan bank funding. At one stage, we had everything replaced with the home loan bank, but that situation has changed. Currently, favorable funding is primarily sourced from the home loan bank. The transition you see is mainly a shift from broker deposits to home loan bank advances to cover those cash flow swaps. In the first quarter, $30 million of cash flow swaps rolled off, which has now been updated to $25 million. We're down to about $550 million in those cash flow swaps. Notably, $550 million of this amount has fixed pricing. We also have some overnight funding at the Home Loan Bank due to its cost-effectiveness for obtaining additional wholesale funding.

Brad Milsaps, Analyst

Yes, I have those numbers ready. You're paying approximately 113 basis points on the $575 million, correct?

Lee Gibson, President and CEO

That was correct at year-end.

Brad Milsaps, Analyst

At September 30th, yes, okay. Got it.

Lee Gibson, President and CEO

Yes. And so the one that rolled off, I think, was at 140 something, wouldn't it or somewhere in that range. We'll find it and let you know.

Brad Milsaps, Analyst

Okay. Okay. Great. Okay, great. And then just on your loan growth, I mean, 9%, maybe that was a touch higher than maybe I expected given kind of what's going on in the market. But it sounds like you've got a number of construction projects that you planned that you plan on funding up. Anything else in there is kind of a big driver in any new lenders. Just trying to kind of get a better sense of what's kind of driving your loan growth target?

Lee Gibson, President and CEO

We have some new lenders, and those who joined us in 2020 and 2021 are performing well. In Houston, about $300 million of our loan growth this year came from that area. We opened a loan production office there in early 2020, and while they faced challenges during the pandemic, they have significantly improved in 2022. Additionally, a couple of our new lenders have existing relationships in Houston. We expect this trend to continue. While we don't anticipate reaching our previous target of 14.8% loan growth, we believe that 9% is achievable. If anything changes, we will provide updates during future quarterly calls.

Brad Milsaps, Analyst

Got it. And then just a follow-up on my first question, we kind of got bogged down there in the swap talk. But the 9% loan growth target. Do you think you can fund that flu with deposits or aside on what's going on with swapping back and forth between brokered and FHLB, but do you anticipate bringing the bond book down? Or just kind of just some way to think about the size of the balance sheet and kind of how you plan to fund it?

Lee Gibson, President and CEO

We could reduce the bond portfolio to some extent. There may be a cap on how much we'd be willing to do depending on long-term rates. However, we could likely fund about a quarter of the loan growth by decreasing the bond portfolio. We expect some increase in deposits, which may not be inexpensive if they are interest-bearing, but we are exploring other funding opportunities. Regarding the January maturity, we will consider the broker market or home loan bank advances, depending on which option is more advantageous for our additional funding needs.

Brad Milsaps, Analyst

Okay, perfect. All right. Thanks Lee, I really appreciate it.

Lee Gibson, President and CEO

All right.

Operator, Operator

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

Brian Conner, Analyst

Hey guys, this is Brian Conner from Brett. How is it going?

Lee Gibson, President and CEO

Good. How are doing Brian?

Brian Conner, Analyst

Good. Thanks. Could you just provide a little color on the remaining maturity profile of the securities book there? What do you have maturing in the short-term?

Lee Gibson, President and CEO

Yes, maturing in the short term. I know we have monthly amounts that come off the mortgage portfolio. They're not huge. I think we've got about $11 million or $12 million MBS pool that matures in March, and it's at a fairly low rate. Other than that, we have probably about $20 million in municipals that while they're not going to mature, they will come up on their call dates and that have 4% or higher coupons. And if they don't mature, we're going to see a nice pickup in yield on that. In terms of what's coming off on the MBS portfolio, it's probably about $2 million to $3 million a month, somewhere in that range.

Brian Conner, Analyst

Great, that's really helpful. And then one more, if I could. Just wanted to get your thoughts on CRE. Are you planning on doing any sort of credit review on that book? And then also wanted to get your thoughts on office space as well?

Lee Gibson, President and CEO

Okay. In terms of credit reviews on CRE, really what we do probably every six months or so, and we just did one in the fall. So, we'll have one coming up probably here in the spring, early spring. We go through and we take a look at all the credits above a certain dollar amount, and I believe that dollar amount is $5 million. So, we get an update from the officer on just about everything and take a look at what their average rents are, the vacancy rates, things of that nature, just see if there have been any changes and then any changes in the financial condition of the borrower. So, that's something we do at least twice a year, and it's not just limited to CRE, but it's all of our credits. In terms of office, we're extremely careful on office. I'm not saying we don't make office loans, but we look at the quality of the tenants that are in there. We look at how long they are tied up for when those leases come due. And those typically require a fair amount of equity going in, and we look for really solid debt service coverage ratio. So, office is not probably at the top of our list right now, but there are some good office loans out there to make. You just have to be very selective and make sure that the borrower is somebody that has a lot of familiarity and experience in that area and that the tenant role is such that you feel like for the life of the loan, you're in pretty good shape. So, those we look at extra hard.

Brian Conner, Analyst

Great. Thanks. That’s good color. Appreciate the questions.

Lee Gibson, President and CEO

All right. Thank you.

Operator, Operator

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.

Lee Gibson, President and CEO

All right. Thank you very much to 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 2023 and look forward to reporting first quarter results to you during our next earnings call in April. This concludes the call. Thank you again.

Operator, Operator

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