Southside Bancshares, Inc. (SBSI) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Southside Bancshares’ Quarterly Investor Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Deborah Wilkinson, Executive Vice President of Investor Relations for Southside Bancshares. You may begin.

Thank you, Becky. Good morning, everyone. And thank you for joining Southside Bancshares’ First Quarterly Earnings Call. The purpose of our call is to discuss the company's results for the quarter just ended and our outlook for upcoming quarters. A transcript of today's call will be posted on southside.com under Investor Relations tab. During today's call and in other disclosures and presentations, I'll remind you that any forward-looking statements made are subject to risks and uncertainties. Factors that could materially change our current forward-looking assumptions are described in our earnings release and in our Form 10-K. Joining me today to review Southside Bancshares’ third quarter 2015 results are, Sam Dawson, President and CEO; and Lee Gibson, Senior Executive Vice President and CFO. Our agenda today is as follow, first you will hear, Lee discuss an overview of financial results for the quarter, including loan growth, oil and gas exposure in our loan portfolio, and update on our securities portfolio, and an update on efficiencies and cost savings subsequent to our merger with OmniAmerican Bank in December of 2014. Then Sam will share his comments on the quarter. I will now turn the call over to Lee.

Thank you, and good morning, everyone. Welcome to Southside Bancshares’ third quarter 2015 earnings call. We had another successful quarter, with net income of $11.8 million, a 93% increase over the same period in 2014. Net income for the nine months was $32.3 million, a 30% increase over the same period in 2014. Our diluted earnings per share increased 48% to $0.46 per share for the quarter ended September 30, 2015 compared to 2014. During the third quarter, we reported loan growth of $59.3 million, or 10.8% on an annualized basis. This is in line with our expectations for loan growth for the next several quarters. It’s important to note that over 65% of this loan growth occurred in September and as a result, we expect to realize the full net interest income benefits of this third quarter loan growth during the fourth quarter. We continue to experience roll-off from the acquired indirect auto loan portfolio, which decreased approximately $18 million during the third quarter. Since December 31, 2014, the balance of this portfolio has decrease 39% and was approximately $93 million at the end of the third quarter and is declining at an average monthly rate of $6 million. Because Southside is the Texas-based bank, we are continually asked about the oil and gas exposure in our loan portfolio. I can tell you that it is minimal and that it is our intention that it will remain minimal. The direct oil and gas exposure at the end of the quarter was $33.5 million, or 1.48% of the loan portfolio. Total direct and indirect oil and gas exposure at the end of the quarter was $61.1 million, or 2.69% of the loan portfolio. At the end of the quarter, we did not have any oil and gas loans and non-accrual status. Loan loss provision expense during the quarter of $2.3 million was a little higher than we anticipated. During the quarter, we renewed one purchase impaired credit that required an additional reserve of approximately $400,000. At renewal this purchase impaired credit was restructured and is now reflected in nonperforming assets, which is the reason for the increase in nonperforming assets this quarter. We also determined during the third quarter that credit placed on non-accrual during the first quarter required an additional reserve of approximately $600,000. This combined with the reserves required with respect to $59 million of loan growth during the third quarter accounting for most of the provision expense. Next, I will provide a brief update on the securities portfolio. At the end of the quarter the securities portfolio reflected a decrease of approximately $75 million from the prior quarter. The duration of the portfolio is 4.72 years, up just slightly from the prior quarters’ duration of 4.69. The average balance during the quarter increased $52 million from the second quarter and the yield increased 1 basis point, as premium amortization decreased approximately $280,000 during the third quarter due to decreased prepayments. During August and September, we sold approximately $75 million of CMOs where continued prepayment risk was a concern and book yield was near zero. We anticipate continuing to use a barbell approach for our purchases, utilizing CMOs for the short end and U.S. agency CMBS and Texas municipal securities for the longer end. Our net interest margins decreased 4 basis points on a linked quarter basis to 3.35% during the third quarter. We believe that since a large portion of our loan growth occurred in the latter part of the third quarter and our loan pipeline for the fourth quarter looks very healthy. Combined with the changes we made in the securities portfolio during the third quarter by selling very low yielding CMO securities, the margins should hold during the fourth quarter or may improve, depending on loan growth. A couple of comments on non-interest expense. During the third quarter, depreciation expense, which is a part of occupancy expense, reflected a normalized level. During the second quarter, we made an adjustment of approximately $600,000. Reducing occupancy expense and non-interest income to adjust for the depreciation expense associated with the basis step up of the leased building we acquired in Fort Worth. This depreciation expense reduced that lease income. In addition, during the third quarter, we converted all of our debit cards to another processor and incurred approximately $400,000 in unexpected losses during a short period of time. The issue that caused these losses was corrected during the quarter. This amount has reflected in other expense. We are extremely pleased with the cost savings achieved as a result of the merger with OmniAmerican. Cost savings realized today have approximately 37.5%, have exceeded our initial projections of 30% to 35%. We have also undertaken a project to identify other operational efficiencies, cost containment opportunities and non-interest income revenue generating opportunities, which should be complete by the middle of 2016. I will now turn the call over to Sam.

Thank you for joining us this morning. As Lee just outlined, we have good news to share this quarter. We're very pleased with the 10.8% annualized loan growth during the third quarter. Our Fort Worth and Austin markets are doing exceptionally well and we continued to see strong quality loan demand from both of these markets. Our East Texas market continues to grow at a more measured pace and loan demand there remains good. With the pace of the indirect auto portfolio roll off slowing and the rate at which the loans we have committed are now funding, we believe annualized double-digit loan growth could be sustainable well into 2016. Our third quarter loan growth was driven by a $46.6 million increase in construction loans, a $36.3 million increase in commercial real estate loans and a $5.9 million increase in municipal loans. Several of our construction loans have long-term leases from a highly rated national tenants as collateral. The growth experienced in both construction and commercial real estate loans is diversified among our market areas. Our merger with OmniAmerican was approved in December 2014 and our systems conversion was completed in March of this year. As with most bank mergers, we have made systems selections across the bank and through the hard work of our dedicated staff, it was a relatively smooth transition, completed only four months after closing date. Basically, the merger transaction is complete and has gone far better than expected. Again, it was hard work by North Texas and East Texas teams that have made the transition go so well. Not perfect, but awfully close. We knew there were significant synergies and a similar credit culture from the start. And through this integration process, a true partnership has emerged as we worked closely together and analyze the various expenses and the appropriate centralization of several functions. We continue to fine tune processes to ensure quality customer service as well as a focus on additional efficiency. We are focused on loan growth with a long-term target of moving loans to comprise approximately 70% of balance sheet assets. It may well take 3 to 5 years to accomplish this, but we are beginning to see through progress. The indirect automobile portfolio we required in the recent acquisition of OmniAmerican continues to roll off and the total balance outstanding now is under $100 million. That roll off clouds our actual loan growth numbers and as far as what we believe is solid loan growth, especially over the past several months. Our target loan growth remains 10% to 12% annually. Fortunately, as Lee indicated earlier, our exposure to oil and oil-related industries is nominal. These are the Austin or the Fort Worth economies are centered in oil production or -- and as a result, we have seen no deterioration in either market due to the current oil pricing downturn. On the acquisition front, we anticipate beginning to look for opportunities in early 2016. Our focus market for an acquisition remains a triangle from Tyler to Fort Worth to Austin and back to Tyler. Our preferred target bank would be above $500 million in assets. At this time, we will conclude our prepared remarks and open the lines for your questions. Becky, if you would open the lines please.

[Operator Instructions] And our first line comes from Kevin Fitzsimmons with Hovde Group. Your line is now open.

Hey, guys, good morning.

Good morning.

Good morning.

I was trying to write down quickly. I just want to make sure I’ve got the street, the things Lee that you were going over that kind of lumpiness in some of the run rate. So I got that there were $400,000 of unexpected losses from this card system conversion, that's baked in other expenses that we should really pull out or think about pulling out for run rate when we are planning for next quarter. Is that right?

That's correct.

And then the second was this depreciation expense adjustment within occupancy costs, and so I didn’t get the amount on that. And is that something we pull out going forward or was that just something?

Okay. It looks like -- if you look at second quarter to third quarter, it looks like the expense, non-interest income, expense went up and really it’s just normalized, because if you look at the first quarter to second quarter, it went way down and it’s back up, but it's at a normalized level.

Okay. Great. That's helpful. Can you give us a little sense of your outlook on how we should think about provisioning going forward? So I mean, we’ve had -- I’m looking back over the last several quarters and we had number of quarters of elevated provisions, but that was mainly with indirect auto. I guess, it was a bigger piece of it and -- or subprime rather right. And then in second quarter, we had this big drop off and now we’re stepping up and the things that you outlined, I guess if we pull them out, but you're also thinking about much stronger loan growth. So I think we’re thinking about a provision maybe not as high as this quarter but definitely higher than last quarter just because of the loan growth you’re seeing. Thanks.

That's correct. With the loan growth we’re anticipating, we would -- it would certainly be higher than the second quarters of provisioning expense that the credits that we had to put additional reserves against are credits that we've been, one of them is credit that was from the merger that we had discounted fairly heavily coming in at the merger date. When we restructured it, we did need to put an additional reserve on it. And then the other one is the credit from first quarter. So it's not new credits that are popping up, it’s those two credits. So at this point, we believe the provision expense is going to be driven by loan growth.

Okay. And those amounts were like a $400,000 reserve for the PCI credit, $500,000 reserve for this non-accrual loan from first quarter and then everything other than that in the provision was really for loan growth for the most part this quarter?

For the most part, yes.

Okay. Just one quick last one. Sam, on M&A, when you say you’re going to start looking in early '16, are those conversations already happening and starting, and what's your sense on the willingness of sellers in Texas? I know there is still little bit of shock over the price of oil and I don't know whether that caused for activity or…

Yeah, I think there's probably a little bit of shock on the part of the bankers who are right now also. As you know, when we start looking, we kick a lot of tires. We anticipate that we will start that process in ‘16 we had not started yet. Obviously, our focus has been on the transition of OmniAmerican and as we've said it has gone very, very well but we will start to look. We realized there is not a lot going on in the market right now because of the oil situation I think. So we'll see what's out there. We made an acquisition in 2007. We made our second acquisition in 2014. I doubt seriously it will be seven years before we pull the trigger but we do kick a lot of tires. And we want to start looking because there may be opportunities and if there are, we want to be able to take advantage of that.

And when you -- you described that triangle when we think about it, is it really the potential targets be on one of the three points of the triangle or could it be any -- in the middle really?

Well, it obviously could be in the middle. And we could -- that's just kind of a basic triangle we use. We might slide outside of the triangle a little bit. But I doubt we had slide as far as Houston. We want to stay in that triangle if we can. We feel like that we're in probably two of the strongest markets in the country in Fort Worth and Austin. And so we don’t want to get too far away from that.

Got it. Okay. Thanks very much guys.

Thank you.

And our next question comes from the line of Brady Gailey with KBW. Your line is now open.

Hey good morning guys.

Good morning Brady.

Good morning Brady

I had a follow-up question on cost saving. So it sounds like the OmniAmerican cost saves were all realized as of today. Were those savings all reflected in the 3Q number like the 3Q expense base. If you strip out the couple of non-recurring things, it was a little under $26 million. Is that kind of good base to go into the end of year and into 2016?

I think so. I think it is. We have hired some new lenders in Austin. So that skews a little bit of the cost saves but that occurred during the third quarter. And they are already beginning to produce and book loans. So -- but yeah, I think that's a good number to use.

Okay. And then as you talk about now that OmniAmerican cost saves was behind it, you’re going to work on additional operational efficiencies, also cost containment opportunities and that should be done by kind of mid-next year. Is there anyway to quantify what the potential expense reductions could be from these additional initiatives or is it too early?

I think it's a little too early to quantify that. But we do believe that there are some nice -- and quite frankly a lot of it is revenue driven, we believe in non-interest income. So -- but that we think it’s a little too early to quantify that, probably be able to do that sometime in the first quarter.

Okay. And then Lee, so the margin guidance for the fourth quarter is kind of flat, maybe up a little bit. Any shot at, where we think the margin will be in 2016? You think it will still be in the top three 30 to 340 range?

I would -- I would hope that if loan growth continues at this double-digit pace that we should see the margins start to gradual decline during 2016 as the investments become a smaller percentage of the earning asset base and loans become a higher percentage of the earning asset base.

As that happens, the low loan growth, well we go to see next year on the double-digit basis but if you look at bond balances, you expect those to continue to fall as you see that loan growth come in?

I think that kind of remains stable for a while and then we’ll just -- we'll see what happens in the marketplace and that will really be more driven by what the market dictates as far as securities go. If the market dictates that we need to shrink the securities portfolio then we will. If we continue to have a really steep yield curve, we may hold the securities portfolio where it is.

Okay. Great. Thanks for the color guys.

And our next question comes from the line of Brad Milsaps with Sandler O'Neill. Your line is now open.

Hey good morning.

Good morning Brad.

Good morning Brad.

Just a couple of follow-ups, most of everything has been addressed but Lee, I had my notes that in addition to that, that $600,000 kind of reversal in depreciation expense you had last quarter, you also had a like adjustment to other income. Did you get that back this quarter or most of that just eating up with the decline in mortgage banking because I had both those sort of offsetting last quarter and just kind of curious if that was incorrect or if you didn’t make that back and kind of how to think about it?

It’s normalized also because basically the $600,000, $300,000 of it had to do with the first quarter and $300,000 had to do with second quarter because it was a basis adjustment on that building. In December that -- basically, we finalized during the second quarter. And so the non-interest income is basically in more normalized level in the third quarter as well.

Okay. All right. That make sense. And then just a follow-up, the tax rate, I know you’re one of the best at working the tax rate lower but it was even maybe a little lower than I thought you kind of thought that maybe it might be kind of high-teens with Omni fully loaded. You kind of still hear in these mid-teens number, what are you thinking going forward in the ‘16?

In ‘16, I’m thinking that we will be in the high-teens in ‘16, most definitely. The reason we’re in this mid-teens is really driven by the first two quarters when we have a lot of the merger costs still baked in and so that’s basically an annualized tax rate, it goes flows through all four quarters.

Okay. Great. Thank you.

And our next question comes from line of Michael Young with SunTrust. Your line is now open.

Hey, good morning, guys. Wanted to follow-up on Brady’s question a little bit on the balance sheet remix getting towards that 70% mix of loans. As we look at sort of a 10% to 12% loan growth next year, would you expect sort of the balance sheet growth or earning asset growth to be about half of that or do you think that it’s going to be higher, given what you said about holding the bond books steady?

Let me jump in and then Lee can jump in after me. But I think we're hopeful that we will be able to achieve double-digit loan growth. As we see the roll-off continue and with the way things have been moving the past several months, I think we have a good shot at seeing double-digit loan growth. With that, Lee, what are your -- any different?

No. I think, that's correct, and that's really where we’re anticipating that our growth is going to come from, unless something unusual happens in the marketplace. I don't really see asset growth coming on the investment side to any great extent. You may see a little bit. But we could also see some decline and it really just depends what happens to the investment environment.

Okay. And you have pretty good construction loan growth this quarter, I was just curious if you could provide some color around how much of that was existing loans that were funding up versus new relationships put on during the quarter?

A lot of it were existing relationships that we had committed back, lot -- some in the first quarter and second quarter that were just now -- they had put in their equity fundings and we're just now starting to fund those projects. I think, Sam mentioned, several of them are to -- have leases as collateral that from highly rated corporations. So there -- lot of the projects are very, very strong.

Okay. And just one last one, Lee, do you have the amount of the margin benefit this quarter from purchase accounting accretion or the dollar amount either?

Its right around 8 basis points and I can get to the amount but its right around 8 basis points.

Okay. That's fine. Thanks. That’s all for me.

[Operator Instructions] And our next question comes from the line of Brett Rabatin from Piper Jaffray. Your line is now open.

Hi, guys. Good morning.

Good morning, Brett.

Good morning, Brett.

Wanted to -- I joined in few minutes late, so you may have covered this, but just wanted to talk about the loan growth and get maybe a little more color if I could around just the construction loan growth. What kind of projects you guys are doing? And on the CRE side kind of what kind of top properties you're doing on that as well?

I think probably as we said, we’re working with some national firms, a lot of things that are coming out of the Austin market. We’re seeing a lot of flow I think to at Fort Worth. I think probably to talk about specifics as we see it, both of those markets have really shown the broadly the last few years. And so we are continuing to generate a lot of growth. Some of the projects are not necessarily in the state of Texas also, some of the projects may be outside of the state. So I don’t know if that really gives you the color you want. Lee, you may be able to amplify more on it.

I think most of the CRE projects are probably in the markets that we are in and we have strong LTVs, strong debt coverage ratios, things of that nature, fully leased, up good solid tenants, that type of thing. The only projects in terms of construction that we have I think outside the state of Texas are related to these national tenants that we have leases as collateral that if we told you name of the tenant, it’s someone that we all know and we’re very comfortable with. So those are the type of projects we are looking at.

Okay. And Lee on the commercial real estate side, would a lot of that be office, retail, what sort of -- maybe a little breakdown on the commercial real estate type?

It is really a combination of both. It is office and retail. We have a project down, I think in the Austin area, that is a retail project where HUD is an anchor tenant and it is a big retail center that is -- it’s a great project and it’s fully leased out and very successful. So, I mean it is a combination of both retail and office.

Okay. Great. Thanks for the color.

Thank you. [Operator Instructions] And we do have a follow-up question from Michael Young. Your line is now open.

Hey, guys. So, just one follow-up on the loan that moved to non-accrual in the first quarter. You took an additional mark this quarter. Does that sort of pretend that you're ready to move out on now, or was that an updated appraisal, can you give any color there?

It had to do with an updated, not so much appraisal but reevaluation of the collateral position and that was the reason for the additional provision expense.

Okay. Great. Thanks.

[Operator Instructions] I’m not showing any further questions at this time. I would now like to turn the call back over to Sam Dawson.

Thank you, Vickie. We’d like to thank you for being on our first earnings call today. The earnings are beginning to fall into places we had hoped. Our loan growth has started to ramp up and we expect it will continue. The merger is, in reality completed and it was far smoother than we anticipated. Asset quality is a strong. We operate in two dynamic markets and one very stable solid market. The fourth quarter looks promising and we are excited about 2016. See you soon and thanks again for joining us.