South Plains Financial, Inc. Q3 FY2022 Earnings Call

Good morning, ladies and gentlemen. Welcome to the South Plains Financial Incorporated Third Quarter 2022 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 conference over to Mr. Steven Crockett, Chief Financial Officer and Treasurer of South Plains Financial. Please go ahead, sir.

Thank you, operator. And good morning, everyone. We appreciate your participation in our third 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 this call until November 4, 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 morning 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 briefly review the highlights of our third quarter 2022 results, which we believe are a clear validation of our ongoing strategy to grow the bank. Cory will discuss our loan growth in more detail and well as review the credit profile of our portfolio, which remains strong. Steve will then conclude with a more detailed review of our Q3 results. To start, there are five key points that I hope you will take away from today's call. First, we spoke to our business being at an inflection point on last quarter's call, and I'm proud to say that our results this quarter validate that view. Second, we delivered 17% annualized loan growth in the third quarter, driven by strength in both our community markets and our major markets of Dallas, Houston and El Paso. Third, this strong loan growth is building the earnings power of the bank and we continue to have liquidity to fund further loan growth. Fourth, the credit quality of our portfolio continued to improve through the third quarter and we believe we are well positioned for an uncertain economy. Lastly, we continue to believe that our shares have been trading below intrinsic value and remained active with our share repurchase program having bought back approximately 366,000 shares in the third quarter. Looking at our results on slide four of our earnings presentation, we delivered net income of $15.5 million or $0.86 per diluted common share for the third quarter of 2022. This compares to net income of $15.9 million or $0.88 per diluted common share in the second quarter of 2022 and $15.2 million or $0.82 per diluted common share in the year ago third quarter. It's important to highlight that our results over the last three quarters have included certain items which are making comparisons difficult, as well as obscuring the improving earnings power of the bank. These items include large recoveries, negative provisions for loan losses and fair value increases in our MSR portfolio. Looking at this in more detail our second quarter 2022 results benefited from $0.24 per share of these items net of tax, which we had discussed on last quarter's call. Likewise, our third quarter results benefited from approximately $0.10 per share of these items net of tax. As a result, our third quarter earnings per share increased by approximately 19% from the second quarter of 2022 when normalizing for these items. We recorded a negative provision for loan loss of $782,000 in the third quarter of 2022, which was triggered by a loan loss recovery in our energy segment of $822,000, combined with paydowns of $19.6 million in our hotel portfolio, over half of which of those paydowns was adversely classified. The improving credit quality of the portfolio largely offset the reserves required for the new organic loan growth experienced during the quarter. Looking forward, we remain well reserved for an uncertain economic outlook, given that our allowance for loan loss ratio is 34 basis points higher than pre-pandemic levels. Nevertheless, concerns regarding forecasted economic conditions continue to increase due to the rising interest rate environment and persistent high inflation levels in the United States and our markets, and provisions for loan losses may be necessary in future periods. While we expect economic growth to moderate as the Federal Reserve continues to raise their target benchmark interest rate. Loan demand remained strong through the third quarter as we grew our loan portfolio of 17% annualized from the second quarter of 2022. Our loan growth was driven by gains in both, our community markets, as well as our major metropolitan markets. Importantly, the scale that we have achieved in our lending portfolio has more than offset the declines in our mortgage business, where our mortgage banking revenues declined to 11% of bank revenues in the third quarter of 2022. This is significant as the core earnings power of the bank is now readily visible and expected to continue to grow through year end. Additionally, we continue to have liquidity to fund future loan growth as our loan to deposit ratio was 77.7% at September 30, 2022 as compared to 75.3% at the end of the second quarter of 2022. We have historically been comfortable running the bank at a loan to deposit ratio in the mid to upper 80% range, which provides significant capacity for future loan growth as we work to redeploy our low cost deposits into higher yielding commercial loans. This liquidity represents significant earnings potential as we continue to fund our yielding loans over time. Overall, I am very proud of our accomplishments as we have grown our lending team. Increased share across our markets and delivered results above our expectations. Most notably, we have achieved 10.4% loan growth year to date, which is ahead of our mid to high single digit loan growth guidance for the full year 2022. As we have improved the earnings power of the bank through the year, our share price has not fully reflected this improvement as we believe our shares have been trading below intrinsic value. As a result, we accelerated our share repurchases in the third quarter, having bought back 366,000 shares as compared to 257,000 shares in the second quarter. Year to date, we have repurchased approximately 730,000 shares under our stock repurchase program. Returning a steady stream of capital to our shareholders through our stock repurchases and dividend remains a priority for our management team. Along those lines, our Board of Directors authorized a $0.12 per share dividend as announced earlier this week. This will be our 15th consecutive quarterly dividend to be paid on November 15, 2022 for shareholders of record on October 31, 2022. To conclude, we remain cautiously optimistic as the Texas economy continues to experience healthy economic growth and low unemployment. While we expect growth to moderate, we are not seeing concerning signs in our portfolio, nor in our markets. The credit quality of our loan portfolio is strong and we continue to underwrite to more conservative assumptions, including not sacrificing credit quality for loan growth. We believe that we are in an advantageous position and remain excited with the opportunities that lie ahead. 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 during the third quarter of 2022 by $109.9 million or 17% annualized, compared to the second quarter of 2022 as outlined on slide five. Our loan demand remained primarily in the commercial real estate market, residential mortgage and in consumer auto. Overall, loan demand was strong despite the noted paydowns in our hotel segment, which is not a growth sector for us. Our loan yield in the third quarter of 2022 was 5.12%, which compares to 5.57% in the second quarter of 2022. That said, it is important to adjust our second quarter loan yield for the $4.4 million of large recoveries and prepayment penalties that we experienced. When adjusting for those items, our second quarter 2022 loan yield was 4.88%. As Curtis touched on, the improving trends and our results over the last three quarters have been obscured and we believe it is important to adjust for these benefits in order to properly model to growing earnings power of the bank. The rise in our loan yields in the third quarter also reflects our concerted effort to proactively price new loans to account for a higher interest rate environment, combined with the rise in funding costs, which we have started to see through the third quarter. We are working hard to stay ahead of the market, while also maintaining our competitive position, which remains a focus as the Federal Reserve continues their aggressive interest rate increases and tightening policies. As we discussed in our second quarter 2022 call, 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 as outlined on slide six. Our strategy is to redeploy our excess liquidity consisting of low-cost deposits from our community-oriented markets into our major metropolitan markets. To accomplish this, we have added experienced commercial lenders to share our cultural values and who focus on developing long-term customer relationships the right way. Our expansion and growing scale in our metropolitan markets is a key factor to the accelerating loan growth that we have delivered through the year, combined with the share gain that our community bankers continue to deliver. As outlined on slide seven, we grew loans in our metropolitan markets by $30 million in the third quarter of 2022, representing 14.6% annualized growth as compared to the second quarter of 2022. Year to date, we've grown our loan portfolio by 15.2% to $849 million in our metro markets, which strongly contribute to the bank's 10% total loan growth through the first three quarters of the year. Our growing scale and presence in the metro markets provide us with optimism on our ability to sustain mid to high single-digit loan growth over time. Additionally, we have the ability to add space and bankers in our metro markets as growth opportunities present themselves. As Curtis touched on, we have seen loan growth moderate given the rapid rise in rates as borrowers need to put more equity into deals and builders are beginning to offer more incentive to buyers to keep builds going. That said, inventory remains constrained and the Texas economy is still very healthy. If the economy transitions to a higher market interest rate environment, we are proactively underwriting to more normal levels and asking for more money down on new loans as we focus on disciplined growth. Likewise, we continue underwriting to lower energy prices in the Permian Basin to ensure we avoid potential problems if an economic downturn occurs. We are continually stress testing our loan portfolio and remain pleased with the improving credit quality that we have experienced year to date. Overall, we want to enter the next downturn in an advantageous position and remain pleased with our asset quality, liquidity and strong capital position. Skipping ahead to slide nine, our indirect auto loan portfolio increased by $7 million to $289 million in the third quarter of 2022 as compared to the second quarter of 2022. While there was growth in this sector, the level of increases declined given the rising market interest rate environment. Importantly, we have maintained a disciplined approach to underwriting 78% of the indirect auto loan portfolio originated with a credit score of 690 or better. This strong credit profile positions the portfolio for resilience across varying economic cycles. Turning to our mortgage business on slide 10. Mortgage loan originations decreased 26.6% to $152 million in the third quarter of 2022 as compared to the second quarter of 2022 as a result of rising market interest rates combined with normal seasonality. As we discussed last quarter, our strategy with mortgage banking business has been deliberate. We have been aggressively managing this business for profitability as volumes decline, while focusing on growing our commercial lending platform across both community and metro markets. As Curtis has commented, we believe we reached an inflection point in the second quarter of 2022 where our growing loan portfolio would generate improving interest income and return the bank to growth despite the decline in our mortgage banking business. That can clearly be seen in our results this quarter. Our mortgage business is now at a level which may no longer have a material impact on our results, positive or negative. We remain in the business as long as it is possible and drives incremental business in the way of cross-sell. Turning to slide 11, we generated $20.9 million of non-interest income in the third quarter of 2022 compared to $18.8 million in the second quarter of 2022. This increase was primarily the result of $2.1 million in legal settlements and seasonal increase of $3.3 million from insurance activities in our insurance business. For the third quarter of 2022, non-interest income was 37% of bank revenues as compared to 34% in the second quarter of 2022. To conclude, our organic growth strategy has been deliberate and focused as we add experienced commercial lenders in our major metro markets where we have the infrastructure in place and can quickly scale. These markets represent large 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 fourth quarter of the year as cash balances remain 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 $35.1 million for the third quarter of 2022, down from $37.1 million in the second quarter of 2022. This decrease is influenced by $4.4 million in large loan recoveries and prepayment penalties recognized in the second quarter. Excluding these one-time factors, net interest income actually increased by $2.4 million, mainly due to a $122 million rise in average loans outstanding, along with higher interest income from securities and other interest-earning assets, driven by the increasing market interest rates. Looking ahead, we are confident that our net interest income will benefit from our growing loan portfolio and the expected rise in interest rates through the fourth quarter and into the upcoming year. Our net interest margin, calculated on a tax-equivalent basis, was 3.7% in the third quarter of 2022, compared to 4.02% in the second quarter. Adjusted for the $4.4 million in large loan recoveries and prepayment penalties recognized previously, our net interest margin was 3.54%, providing a better comparison to the 3.7% for the third quarter. The improvement from the second quarter was driven by strong organic loan growth in conjunction with the rising market interest rates. Our average cost of deposits rose to 52 basis points from 27 basis points in Q2. During the third quarter, we decided to proactively increase our deposit interest rates due to heightened competition for deposits in our markets. We are strategically managing how we raise these interest rates to maintain our deposit relationships amid increasing rates. Looking ahead, we foresee our funding costs continuing to gradually rise as the Federal Reserve pushes up their target benchmark interest rate. On slide 14, total deposits grew by $34.7 million in the third quarter to $3.46 billion compared to the second quarter of 2022, benefiting from strong customer relationships that drive organic growth. We also observed a positive shift in our deposit mix, with non-interest-bearing deposits rising to 36.5% of total deposits in the third quarter, up from 34.9% in the second quarter. On slide 15, we reaffirm that our loan portfolio is appropriately reserved, with our allowance for total loans at 1.47% as of September 30, 2022, down from 1.54% at June 30, 2022. As Curtis mentioned, we recorded a negative provision for loan loss of $782,000 in the third quarter, compared to no provision in the second quarter of 2022. Importantly, we believe we are well reserved for the uncertain economic outlook, as our allowance for loan loss ratio stands 34 basis points higher than pre-pandemic levels. Overall, we see improving credit metrics in our loan portfolio, particularly in the hotel sector, where non-performing assets to total assets slightly decreased to 19 basis points in the third quarter, down from 20 basis points in the second quarter and 33 basis points in the first quarter. Nonetheless, we remain cautious about the worsening economic forecasts due to rising rates and persistent high inflation in the United States, indicating that additional provisions for loan losses may be needed in the future. Moving to slide 17, non-interest expense was $37.4 million in the third quarter of 2022, compared to $36.1 million in the second quarter. This increase was mainly due to an additional $937,000 in insurance commission expenses related to higher revenue from insurance activities, partially offset by a decline in variable mortgage-related expenses resulting from reduced demand for mortgage originations, as discussed by Cory. For the fourth quarter of 2022, we expect non-interest expenses to be slightly lower than in the third quarter, as elevated legal expenses are largely behind us following legal settlements reached during the third quarter. However, we do anticipate continued wage pressures to retain personnel, given the current inflationary climate, which may pose challenges in the upcoming year. Moving to slide 19, we remain well capitalized with tangible common equity to tangible assets at 8.00% at the end of the third quarter, down from 8.60% at the end of the second quarter. This decline was largely due to a $26.7 million decrease in the fair value of our available-for-sale securities and related fair value hedges, net of tax, slightly offset by net income after dividends of $13.4 million. The drop in the fair value of our securities was a consequence of increased market interest rates during the period. Tangible book value per share decreased by $0.89 to $18.61 in the third quarter of 2022. I will now turn the call back to Curtis for concluding remarks.

Thank you, Steve. To conclude, our third quarter results validate our view that our business has reached an inflection point and the bank is now positioned for additional growth. Our strategy to expand our lending platform and our metro markets is driving improved loan growth as we quickly build scale in Dallas, Houston and El Paso, while our community bankers continue to increase our share in those markets. Importantly, we have liquidity to put to work in higher yielding loans, which will serve to further improve the earnings power of the bank. As we grow, we will see our returns improve, which we believe will increase the value of South Plains. While the economic outlook remains uncertain, the Texas economy remains healthy and we have maintained our disciplined approach to underwriting. The credit profile of our loan portfolio has continued to improve and we remain in an advantageous position for whatever the future may hold. I would like to thank our employees for their hard work and commitment to our customers and communities once again this quarter. None of our success is possible without them. Thank you again for your time today. Operator, please open the line for any questions.

Thank you. We will now start the question-and-answer session. Our first question comes from Brady Gailey with KBW. Please go ahead with your question.

Thank you. Good morning, guys.

Good morning, Brady.

Good morning, Brady.

It's good to hear that expenses will be down a little bit linked quarter in the fourth quarter, but I heard the comment on wage inflation, which I know everybody is seeing. So how do you all think about the level of expense creep that we could see into 2023?

I’ll let Steve talk about that when he's been running the numbers for us?

Yes. So, Brady, as far as what we're showing, Q4, we definitely expect to see that lower than where we were in Q3 as we get into 2023. We still think that we'll be flat to slightly better than the run rate there that we were showing in Q3, that we'd be able to offset some of that personnel expense due to inflation with other cost saves that we've got, also including the reduced legal that we spoke to.

All right. And then it was great to see the share repurchases. I know year to date you repurchased about 4% of the company. How do you think about kind of continuing at this pace of buybacks? I mean, you still have excess capital, but we are potentially headed into a recession. So how do you think about buybacks into 2023?

Well, our Board is going to have some good discussion on that at our next meeting. We will likely reauthorize repurchase program, but I also would think that given the potential recessionary fears issues out there and frankly where our stock price improved as well that the level, the speed of repurchase might be slowing a little bit. But I think we'll still stay in the market as long as we feel like we have slightly undervalued stock.

All right. And then finally for me, I know Lubbock can be a fairly competitive market when it comes to deposit rates. Deposit rates moved up in the quarter, so what should we expect on how much those deposit rates should continue to go up next quarter and into next year?

This is Cory. There’s no doubt we will see some increase in rates given the current situation. Locally, things aren’t getting too crazy. There was some movement early on, but it’s manageable, which is reassuring about the market and our competitors. We anticipate some increases, and our expectations align with that. We discussed last quarter that we are introducing additional products in markets where we haven't been active before, and we are starting to see positive results. So yes, we will experience some increase, but I don’t believe it will become overwhelming.

Everything we're observing leads us to believe we can maintain that beta of 50% or higher. Additionally, locally, there has been recent M&A activity in our markets, which we believe could help alleviate some deposit pricing pressure as these transactions progress. The reduction in the number of competitors vying for the limited pool of deposits is likely beneficial for us.

Yes, that makes sense. All right. Thank you, guys.

Thanks, Brady.

Our next question is from Brad Milsaps with Piper Stanley. Please proceed with your question.

Hey, good morning, guys.

Hi, Brad.

Good morning, Brad.

You guys addressed a few of my questions already, but just did want to follow-up on the deposit beta discussion. I hear you say correctly that you think 50% or less, would that be total deposits or interest bearing deposits? How do you think about that 50% beta number that you just put out there?

That's on interest bearing.

Okay.

And we do have, like our last DDA numbers, but some of those are somewhat seasonal for various reasons, including public funds and others. So that's one thing that DDA numbers will move up and down for us, but we're also trying to just add customer relationships and bring the DDA accounts in as we go with that. We still are big believers in what we're doing in treasury management and are reaching out not only here locally, but also in our metro markets with those. So over time, I think you'll see the average of the DDA piece continue to grow. But don't be surprised if you see it bounce up and down a little bit quarter to quarter.

Sure. And on the flip side, it looked like your loan beta on a core basis was somewhere around 25%. It does look like you're putting on a lot of CRE with your new lenders. Just curious, is that kind of the right number to think you know, as the Fed continues to increase, you'll see that type of lift in your loan yield going forward?

Yes, we are cautiously prepared to respond to that. We are achieving good yields on the loans we are issuing, which is advantageous. From a pipeline perspective, while it remains robust, it is showing some signs of moderation. We are encountering significant challenges primarily with our own underwriting processes, ensuring we are comfortable with what we take on and how we conduct our stress testing. Overall, we are seeing strong yields on the loans we are processing.

Great. Finally, regarding insurance revenue, I know the third quarter typically sees significant performance for your company, but you're on track for over 20% growth year over year, which is impressive. I understand the insurance market is favorable and your focus is on agriculture. Is there anything else contributing to this growth? Or do you anticipate reverting to a more typical growth rate of high single digits, around 9% or 10%, in 2023? Or do you see factors that could make this growth more sustainable?

I'll begin, and then Curtis or Cory can add their thoughts. Some of the revenue timing played a role in this; a portion of what usually comes in during the fourth quarter was recognized in the third quarter, which slightly increased that figure. Overall, I believe their revenues improved compared to last year, but I don't expect that to translate into increases for the upcoming year based on our current observations.

We effectively diversify across various states, and much of our growth is influenced by the year’s loss rates and similar factors. We do not take any underwriting risk now or in the future. However, from a profit-sharing perspective, we need to evaluate how the year has unfolded to consider any potential increase for the next year. Our expansion, in terms of agents and other factors, looks promising, and we are pleased with it.

It is a good business, and please remember that nearly all of what we report as insurance income is linked to the federal crop insurance program. As Cory mentioned, we do receive some profit sharing from that, which is related to underwriting gains at the companies we partner with. While 2021 was a very strong year for those companies, and we received a substantial payment this time, 2022 has not been as favorable in many areas, though not uniformly across the country, and they have experienced some underwriting losses. Currently, our own forecast suggests that we will likely see a slight decline for the same period in 2023, whenever those profit-sharing payments are issued.

That’s on the profit-sharing side, not on the overall banks' revenue.

Not on overall base revenue side. We continue to grow that.

Right. Okay. And then maybe final question, kind of more housekeeping. Curtis, you mentioned the kind of $0.10 this quarter of what you might consider non-run rate items. Can you tell me kind of what encompasses that? I'm curious, was there any type of MSR write-up this quarter? I mean, I saw the $2.1 million of litigation proceeds, but just making sure I didn't miss anything else that should be pulled out either positively or negatively in your mind?

Steve indicated and he confirmed it, but $400,000 in MSR gains for this quarter. So not a big number, but it was some in there. So yes, that's in there.

Yes. So Brad, on the legal settlement, we did net off some of the increased legal expense that we had in the quarter related to that. So that kind of lowered that number just a little bit and coming up with the $0.10 number.

And we did have a couple of loss recoveries, not on the level that we did in Q2 on one loss recoveries, but we did have some in Q3 as well.

Got it. So those, as you mentioned in response to Brady's question, some of those legal expenses are going to come out in the fourth quarter, which kind of drives your guidance for lower expenses in the fourth?

Yes, sure.

Okay, great. Thanks for the color. Appreciate it.

Thank you, Brad.

Thank you.

We have reached the end of the question and answer session. I'd now like to turn the call back over to Curtis Griffith for closing comments.

Thank you, operator, and thanks to all of you on the call today for your time. I am proud of our results again this quarter. We are delivering on our strategy to organically grow the bank and here with disruptions from M&A and our community markets are really adding some great opportunities for our lenders to increase our market share. And as we just discussed, probably pick up and deposits as well. Our lenders in our metro markets are continuing to grow their portfolios, bringing on strong customer relationships to the bank. Our mortgage is still profitable, but now down at a level that it won't meaningfully impact results, positively or negatively going forward. The earning power of our core business really does continue to grow and so we are optimistic about the future. Our markets do remain healthy, but I think our activity will moderate as the Federal Reserve continues to raise rates. We'll remain focused on the credit profile of our loan portfolio, which continues to be very strong. So thanks again today for everybody for your time and for your interest in South Plains Financial.

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