South Plains Financial, Inc. Q2 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to the South Plains Financial, Inc. Second Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Steve Crockett, Chief Financial Officer and Treasurer of South Plains Financial. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. We appreciate your participation in our second quarter 2022 earnings conference call. With me here today are Curtis Griffith, our Chairman and Chief Executive Officer; and Cory Newsom, our President. A replay of this call will be available on our website within two hours of the conclusion of the call until August 5, 2022. Additionally, a slide deck presentation to complement today’s discussion is available on the News and Events section of our website. Before we begin, let me remind everyone that this call may contain forward-looking statements and are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those anticipated future results. Please see our safe harbor statement in our earnings press release that was issued this afternoon and on slide two of the slide deck presentation available on our website. All comments made during today’s call are subject to those safe harbor statements. Any forward-looking statements presented herein are made only as of today’s date, and we do not undertake any duty to update such forward-looking statements, except as required by law. Additionally, during today’s call, we may discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. A reconciliation of these non-GAAP measures to the most comparable GAAP measures can also be found in our earnings release and on slide 22 of the slide deck presentation. At this point, I’ll turn the call over to Curtis.

Thank you, Steve, and good morning. On today’s call, I will review the main drivers of our strong second quarter results, highlighted by robust organic loan growth, combined with stabilizing Mortgage Banking revenues, which, taken together, have increased the earnings power of South Plains as we look to the second half of the year. Cory will then discuss our loan growth in more detail as we expand our commercial lending capabilities in our major markets of Dallas, Houston, and El Paso. Steve will then conclude with a more detailed review of our Q2 results. Beginning on slide four, we delivered net income of $15.9 million or $0.88 per diluted common share for the second quarter of 2022, which compares to net income of $14.3 million or $0.78 per diluted common share in the first quarter of 2022 and $13.7 million or $0.74 per diluted common share in the year-ago second quarter. Our second quarter 2022 results benefited from $0.25 per share of income received related to four loan credits for the recovery of interest income on previously charged-off credits, purchase discount, principal recovery, and prepayment penalties. We also had $0.11 per share from SBIC investment income and an increase in the fair value of our mortgage servicing rights. The total of these items was $0.28 per share net of tax. As a reminder, our first quarter 2022 earnings included $0.28 per share net of tax of a positive fair value adjustment to our mortgage servicing rights and a negative provision for loan losses. The strong earnings growth that we experienced in the second quarter was primarily driven by the 20.8% annualized increase in our loan portfolio compared to the first quarter of 2022, as we continue to benefit from our newly hired commercial lenders who are building their loan portfolios more quickly than anticipated, combined with our existing team's continued focus on organic growth. As we enter the third quarter, we've largely completed our initial hiring plan, which we outlined a year ago, and remain very pleased with our lenders' initial success. As Cory will discuss, we have the infrastructure in place in our major markets of Dallas, Houston, and El Paso to support further expansion given the significant growth potential that we believe exists, as we strive to redeploy our low-cost deposits into higher-yielding commercial loans. Additionally, we believe that we have ample liquidity to fund our growth, given our comfort running the bank at a loan-to-deposit ratio in the mid to upper 80% range as compared to our 75.3% at the end of the second quarter. This excess liquidity represents significant earnings potential as we continue to fund higher-yielding loans over time. Importantly, our second quarter results mark a clear inflection point, as we believe that our Mortgage Banking revenues have largely moderated to more historical levels. As we have discussed on prior calls, we have expected our mortgage revenues to bottom at 10% to 15% of total bank revenues over time. In the second quarter, our Mortgage Banking revenue, excluding the large MSR fair value adjustments, was 14% of total bank revenue, which compares to 19% of total bank revenue in the first quarter of 2022 and 23% in the fourth quarter of 2021. Given current mortgage rates, we believe refinance volumes have largely bottomed, while demand for housing and construction remains robust given the strength of the Texas economy, which continues to enjoy strong in-migration and job growth. Looking to the second half of the year, we expect the financial benefits of our strong second quarter loan growth to continue to flow through to the bottom line as our mortgage revenues stabilize, combined with our plans to continue to redeploy our excess liquidity. Taken together, we believe this will continue to improve the earnings power and value of South Plains, which we believe is not currently reflected in our share price. Given our view that our shares are trading below intrinsic value, we increased the pace of our share repurchases through the second quarter of 2022, having repurchased approximately 257,000 shares as compared to 106,000 shares in the first quarter of 2022. We will continue to strategically utilize our share repurchase plan while steadily returning capital to our shareholders through our quarterly dividend, as our Board authorized a $0.12 per share dividend this week, which is a $0.01 per share increase from the prior quarter's dividend. This will be our 14th consecutive quarterly dividend to be paid on August 15, 2022, for shareholders of record on August 1, 2022. To conclude, we continue to experience healthy loan growth across our markets as the Texas economy continues to deliver employment and GDP growth above the national average. While we expect activity to slow in light of the continued uncertainty about future economic conditions due to the rising interest rate environment and persistent high inflation levels, we remain cautiously optimistic about the second half of the year, as our loan pipelines remain healthy and our new lenders continue to have success in bringing quality credits to the bank. This provides confidence in our meeting or exceeding our mid-to-high single-digit loan growth guidance for the full year of 2022. That said, we will not sacrifice credit quality for growth and will remain vigilant to ensure that we maintain our disciplined credit culture, which can also be seen in this quarter's results as our credit metrics continue to improve. Now, let me turn the call over to Cory.

Thank you, Curtis, and good morning, everyone. As Curtis touched on, loans held for investment increased by $126.9 million or 20.8% annualized compared to the first quarter of 2022, as outlined on slide five. Underlying loan demand was even stronger, given the payoff of a $46 million relationship in the energy sector, which we discussed last quarter, combined with a $21.3 million reduction in PPP loans due to the SBA forgiveness and repayments. Loan growth this quarter was primarily in commercial real estate, commercial retail, residential mortgage, and consumer auto. Excluding PPP loans, our loan yields in the second quarter were 5.47%. Excluding the large loan recoveries and prepayment penalties, which we benefited from in the second quarter, our loan yields were 4.77%, which compares to 4.74% in the first quarter of 2022. We have made a deliberate decision to proactively price new loans to account for a higher rate environment and the eventual rise in funding costs to ensure we stay ahead of the market while trying to stay competitive. Turning to slide six, it is also important to highlight that we are a community retail bank in our smaller markets and primarily a commercial bank in our major markets of Dallas, Houston, and El Paso. Our strategy is to redeploy our excess liquidity consisting of low-cost deposits from our community-oriented markets into our commercial markets. To accomplish this, we have added experienced commercial lenders who share our culture and values and who focus on developing long-term customer relationships done the right way. Our loan growth this quarter is a validation of our strategy as our new commercial lenders have quickly grown their portfolios and are reaching breakeven ahead of our original expectation of six months on average, while our seasoned bankers continue to deliver solid organic loan growth. A good example of our commercial lending strategy is in Houston, where we've added a new market leader and two experienced lenders over the last year. Our new team has quickly built their pipelines and started to generate meaningful business. In the second quarter, our Houston team grew their loan portfolio approximately 122% compared to the end of the first quarter of 2022, which was primarily in commercial real estate. Additionally, our new lenders share our focus on developing long-term customer relationships, which can be seen in the type of business they are generating as they bring new relationships to South Plains that include deposits, commercial loans, and other services like treasury management. Overall, we grew total loans 28% in our major markets of Dallas, Houston, and El Paso during the second quarter, as can be seen on slide seven. Another region that we continue to be very excited about is the Permian Basin, given the commercial lending and deposit opportunities that we see in the region. While it's taken time for us to install the right leaders and attract experienced lenders, we believe our team is now in a good position and starting to deliver results. This can be seen in the region's underlying loan momentum during the second quarter despite the previously mentioned payoff of a large relationship that moved to a non-bank structure. We continue to believe that we can double our loan portfolio in the Permian Basin over time as we focus on developing private banking relationships while also growing our C&I loan portfolio. Importantly, our building momentum in this market is tied much more to improved execution than the benefits of a stronger commodity environment. We believe there is significant, low-hanging fruit within our current customer base, as well as the opportunity to take market share. Getting ahead to slide nine, we also saw healthy loan growth in our community markets across the South Plains region as we continue to benefit from focused organic growth in various portfolio sectors. Our indirect auto loan portfolio increased by $40.8 million to $280.4 million in the second quarter of 2022 as compared to the first quarter of 2022. This was due to continued strong demand for car loans and the addition of a few high-quality auto dealerships to our customer base. Importantly, we've maintained a disciplined approach to underwriting; 78% of the indirect auto loan portfolio has a credit score of 690 or better. This strong credit profile positions the portfolio for resilience across varying economic cycles. Along those lines, remaining disciplined on credit is ingrained in our culture and has been a focus of our recent hiring as we continue to add seasoned professionals from larger banks to our loan review team and underwriting staff. We've also implemented a loan approval process to include our regional presidents, which we believe has further improved our underwriting process. Turning to our mortgage business on slide 10, mortgage loan originations decreased 12% compared to the first quarter of 2022. We continue to aggressively manage our business for profitability, having reduced lenders and back-office staff. This has been a deliberate effort over the last year as mortgage volumes have steadily declined and now appear to have bottomed, as Curtis noted. Turning to slide 11, we generated $18.8 million of non-interest income in the second quarter of 2022 compared to $23.7 million in the first quarter of 2022. The decrease was primarily due to a $5 million decrease in Mortgage Banking activities revenue. For the second quarter of 2022, non-interest income was 34% of bank revenues, which is a decline from the 44% in the first quarter of 2022. As our Mortgage Banking revenues begin to trough and stabilize, so will our non-interest income. We have aggressively managed our mortgage business through this downcycle and believe that the headwinds that we have faced are now largely behind us, which positions the bank for improved earnings growth looking to the second half of the year. To conclude, our organic growth strategy has been deliberate and focused as we add experienced commercial lenders in our major MSAs where we have the infrastructure in place and can quickly scale. Our MSAs represent large market opportunities for commercial loan growth as well as other services, and we will continue to selectively add to our team to further build our presence in these markets. While loan demand has remained robust, we have experienced a moderation as the Federal Reserve continues to raise their target benchmark interest rate. We remain cautious but optimistic looking to the second half of the year as cash balances have remained healthy for both our business and consumer customers, and we continue to see healthy cash levels go into new deals. I would like to now turn the call over to Steve.

Thank you, Cory. Starting on slide 13, net interest income was $37.1 million for the second quarter of 2022 as compared to $29.9 million for the first quarter of 2022. The increase since the first quarter was primarily due to a $6.1 million increase in loan interest income and a $1.6 million increase in interest income from securities and other interest-earning assets. As Curtis touched on, we benefited from $4.4 million of large loan recoveries and prepayment penalties during the second quarter. The remaining increase of $2.8 million was a result of our loan growth, liquidity redeployment, and rising interest rates. Looking forward, we continue to believe that we are well-positioned for our net interest income to benefit as we grow our loan portfolio and benefit from the anticipated rise in interest rates throughout the year. During the second quarter of 2022, we recognized $898,000 in PPP fee income as an adjustment to interest income, which included accelerated income on PPP loans forgiven by the SBA. At June 30, 2022, the company had $401,000 remaining in deferred PPP fees, the majority of which are expected to be recognized as PPP loans continue to be forgiven by the SBA or repaid over the next several quarters. Our net interest margin, calculated on a tax-equivalent basis, was 4.02% in the second quarter of 2022, as compared to 3.33% in the first quarter of 2022. Excluding the $4.4 million of large loan recoveries and prepayment penalties that we recognized in the second quarter, our net interest margin was 3.54%, up 21 basis points as compared to the first quarter. This improvement was driven by our strong organic loan growth combined with the rising rate environment. Our average cost of deposits was 27 basis points, an increase from 23 basis points in the first quarter. The increase was primarily attributable to our intentional lag to increase our deposit rates as the Federal Reserve continues to raise their target benchmark interest rate. Turning to slide 14, total deposits decreased by $24.3 million to $3.43 billion as compared to the first quarter of 2022. The decrease was primarily due to customers withdrawing deposits to make large tax payments during the quarter. Importantly, we saw outflows early in the quarter, which stabilized and turned back to inflows as we moved through the second quarter. We also experienced a positive mix shift in our deposit base as non-interest bearing deposits increased to 34.9% of total deposits as compared to 32.8% in the first quarter of 2022. Turning to slide 15, we continue to believe that our loan portfolio remains appropriately reserved, and our allowance to total loans was 1.54% at June 30, 2022, as compared to 1.62% at March 31, 2022. During the second quarter, we did not record a provision for loan loss as we continue to experience improving credit metrics in our loan portfolio, as non-performing assets to total assets declined to 20 basis points in the second quarter from 30 basis points in the first quarter of 2022. These improvements were offset by our loan growth during the quarter. Additionally, we subsequently received a full payoff of an approximately $10 million classified hotel credit in July, which further improves the credit quality of our portfolio. Nevertheless, there is continued uncertainty about future economic conditions due to the rising rate environment and persistent high inflation levels, and an additional or reversal provision for loan losses may be necessary in future periods. Skipping ahead to slide 17, our non-interest expense was $36.0 million in the second quarter of 2022 as compared to $37.9 million in the first quarter of 2022. The decline was primarily due to a decrease of $1.3 million in commissions and related personnel expense and other variable mortgage expenses due to the contraction in loan originations in the mortgage market, partially offset by higher costs related to new hires in commercial lending and incentive-based compensation. Looking to the third quarter of 2022, we expect non-interest expense to be in line with or slightly better than the second quarter of 2022. Moving ahead to slide 19, we remain well-capitalized, with tangible common equity to tangible assets of 8.59% at the end of the second quarter of 2022, a decline from 9.11% at the end of the first quarter of 2022. The decline was mainly driven by a $31 million change in the fair value of our available for sale securities and related fair value hedges net of tax, partially offset by net income after dividends paid of $14.0 million. The decline in the fair value of the securities was a result of the rising interest rate environment. Book value per share decreased by $1 to $20.90 during the second quarter of 2022. I will now turn the call back over to Curtis for concluding remarks.

Thank you, Steve. To conclude, our second quarter results represent an inflection point in our business, as our lending team is driving strong organic loan growth, while our mortgage business has declined from historic highs to more traditional levels. Looking forward, we believe the earnings power of South Plains is set to improve as our newly hired lenders drive commercial loan growth in our major markets, while our lenders and our community markets continue to add loans from both new and existing relationships. Importantly, we have remained focused and disciplined on credit, which positions the bank to weather storms that may occur as a result of the Fed's current tightening policy and the persistence of the inflationary environment in the United States. I am very pleased with the success that we have achieved through the second quarter and filled with optimism for the future of South Plains, given the many opportunities for growth that lie ahead. I would like to thank our employees for their hard work; none of this would be possible without their commitment through the bank and our customers. Thank you again for your time today. Operator, please open the line for any questions.

And at this time, we'll be conducting a question-and-answer session. And our first question comes from the line of Brady Gailey with KBW. Please proceed with your question.

Hey. Thank you. Good morning, guys.

Good morning, Brady.

Good morning.

So, you all showed some pretty good expense control in the second quarter. It sounds like the third quarter is going to be in line or better than Q2. So, I know in the past we've talked about expenses being up kind of low to mid-single digit. But it seems like you guys may be able to hold expenses flat this year relative to last year. Is that the better way to think about it now?

Steve?

Yeah, Brady. This is Steve. I would agree with that. Again, a lot of what we have had in the past was on the mortgage side. And as that has come back down, those variable expenses on that side have dropped. So, we've been able to control that a little better. So, that's how we're forecasting it at this point, relatively flat.

And then, quite the loan growth quarter here, you even losing that $45 million energy lines. So, that's great to see. I know in the past we've talked about kind of the mid to high single-digit loan growth. It sounds like you often do better than that. Maybe just kind of how you're thinking about the back half of this year and next year, especially as we potentially head into a recession? Would that cause you to hit the brakes at all on booking some of this loan growth?

You essentially answered your own question. I believe that if things continue as they are today, we will likely be at the high end of our range or even better for 2022. However, I want to express that we are cautiously optimistic about this, as a significant slowdown in the national economy could make achieving any loan growth challenging. We are simply suggesting that we wait to see the effects of the rate increases and how much the tightening influences everything, since a true recession will make things difficult. This is why we are not yet committing to double-digit growth projections. As for 2023, I personally think we could be experiencing at least a mildly recessionary environment then. I do believe we will still see loan growth thanks to our excellent team and the positive results we're achieving from both our new lenders and our seasoned ones. The Texas economy remains strong, but there are some potential challenges ahead, so we must remain cautious. Cory, do you have any comments?

I agree with Curtis. If you look at our pipeline, it's very strong. We've always stated that we aim to have this bank positioned to take advantage of opportunities during a recession. We don't want to be overly optimistic about what we expect can happen, but I think we are quite positive.

Alright. And then, finally for me, just on the share buyback. You had a nice step-up in activity in the second quarter. Should we view this as kind of the new run rate from here, or was Q2 just an especially strong quarter for the buyback?

Well, the way our board looks at it, we do have our kind of internal metrics on the valuation of our stock. And as long as we believe it is undervalued, we're going to keep buying it back. So, we've got our levels that the board is comfortable with, and we're not terminating the plan.

Yeah, Brady, I would just add that we had the chance to consider a few larger block transactions during the quarter. When we can take advantage of those opportunities, I think that's beneficial. We'll keep pursuing that, but we can’t predict how often those situations will arise.

But it was different. To skew our second quarter numbers, as Steve pointed out, there were a couple of block purchases that we took advantage of when the opportunity arose and the price was right, and we will do so in the future.

Okay. That’s great color. Thank you, guys.

Thank you.

Thanks, Brady.

Our next question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Hey. Good morning, guys.

Good morning, Brad.

How are you doing?

Doing well, thanks for taking my questions. Cory, I apologize if I missed this in your prepared remarks, but I was curious about the current number of lenders you have hired. I believe you were targeting 20 at one point and were roughly halfway there. What is that number now? I apologize if I missed that information earlier.

Yeah. I don't think we actually put that number. We're basically at the finish line on that. We're not stopping on the hiring by any stretch, but we probably hit the 18, 19 number range on where we were. But we've still got quite a bit of stuff that we're working on and feel very confident about it.

Okay. Great. Great. And it sounds like those folks are just now hitting their stride based on kind of what you said in terms of the annualized growth coming out of Houston. I'm sure those folks that you brought in still have plenty of capacity.

Houston serves as a great example, but it isn’t unique for us. If you consider all of the metro areas we discussed, we must also remember the South Plains. We have achieved significant success here as well. We are pleased with the markets we are in and have successfully recruited excellent talent. However, as we have consistently indicated, we undergo a thorough process before hiring someone to ensure they align with our culture. This approach has proven effective. When we assess our new hires, we see they quickly reach breakeven and then profitability, which has been very beneficial for us.

Specifically in the Houston and Permian markets, we do have still fairly new, I'll say, leadership in place there, and those changes have allowed us to bring on some great additional lenders in those. And we are going to continue to hire good lenders in any market we are in. That's still a key part of our long-term business strategy. This was just a period for a, I guess, faster than usual ramp-up maybe in hirings, and it's working out really well for us. These lenders have come on and brought some great customer relationships with them. And we think there's still a lot of room to run in those relationships, but it doesn't mean we're not going to still be hiring good people. We're not stopping on that.

And we've taken some approaches with the expenses. If you look at some of the metro markets we're in, we've added square footage in existing properties just to be able to expand those without bringing in all the other overhead that comes with it. So, it's been a really good program that we put into play. But I will tell you, I mean, we've never not been in the hiring business and very much focused on the way we've done it and keep moving forward.

Great. That's helpful. And Steve, just maybe want to touch on the margin a little bit. You had nice core expansion this quarter. I think pre-COVID you guys were kind of in the high threes, close to four. Obviously, the bond portfolio is a little bigger now, but just kind of curious how you see you guys benefiting from continued rate hikes in terms of margin expansion?

We have historically maintained a slightly asset-sensitive position, and we still do, though we're likely a bit less asset-sensitive than at the end of last quarter due to loan growth and some securities purchases. We experienced good expansion in our net interest margin during the quarter, even considering the significant items that came up. We aim to maintain a healthy net interest margin, but it will probably be lower than it was a couple of years ago. There is definitely considerable competition in the loan market, so despite rising rates, loan rates may have slightly decreased. Additionally, we noticed an increase in interest expense. It was only slightly reflected in Q2, but it will be more noticeable in Q3 due to the timing of our recent rate increases, which primarily occurred in the latter part of June. Therefore, interest expense will be somewhat higher in the next quarter.

And this is Cory. We're also trying to be very proactive about how we approach that. We're rolling out some deposit products in markets where we haven't had specific offerings before, and we believe this will help us manage that better. We're quite excited about that.

I might give a little more color too. We're seeing very wide disparity right now in our markets, at least some of our markets in deposit rates, especially for CDs, but so far, most banks in our markets are trying just like we are to maintain a very favorable beta between the rate we're seeing on the Fed increases and actual deposit rates. So, if everybody stays that course, we're going to see increased deposit rates, but I don't think it's going to be anything dramatic.

Great. And just maybe a final question for me. I know these aren't large numbers. But it looks like your insurance business is tracking at least through the first six months of the year maybe up close to 30% year-over-year. I know in the third quarter, it takes another leg up due to some payments that you received. But usually that business is kind of a 9%, 10% grower. Is this just a function of a harder market in insurance? Are you doing anything differently there? Just kind of curious what's driving the increase, again not huge numbers, but every little bit helps.

This is Cory, and Steve may have some additional insights. One factor to consider is the cycle between incoming premiums and the timing of claims, which have been affected by a lack of rainfall in certain markets. That’s the way these things tend to align. I don’t believe it’s anything unusual, and I expect it to stabilize by the end of the year.

I would agree. Some of that is simply timing issues. We have a couple of very small acquisitions from last year that may have contributed incrementally to some of the revenue figures, but the expenses related to those would also be slightly higher. So, there shouldn't be anything significant regarding insurance.

To provide more clarity, our insurance business focuses on federal crop insurance. It doesn't follow the cycles typical of traditional property and casualty markets. The rates are standardized. As Cory mentioned, we did acquire a few agencies this spring, which contributed slightly. In the current very dry conditions, some farmers are accessing crop insurance payouts earlier than in a normal year. While we may not receive the funding we’d prefer for our Ag loans, we aren't facing credit risks. These farmers will likely benefit from their coverage, allowing us to recognize the income from premiums since those policies are fully paid, and the farmers have already received their benefits.

Great. Thank you, guys. Appreciate all the color.

Thank you.

Thanks, Brad.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to Curtis Griffith for closing remarks.

Thank you, operator. Just to summarize, we're very pleased with our second quarter results. It has been driven by some strong loan growth from both our new lenders and our existing team. We believe that our mortgage business has now returned to more historical levels and seasonal cycles, as it always has. So, we think that we're not going to see anything that will negatively impact us moving into the second half of the year from that. Our Texas markets continue to be very strong, with very robust economic growth, and we tend to try to take advantage of those opportunities where we can. We also see opportunities to grow the company as we expand both our community markets across the South Plains as well as in our major markets in Dallas, Houston, and El Paso. It's a good time to be in Texas banking. And we're going to focus very hard on our organic growth in our footprints that we have, grow market share and put more dollars to the bottom line. And for that, we thank you for your time today. And please reach out to us if you have any questions.

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