Southside Bancshares, Inc. (SBSI) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Southside Bancshares, Inc. Second Quarter Earnings 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 call is being recorded. I would now like to introduce your host for today's conference, Ms. Deborah Wilkinson, Executive Vice President of Investor Relations for Southside Bancshares. Ma'am, you may begin.

Thank you, Sylvia. Good morning everyone and thank you for joining Southside Bancshares' second quarter 2016 earnings call. The purpose for this 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. During today's call and in other discussions -- excuse me, disclosures and presentations, I will 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' second quarter 2016 results are Sam Dawson, our CEO, and Lee Gibson, our President. Our agenda today is as follows. First you will hear Lee discuss an overview of financial results for the second quarter of 2016, including loan activity, oil and gas exposure in our loan portfolio, an update on our securities portfolio, and an update on our cost savings. 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' 2016 second quarter earnings call. We had a solid second quarter, with net income of $11.4 million. Our diluted earnings per share for the second quarter ended June 30, 2016, were $0.43 per share, an increase of 2.4%, compared to the same period in 2015. Our diluted earnings per share for the six months ended June 30, 2016, were $0.94, an increase of 22.1%, compared to the same period in 2015. On a length quarter basis, we reported a $59 million decrease in loans. This was primarily driven by payoffs in our commercial and construction real estate loan portfolios and the continued roll-off in the indirect auto portfolio of $12 million. In addition, we charged off $10.6 million associated with two commercial loans that comprised approximately 62% of our nonperforming loans at March 31, 2016. Despite the decrease in loan balances during the second quarter, we continue to believe we will experience solid loan growth during the balance of 2016, based on our existing pipeline of approved, unfunded loans, the loans we have already booked in July and loans currently expected to close in the very near future. At June 30, 2016, our loans with oil & gas industry exposure remain very minimal, at 1.2% of our loans. At June 30, 2016, $5.7 million of our oil & gas industry loans were classified substandard, with a 4% reserve. We did not have any oil & gas loans in nonaccrual status at quarter end. Loan loss provision expense during the second quarter was $3.8 million, virtually all of which was related to the two large impaired commercial loans that had been charged down to reflect the estimated net selling price of the remaining assets. We currently anticipate cash sales of these assets in excess of $8 million related to these two loans prior to the end of the third quarter. During the first half of 2016, nonperforming assets decreased $8 million, or 24.5%, to $24.5 million, and the ratio of our nonperforming assets to total assets decreased to 0.49% at June 30, 2016, from 0.63% at December 31, 2015. Next, I will provide a brief update on our securities portfolio. At June 30, 2016, we had a net unrealized gain in the securities portfolio of $85 million. The duration of the securities portfolio at June 30 had decreased to 4.52 years, compared to the prior quarter's duration of 4.8 years. And the average yield of the securities portfolio increased 1 basis point on a linked quarter basis. We anticipate continuing to utilize a barbell approach for our security purchases using U.S. agency CMOs for the short end and treasury notes, agency commercial mortgage-backed securities and Texas Municipal securities for the longer end. During the second quarter, our net interest margin decreased 16 basis points to 3.35%, and our interest spread decreased 16 basis points to 3.24% on a linked quarter basis. Eleven of the 16 basis points of this decrease were related to the $1.3 million, one-time interest income in the first quarter associated with the long-time, nonaccrual loan payoff. The remaining 5-basis-point decrease in our net interest margin and spread on a linked quarter basis was due to a decrease in the average loan balance and an increase in our cost of funds. Cost containment efforts came in above expectations during the second quarter. We anticipate cost containment initiatives that we are currently implementing will result in additional cost savings in future quarters. I will now turn the call over to Sam.

Thank you, Lee. The second quarter saw earnings improve 2.1% over last year, and six-month earnings jumped 21.3% over the first six months of 2015. The Company showed solid performance by almost any measure, primarily due to increasing revenues and improvements in expense control. Net loans were down from year end, but we experienced basically the same pattern in 2015. During the second half of 2015, loans exploded and, while we do not expect the 11.5% growth of last year, we still anticipate loans will expand in the 7% to 9% range for this year. The pipeline is on track. Patience is our watchword. We have been here before. We continue to experience improvement in our expense control. Efforts to improve procedures and streamline our operating processes are now beginning to pay real dividends. Our efforts are not complete and will continue through the remainder of the year as we target our efficiency ratio in the low 50s. Overall, we are poised for strong performance in the second half of 2016. We believe that loan growth will materialize and our focus on expense control will continue to provide a positive impact on the bottom line. The fact that the Texas economy has shown resilience, coupled with a slight stabilization in oil prices, bodes well for the Company. Our outlook for 2016 is very promising. At this time, we will conclude our prepared remarks and open the lines for your questions.

[Operator Instructions] And our first question comes from the line of Brady Gailey of KBW. Your line is now open.

Hey, good morning, guys. Could you just start off and give a little more color on these two nonperforming loans that are going through the foreclosure process? Maybe what they are and what exactly is going on there?

They are -- one is a loan that we acquired in the merger. The other loan is a loan that's been on nonaccrual for a little -- probably a year and a quarter. Both of them matured during the quarter and we have dealt with them, basically, through foreclosures and we are in the process of selling the assets. We have a contract on one of them and we have a letter of intent on the other one, the assets, and we anticipate, assuming everything goes as planned, that these will sell at August. And this will take care of 62% of the nonperforming loans that were on the books in March, and there really aren't any other major credits that we see at this time. And that was basically the impetus behind the reserve that we had put out there in the second quarter.

Yes, I think that's one of the reasons that we are positive about the second half of the year, Brady. We felt like we've dealt with our problem children. Right now we see clear sailing. We're anticipating that loan growth that we saw last year. It's a little frustrating that it doesn't come exactly when we want it to, but we know that the funding's will come. A lot of the loans that we've approved have a large equity portion that has to go in before they start to draw, and so we feel like that the second half offers some real potential for us.

I mean, we've already seen close to half of the decrease in the loans in the second quarter have already funded up in July and then we have a large loan that is supposed to fund on Monday that will put us back almost on track with where we were at March 31.

Okay. So the two loans that are being sold, are those commercial real estate loans? What type of loans are those?

They're both commercial loans.

They're both commercial loans. Okay. So not necessarily CRE, but…

They were not CRE loans; they were both commercial loans. And one of them was an acquired loan and one of them was a loan that we made several years ago.

And they're not energy related?

They are not energy related.

Okay. And then I'm trying to figure out the math. I think I backed into these two NPLs being around $13.6 million at the end of March, so you're going to sell them for at least $8 million, so that leaves a delta of around $5.6 million? While your net charge-offs were $10.6 million. I'm just trying to figure out the difference there.

No, these were around $20 million if I am -- Is that correct? One of them was around $13 million roughly and the other one was around $7 million –

Alright then

And we had reserves built up on them, the one we acquired we had you know to purchase accounting had charged down pretty heavily.

So as a result of that the reserve is now 63 basis points, which creates a little I know you have OmniAmerican market still out there which will push that ratio up but have -- how do you pick the reserve trends from here we think we see kind of a notable climb back up to 1% over the next few years?

You know with the -- with the Omni discount I think it's up closer to 77. And you know we have a little over I think it's spent $280 million or $292 million of municipal ones out there that we keep a reserve about 0.25 because we've never had a loss on any of those. So that brings that reserve down, we have a fairly large wonderful family home loan portfolio that reserve is not sitting at 1% so when you look at the size of the types of loans that we have out there in the risk profile, it doesn't necessarily you know generates an overall 1% reserve. But yes I mean eventually will the preserve will build back up soon. I know the reserve we believe is adequate.

Okay that is helpful, just last for me you're talking about the cost containment effort, can you maybe just quantify how much it cost savings you think will be realized if you look at the expenses and the core expenses in the second quarter I think they were around $25.1 million on your head, how much how much lower where you go there?

It's tough to say exactly you know how much lower it's going to go but there are more things that that they were working on there and then some of its going to happen through attrition over time, there's additional grant a cost control that is going to occur. There are number things that are rolling all over the balance of this year. So I think there's room for probably another at least maybe $0.5 million a quarter, if not if not maybe as a little bit more.

But I think one of the things that we had always said is that we really wanted to see our efficiency ratio might be in the mid fifties

Right

And I think now we have brought it down to the lower fifties and I think that certainly is something we've attained and something we should be able to hold, and who know it might get even lower. I mean I don't think we got anything radical on the line at this point, but again there are still measures out there that I think will prove fruitful to our bottom line.

And I'm forgetting the fact that we also had the of professional fees associated with the consultants that we want you know we won't be playing at that level, and on a go forward basis either. So you know the expenses are going to continue to come down.

Alright great, thanks for the color guys.

Thank you our next question crescent Brad Milsaps of Sandler O'Neill. Your line is now open.

I just want to follow up on the larger of the of the two credits at my notes that and I need to work with this guy for a while you've been trying to keep the business going you got a fair amount of I think marketable securities -- any kind of what pushed it this quarter to kind of go ahead and move it out of the bank and into -- you have any prospects of any significant recovery there?

And basically what happened was we started seeing a lot of additional losses in this quarter that he was having that were unusual in nature. And so his projections just were coming to fruition and the losses were significantly greater than what they had been in the past. And so we just decided not to renew and to work out a friendly foreclosure within and liquidate the assets and sell them. It was we just -- we decided to do that before we ended up with virtually nothing.

So what we see today there's not a personal -- not like anything else to pursue it's kind of what we see today.

Now what we see today is where we are, there's really nothing to peruse, he has -- he put in several million dollars themselves, I don't know I forget the exact amount but probably is $7 million or $8 million. And there really wasn't anything to pursue.

Got it, thank you.

And we did have we did have marketable securities and we've liquidated those.

Sure okay great then maybe just turn the margin a bit. can talk a little bit about what you're seeing their potential for -- obviously with the loan and coming down what that's going to mean for the -- and if you think about any kind of CMO premium amortization, I know you guys don't -- but maybe as many of those but just kind of curious how you are thinking about the margin over the next couple quarters?

Fortunately of biggest part of our mortgage-backed securities portfolio or in the commercial mortgage-backed securities and locked out CMOs. So they -- our amortization expense isn't really going to be that volatile going forward, because the MBS portfolio is such a huge percentage of the mortgage-backed securities portfolio is probably two-thirds to maybe 75% of that mortgage-backed securities portfolio, so it's just locked in there and it's not going to move, that's what driven the appreciation in the securities portfolio and kept the duration where it is.

Okay, really just get back to you if the loan growth does -- does show up you should get -- just some expansion just from exchange.

Yes, that is correct.

Okay. And then just kind of housekeeping tax rates a little bit of a moving target, did you take kind of near 20% is kind of where you think you'll be or can you can you work some of your magic to push that lower?

It's probably going to be near 20%, we may buy some additional municipals, but I think probably near that 20% I don't think we're going to push it a whole lot lower we may get it down the 19% but it's probably close to that 20%.

Okay, great. Thank you.

Thank you. Our next question comes from Kevin Simmons of Heby Group [ph]. Your line is now open.

The last few calls you guys have spoken about being a little more open and on the lookout for M&A opportunities, can you just give us an update there, just in terms of how -- what pieces of conversations? What the seller pricing expectations? What you think -- how realistic you think it is that you guys would find something over the balance of this year into early next year?

The basic conversations definitely picked up, we are definitely hearing form -- from more folks that have an interest. Pricing expectations it's kind of all over the board, some people's pricing expectations are unrealistic, others are realistic obviously those that are more what we would consider realistic were, the conversations we're more interested in. And so where our currency is and the markets that some of these folks are in, we're actively considering and there's a possibility if everything makes sense.

And, Lee, by geography it's still really anywhere from Tyler over to Dallas, Fort Worth to Austin, those are the main focus areas?

That would be the main focus area most definitely.

Okay, great. Just a quick follow up on fee revenues, just how we should look at that run rate this quarter about $8.6 million. I know there was a pretty steep drop in other fee revenues, but that looked kind of in the high side last quarter. So if you could address that.

We did have, there was about $130,000 we had in fee income or it was a gain in the first quarter on one of our investments, CRA Investments that they came back and said that it really wasn't a gain like in the second quarter. So we had to reimburse that so that would have come out of the first quarter really and it had to come out in the second quarter. Other than that it's just things that we had in the first quarter that didn't repeat in the second quarter.

Okay, got it. One last one; it seems to be a growing topic these days, CRE concentrations, CND concentration, related to those guidelines from the regulators. You all have screened above that level on CND. Just wondering, number one, do you still screen above that? Number two; is that a relevant issue to you all? Is it something where you feel you need to tap on the brakes a little or is it simply the regulators come in and check under the hood a little more diligently and you guys have passed that test?

Right now we screen on construction, at that level, and just a hair above it. I think we're at 105 on construction. But when we run our cash flows by Christmas, if we didn't approve any more construction we'd be way below it. So we feel like we can continue to make construction commitments because they typically don't fund for quite some time. The regulators have been in, they have looked under the hood and as long as we're not -- 150 or something like that, I think they're comfortable. On CRE we're way below the limits, so there's no issue there.

Okay, thanks.

Thank you, and our next question comes from Michael Young of SunTrust Robinson. Your line is now open.

Hey, good morning, guys.

Good morning, Michael.

Wanted to ask you've kind of, as you mentioned have this sort of more seasonal loan growth the last two years, backend weighted. Do you expect that going forward again kind of next year and in the perpetuity? Are you making any adjustments to kind of even that out as we go forward?

No, we honestly don't know why that's occurring. It just seems to have occurred. Last year it all happened in the last four months of the year. It's not something we certainly plan. Once again it seems to be happening again this year. Hopefully it's not going to be the last four months. It looks we have had some good long growth in July, and it looks like we're going to have good long growth in August. So hopefully it's the last six months of this year. But no, it's not something we're anticipating. It's going to be a repeat every year, but I can't guarantee that.

Yes, we're not planning that by the way. It seems to occur that way. So we can't explain it, and we don't like it much either.

That's not our game plan.

That's fair, and then just wanted to see, are there any areas given sort of the focus on CND and CRE, I understand your concentration levels and where they are, but if maybe CND were to, need to kind of slow or cool a little bit are there other areas that you're investing for growth down the line, in terms of hiring or new producers, that sort of thing?

We continue to hire lenders of all types because our buckets really aren't full anywhere except on the construction side, and the construction side usually it converts pretty quickly to regular CRE. So we're hiring loan officers that have good books of business, better seasoned, quality loan officers in all of our markets because they're all strong, very healthy, vibrant markets. So we're open for business and looking for strong quality loan officers in all the markets.

Okay, great. And just last one, and this maybe seasonal in nature but the non-interest bearing deposits were down a little bit this quarter. Just curious if any ship there in terms of classifications or was it just kind of smooth draws this quarter?

That was driven a lot by, we have some public fund deposits and there were some drop-offs in some of the public funds deposits, and their fiscal year-ends are usually September 30, so it could be driven by their budgetary situations as they come to the close of the year, and I did not know that.

So it's not accounts, maybe someone else bidding higher for those public funds, just flows of their...

It could be that also, because we're not out there trying to bid up on different types of funds.

Right, okay.

We don't see rights going up anytime soon.

Fair enough. You've been right so far. Thanks, guys.

Thank you. Our next question comes from Brady Gailey of KBW. Your line is now open.

Hey, thanks. I just have one or two more. I was picking a pass; you have had a little bit of your accretion, close to the margin. I was just wondering what that number was in 2Q?

Are you talking about purchase accretion?

Yes, just the accretable yield from Omni American and the benefits March. I think it's been running maybe it was $1.2 million last quarter. Wondering what that was in 2Q?

It was $1.3 million this quarter, Brady.

Okay, thanks. And then one more question on these two loans. What cities were they in? I'm guessing the one acquired from Omni American was in Fort Worth. What cities were these loans in?

Actually the one acquired from Omni was, I believe it was in the outskirts of Dallas, in Rockwall, and the other one was in Houston. It was a car dealer.

All right, great. Thanks guys.

[Operator Instructions] And at this time I'm showing there are no further participants in the queue. I would like to turn the call back to the management for any further remarks.

As I said quality is strong, while loan growth has been late to the party. We still anticipate 7% to 9% loan portfolio growth for 2016. We expect 2016 to be an exceptional year. Thank you for joining us today.

Ladies and gentlemen, thank you for your participation on today's conference. This concludes your program. You may now disconnect. Everyone have a great day.