South Plains Financial, Inc. Q1 FY2021 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to the South Plains Financial Inc. First Quarter 2021 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions with instructions to follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the call over to Mr. Steven Crockett, Chief Financial Officer of South Plains Financial. Please go ahead, sir.

Thank you, operator, and good afternoon everyone. We appreciate your participation in our first quarter 2021 earnings conference call. With me here today are Curtis Griffith, our Chairman and Chief Executive Officer; Cory Newsom, our President; and Brent Bates, City Bank's Chief Credit Officer. As a reminder, a replay of this call will be available through May 11, 2021. Additionally, a slide deck presentation to complement today's discussion is available on the Investors section of our website.

Thank you, Steve and good afternoon. On today's call, I will briefly review the highlights of our first quarter 2021 results, provide an update on our capital allocation strategy and conclude with comments on our inaugural corporate sustainability report, which we released in February 2021. Cory will discuss our initiatives designed to accelerate organic growth. And Steve will conclude with a more detailed review of our first quarter 2021 financial results. We will then open the call for your questions. Turning to our first quarter 2021 results on Slide 4, we reported net income of $15.2 million, or $0.82 per diluted common share, which compares to net income of $7.1 million, or $0.38 per diluted common share that we reported in the first quarter of 2020. Pre-tax, pre-provision income for the first quarter of 2021 was $19.0 million, which compares to $20.0 million in the fourth quarter of 2020 and $15.1 million in last year's first quarter. Our provision for loan loss in the first quarter of 2021 was minimal for the second consecutive quarter and compares to $6.2 million in the year-ago first quarter. It is important to emphasize that we remain confident in the credit quality of our loan portfolio and the reserves that we have recorded over the last year. We have instilled a conservative credit culture at the bank and adhere to strict underwriting standards, which we believe positioned our loan portfolio to weather the COVID-19 crisis. We recognize that economic activity is accelerating and many of the hardest-hit areas of the economy are improving. That said, we are maintaining our conservative stance and keeping our reserves stable at current levels given the continued stress in certain sectors, most notably the hotel sector. The US government's recent stimulus package has provided much-needed support to many individuals and businesses and we're watching to see how the economy evolves as that stimulus is spent throughout the year. While we have started to see more banks releasing some of their reserves this quarter, we will continue to monitor our position at the end of each quarter as we assess the risks in the loan portfolio, along with the economic environment at that time, and will adjust accordingly.

Thank you, Curtis and good afternoon everyone. Starting with our loan portfolio on Slide 5. Loans held for investment at the end of the first quarter of 2021 were $2.24 billion, which is a $21 million increase from the fourth quarter of 2020 and a $134 million increase from the first quarter of 2020. The increase from the fourth quarter of 2020 was largely driven by organic net loan growth of $47 million, partially offset by seasonal payments of $25 million in agricultural operating loans. Additionally, we funded $78 million of new PPP loans during the first quarter of 2021, which resulted in a net increase in PPP loans of $4 million. Our loan growth is being driven by improved demand from our customers for credit as the economy continues to recover from the COVID-19 pandemic. While we were still early in the economic recovery, we're seeing strengthened residential construction across many of our markets, as well as continued improvement in our indirect auto channel, which began in the fourth quarter of 2020.

Thank you, Cory. Starting on Slide 11, net interest income was $29.5 million for the first quarter of 2021 as compared to $30.4 million for the fourth quarter of 2020 and $30.2 million for the first quarter of 2020. The decrease since the first quarter of 2020 was due to a decline of 69 basis points in loan rates and interest expense for the $50 million of subordinated notes that we issued in the third quarter of 2020, partially offset by a decrease of 50 basis points in the cost of interest-bearing deposits. During the first quarter of 2021, we recognized $2.5 million in PPP-related SBA fee income as an adjustment to interest income, which included accelerated income on loans forgiven during the quarter.

Thank you, Steve. I would like to thank all of our employees for their hard work throughout this challenging environment. The success that we have achieved through the first quarter of 2021 and our strong foundation, which positions us for the future, would not have been possible without your tireless efforts and commitment to the bank. As I look to the balance of the year, I'm filled with optimism and hope that the economic recovery will take hold, providing a real tailwind to our business. I am also comforted by our cautious approach to credit and the provisions that we have taken to safeguard the bank and our shareholders against the unexpected, which I have encountered often over my almost five-decade career in banking. We believe we are well positioned for the future and excited to take advantage of the many opportunities that we see in front of us. Thank you again for your time today. Operator, please open the line for any questions.

The first question is from Brad Milsaps from Piper Sandler. Please go ahead.

Hey, good afternoon. It looks like you guys had a nice quarter. Maybe just wanted to touch on the balance sheet and the loan growth that you are seeing. Steve, I think you mentioned some pressure on loan yield. So just kind of curious, where new loans are coming on the books, and then sort of how you're thinking about managing the excess liquidity that you have. It doesn't really look like you bought many bonds during the quarter. So just kind of curious how you're thinking about managing that excess liquidity going forward, as you think about PPP loan forgiveness and then the loan growth that you've hopefully got coming in the second half of the year?

Sure, yes. We had a good first quarter. We saw some good loan demand. We did see some rate pressure. But you know, some of the growth we had, as we mentioned, was in our indirect auto businesses, which do have a little bit lower rates than some of the commercial stuff, and those are obviously much shorter-term and amortize off, so that is a little bit lower yield we're seeing there. But again, it's better than the alternative of having it in overnight liquidity. As far as the securities go, we would like to continue to invest. We did invest, but we would continue to look for good investment opportunities. We don't want to extend too far out in duration at this point. But again, we keep getting flooded in with liquidity. So we don't want to make that decision all at one time to invest all that; we'll just keep looking for good opportunities.

Brad, this is Curtis, kind of echoing what Steve said. We have been a little cautious, we are keeping quite a bit of liquidity. But as the long end of the curve began to move up, we kind of backed off on buying longer securities during that period to try to figure out where the line is headed a little bit. We don't want to get in too early on that. And as Steve said, it's still a bit of a challenge to determine what our liquidity is going to be going forward over an extended period. We're still a little bit surprised, frankly, about the growth in deposits that we're still seeing. But I think with all of the injection of liquidity into the system from the Federal Reserve primarily, I think, expecting everybody to some degree. And I just don't want us to be out there getting too much tied up for too long. What we are seeing—and I'll let Brent Bates speak to this a little bit—is that our pipeline right now is one of the best we've ever seen. I don't know, you never know how much of that turns into final funding. But Brent, do you want to address that a little bit?

Yes, we have a really strong pipeline right now. I'm really encouraged by it; it's the best we've had really since I've been here. As far as the size of it and the probability of closing, we're seeing good demand in commercial and industrial, and still some in the residential side, although that's an area where we're being selective. We're seeing strong demand in owner-occupied commercial real estate, which has been a focus of ours for a while. We saw good traction during the quarter in owner-occupied CRE; we saw about 6% growth quarter-over-quarter just in that category, which also contributed a little bit to the margins there.

So Brad, it's Cory. One of the things—well, as we ran through the middle of the COVID challenges this last year, we got fairly aggressive on rates, trying to figure out how to keep a little bit of the demand going. We've been increasing those rates back up on the loan side and not getting a whole lot of pushback on it. I mean, we'd love to see them keep going up higher than they are today. But we're kind of pleased with what we're seeing.

That's great. And maybe just one follow-up around credit quality. I certainly appreciate you guys being conservative in how you're thinking about provisioning in the reserve. A lot of your peers have maybe been more aggressive with releasing reserves this quarter. I guess, you know, what would have to happen for you guys to maybe take a negative provision? Or based on what Brent's saying around the loan pipeline—is it something you would like to kind of grow into as you move through the year and into next?

Brad, this is Curtis. Obviously, the best answer is to grow into it. But realistically, I don't know that we can ramp it quite that quickly. We still have a very significant qualitative adjustment out there in the calculation. And that really goes back to how we're cautiously optimistic about where we're going as far as the pandemic and the recovery of the overall economy. We do have some issues out there on international supply chains. I don't think any of us know just yet how that's going to affect our everyday customers. But anecdotally, we're seeing many businesses that are having problems getting either things they need to sell or items they need to keep their manufacturing and other operations running. That's not going to be good, and I don't think it's catastrophic by any means. But it still gives us a little bit of pause, and that's one reason we didn't make any adjustment here at the end of the first quarter. We're going to be looking very hard at where everything is as we move forward. If trends continue in a positive direction, probably we would be looking to maybe release some in Q2 or Q3. But right now, we just want to kind of see where everything is going before we start adjusting.

That's great. I appreciate it all. I will back in the queue. Thank you.

I think one comment I would just make is that, along with what Curtis was saying, there are supply chain issues. We're not seeing as many within our own portfolio as we're seeing throughout the economy. So we're pleased with what we've got. But we're just waiting for a bit of clarity to come along.

The next question is from Brady Gailey of KBW. Please go ahead.

Hey, thank you. Good afternoon, guys. I wanted to ask one more on the reserve. Just remind us you guys are not yet a CECL compliant bank, right? If that's correct, when do you expect to be CECL compliant? For some reason our number maybe is January the first of 2023—is that the plan?

That is correct. We have not adopted CECL; that's when we have to. We've gone through the process and we're ready to implement it, just right before COVID hit. And so we're very far down the road, but that's the required date.

All right. Then next, I wanted to ask about mortgage. I think you guys had a little bit of an MSR write-up in there. Even if you back that out, mortgage was still very strong— even stronger than the fourth quarter. You know, I heard your comments earlier about mortgage moderating at some point. But I was just wondering if you could provide a little more color on how you think the degree to which mortgage could moderate, and then as you look ahead to 2022 in a more normalized mortgage market, what you think mortgage fees could ultimately moderate to?

Well, I guess, I'll probably tag team this one. One of the things that I will tell you is that what we saw a difference between the first quarter and where we're taking off on the second quarter is we're seeing a difference between the purchase units as a percentage of the whole, between those two quarters. In the first quarter, we had a little bit more refi business than what we're seeing even in April. We're seeing a pretty substantial swing toward the purchase side. That's what we've been focused on; the teams that we've been bringing on, everything that we've been doing is to be focused on the purchase business to be able to keep our mortgage business headed in the right direction as we move forward. We are seeing margin compression that's already happening, and we don't think that that's going to slow down, but we still anticipate a pretty decent year for 2021.

Yes. No, I mean, I would just add to what Cory is saying. If you look in the slide deck, we've got a chart in there talking about going back to 2019 and 2020, as well as Q1 of this year. 2021 is projected to still be a really good year. But we do see it moderating, and 2022 is hard to know. However, we've added more teams, and we've got more producers than what we had back in 2019. So, you know, we would assume that those levels should be above where they were at that time. Regarding the mortgage servicing rights, we don't necessarily like all the volatility, but we saw a lot of write-downs last year with all the refinances, and this was really the first quarter we've seen an increase in the value we have on those, but that may just be more of a one-off due to market changes.

As we see some pullback—and I mean, everybody across the mortgage industry is struggling with inventory. That's the biggest challenge out there. But as we see volume starts to moderate for the balance of the year, we think within a 30 to 45 day lifetime, our expenses will moderate as well, because the lion's share of our expenses are commissions. And so they're directly tied to it. We've tried to make sure that technology continues to take a larger foothold in what we do and how we process on a daily basis, and we've seen some really good outcomes as a result.

All right, that's helpful. And then I know when we spoke 90 days ago, you all were more upbeat on bank M&A in your markets. Maybe update where we stand today. It seems like stock prices are up and people are feeling better about the economy. It seems like things in Texas are clearly better—maybe just an update on how you view M&A for South Plains?

Well, we are beginning to see some activity, and we're in contact with some potential targets ourselves. We're not in any serious discussions at this point, but definitely staying in touch with some that could be sellers. Our attitude right now is that we could do an all-cash purchase for a smaller bank if we find the right deal that comes along and still generates enough synergies to make a meaningful impact on our growth. I don't see any reason to buy something that's very small and simple to make the purchase. Obviously, right now, with where our stock is trading, doing anything that has a large stock component would be problematic, given where pricing is probably going to be. So until we can hopefully generate something that the market likes us more, it's going to be a little hard to go out and play in that arena. But nevertheless, we are still looking for the right transaction. We'd love to do another deal sometime during 2021.

The deal along with the ongoing trend that we're focused on is making sure that we keep organic growth as front and center as possible. As we continue to look at seasoned quality lenders, we're very cautious about our hiring process and we're very focused on it. But as we continue to stay in that direction, and we're pleased with what we're seeing, I mean, it's our organic growth—just like Brent was talking about the pipeline—it's very robust for what we're seeing coming out of the COVID pandemic.

Alright, and then, sorry if I missed this, but the $50 million of FHLB that was repaid without any prepayment penalty, will that be a material addition to spread income? I'm wondering if that was a costly FHLB advance?

No, it was not. It was actually a variable rate, so it was low cost. But obviously, based on our current liquidity position, it just wasn't anything that we needed.

Got it. That makes sense. Thanks for the color, guys.

This concludes the question-and-answer session. I would like to turn the call back to Mr. Curtis Griffith for closing comments.

Thank you, operator. Thank everybody for participating today and for those listening in on the call as well. We are very pleased with the group that we have leading South Plains Financial; we think we have some great opportunities ahead of us. Our credit quality is strong, and I think continues to improve. We're not seeing the kind of dire consequences of the pandemic that a year ago we were all fearful of. That's a result of many things, but I think we did have strong underwriting going into this, and that's now paying off for us. As Cory indicated, we have great lenders in place and continue to add some. I think our organic growth this year is going to be strong; we are very optimistic about what we're able to achieve. The Texas market is certainly a great place to be right now. We continue to work on saving every opportunity to add new technology when we have the opportunity to and we can see the quick repayment of an investment in that technology. The pandemic has allowed us to spread our digital platform across a much greater percentage of our customers, and I think they're generally very satisfied with that. So overall, we feel really good about where we are right now and think we're going to have a good 2021. The mortgage business will probably see a gradual slowdown, but again, we're pleased that so far it hasn't been anything drastic. Unless we see a significant spike in the long end of rates, I think here in Texas, we're going to see substantial activity in single-family homes, particularly on the purchase side. Even if refis do slow down, I believe it's probably because we're seeing an increase in longer rates. Given the way we've positioned our portfolio, that should allow us to see our net interest margin begin to widen back out to levels above where we've had to deal with in the last several months. So we see a very broad outlook and still welcome any of you to participate in our stock. Thank you for believing in us and being part of our investors, and we look forward to many great years ahead. Thank you, operator.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.