Southside Bancshares, Inc. (SBSI) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Southside Bancshares, Inc., First Quarter 2018 Earnings Call. Currently 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] Also as a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Suni Davis, Senior Vice President of Chief Risk Officer. Please go ahead.

Thank you, Jalam. Good morning, everyone, and thank you for joining Southside Bancshares' first quarter 2018 earnings call. The purpose for this call is to discuss the Company's results for the quarter as well as 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 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' first quarter 2018 results are Lee Gibson, President and CEO; and Julie Shamburger, Senior EVP and CFO. Our agenda today is as follows. First, you will hear Julie discuss an overview of financial results for the quarter, including loan activity, asset quality, and update on our securities portfolio and non-interest expense items for the quarter. Then Lee will share his comments on the quarter, including the core conversion completed over the weekend to integrate Diboll State Bancshares Inc., as a result of the November 30, 2017 merger. I will now turn the call over to Julie.

Thank you, Suni. Good morning, everyone, and welcome to Southside Bancshares’ first quarter 2018 earnings call. We reported first quarter net income of $16.3 million compared to first quarter 2017 net income of $15 million and 8.4% increase. Our diluted earnings per share for the first quarter ended March 31, 2018 were $0.46 per share a decrease of $0.05 or 9.8% compared to $0.51 per share for the same period last year. During the first quarter we experienced only a slight increase in total loans at $15.3 million on a linked quarter basis due to higher than anticipated payoffs. When compared to March 31, 2017, total loans increased by $770.7 million or 30.4%, approximately $621.3 million of the annual growth was a result of loans acquired in the acquisition of Diboll State Bancshares last quarter. At March 31, 2017 our loans with oil and gas industry exposure remain minimal at 1.66% of our total portfolio. We recorded loan loss provision expense during the first quarter of $3.7 million an increase of $2.5 million compared to provision expense recorded in the fourth quarter. As reported earlier today in our earnings release the higher first quarter provision expense was a result of two commercial real estate loan relationships that were placed on non-accrual status. Non-performing assets increased $42.4 million or 0.67% of total assets during the quarter ended March 31, 2018, an increase of $32 million compared to $10.5 million or 0.16% of total assets at December 31, 2017, and $14.1 million or 0.25% at March 31, 2017. Next, for a brief update on our securities portfolio. On a linked quarter basis the size of the securities portfolio decreased $220.1 million during the first quarter primarily due to the sales of lower yielding CMOs and lower yielding short duration agency debentures. The duration of the securities portfolio in March 31, 2018 increased to 5.3 years from 4.8 years at December 31, 2017 due primarily to the sale of the agency debentures. At March 31, 2018, we had a net unrealized loss in the securities portfolio of $48.6 million. Primarily as a result of the decrease in the securities portfolio this quarter and the loans acquired last quarter, the mix of our loans and securities increased to a 60-40 mix compared to a 57-43 mix at year end, and a 52%-48% mix at March 31, 2017 moving closer to our long range goal of 70-30. During the first quarter, our net interest margin increased 7 basis points to 3.19%, and our net interest spread increased 4 basis points to 2.95% on a linked quarter basis. The increase in both the net interest margin and spread were primarily a result of a full quarter of purchase loan accretion from the Diboll portfolio, which positively impacted the average yield on our earning assets. We recorded $1.2 million of loan accretion this quarter higher than we expect on a recurring basis due to the early payoff of three purchased impaired loans resulting in approximately $329,000 of accretion. January 1, we adopted the accounting standard related to revenue recognition. In connection with the adoption of this guidance, we netted debit card expense of $796,000 previously included in ATM and debit card expense with deposit services income, and we also netted brokerage service expense of $151,000 previously included in other non-interest expanse with brokerage services income. Due to the guidance under the modified retrospective method, prior periods have not been adjusted and are not comparable. During the three months ended March 31, 2018, our non-interest expense increased $1.7 million or 5.8% on a linked quarter basis, primarily due to a full quarter of operational expenses associated with our acquisition late in the fourth quarter of 2017 and several other expense items recorded in the first quarter. These additional expenses include acquisition expanse of $832,000 in connection with our acquisition last quarter, consisting of $652,000 of change in control, payment accruals, and severance payments, and the remaining $180,000 included additional professional fees. We also paid one-time $1,000 bonuses to certain employees in response to the benefits received from the Tax Cuts and Jobs Act totaling $744,000. $249,000 of cost related to the close of the grocery store branch within very close proximity of a branch acquired in the Diboll acquisition, and $827,000 of losses on the sale of securities in the first quarter. Our amortization expense increased due to the additional intangible assets recorded last quarter in connection with the acquisition and a full quarter of amortization compared to only one month recorded in the fourth quarter related to the additional intangible assets. On a linked quarter basis, our efficiency ratio increased for the three months ended March 31, 2018, up 1.86% to 51.28% for the first quarter of 2018 from 49.42% for the quarter ended December 31, 2017 and decreased from 51.60% for the quarter ended March 31, 2017. We expect to see additional efficiencies in future quarters as we complete the integration in Diboll. The effective tax rate for the first quarter of 2018 was 11.4%. We recorded a discrete tax credit of $88,000 associated with equity awards that decreased the rate by 48 basis points. At this point, we expect an effective tax rate for 2018 of approximately 12%. Thank you very much. And I will now turn the call over to Lee.

Thank you, Julie. Overall, we experienced a good first quarter. Our net interest margin increased 7 basis points and our efficiency ratio decreased compared to the first quarter of 2017 despite the significant reduction in the corporate tax rate that negatively impacted both. As Julie reported, provision expense and non-performing loans increased during the first quarter. This was driven by two commercial real estate loan relationships, one of which was an acquired loan relationship in our 2014 acquisition. We are not wavering on our underwriting standards and we believe our asset quality remain solid. This last weekend, we completed the core conversion related to the Diboll State Bancshares acquisition. We are pleased with how smooth and seamless the integration has gone. With the integration now virtually complete, we expect to realize additional synergies and cost savings. Diboll’s outstanding acquired deposit franchise was a significant factor in the linked quarter improvement in net interest margin and spread. The decrease in the securities portfolio during the first quarter mostly through the sale of lower yielding securities provides additional balance sheet flexibility in this higher interest rate environment. This additional flexibility and the resulting increase in loans as a percentage of our earning assets to 60% combined with the Diboll acquired core deposit franchise should enhance our future NIM prospects as the anticipated Fed interest rate increases occur. We will continue to focus on cost containment and process improvement in an effort to further improve our efficiency ratio. At this point, we believe the two areas that will yield the greatest future efficiencies are further process automation and continued right sizing of our branches. Economic conditions in the Texas markets we serve remain healthy. The Austin and DFW markets yield primarily by ongoing job growth and company relocations continued to perform exceptionally well. We are excited about our prospects for 2018 given the completed integration of the newly acquired balance sheet, benefits associated with the reduced corporate tax rates, the dynamic markets we serve, our solid balance sheet, strong capital position, and outstanding team members. At this time, we will conclude the prepared remarks and open the lines for your questions.

Thank you, sir. [Operator Instructions] Our first question comes from Brett Rabatin of Piper Jaffray. Your question please.

Hi, good morning everyone.

Good morning, Brett.

Wanted to – I guess first asked on the one credit that was memory care related. Is that a – is the weakness there a function of Medicaid or can you give us any color on kind of what happened with that credit?

They basically the two facilities just have not least as they anticipated. They are continuing to lease up, but they're not at the stage where they thought they'd be at this point in time. So we felt it appropriate to go ahead and place them on non-accrual and put some reserve against them. But they are continuing to show some improvement on a quarterly basis and that's why we said we reevaluate that on a quarterly basis.

Okay, and then I'm just curious, you obviously had higher payoffs than you expected this quarter and that kind of affected the loan growth. Can you talk maybe a little more, Lee about the pipeline and just you've been a faster growth bank here the past year, is that still on track? What might you give for guidance for loan growth kind of on an updated basis?

Our pipeline looks healthy. The issue is we continue to see some payoffs are going to be coming down the road in the next several quarters. Some of the construction projects have completed and some of those are going on the market. So the pipeline is healthy, but we do anticipate some further drag as a result of payoffs.

Okay, so if I'm thinking about growth for the year is in single-digit appropriate or is that going to be kind of tough given the level of payoffs you’re expecting?

I'd like to think that mid single-digit is still achievable. Instead of seven it may be closer to five, but we do have a healthy pipeline. We do have some construction loans that are going to starting to fund up right now. So there are a lot of positive things that are happening and it really just depends, Brett on the level of payoffs that we see during the year.

Okay. Fair enough. I appreciate all the color.

All right. Thank you.

Thank you. Our next question comes from Brad Milsaps of Sandler O'Neill. Your question please.

Hey, Good morning.

Good morning, Brad.

Hey, Julie, just maybe on the expenses I know it sounds like you have a lot of moving parts this quarter between the re-class and some of fees and expenses? Can you kind of just you mention the additional synergies maybe in dollars? Can you talk about where you think expenses will sort of run over the near-term?

Well, if we look at the re-classes that we had and we’d estimated around 32 for the run rate and if you take all the noise out, we would come out of about 30 – and with the re-class the expense that we re-class that to deposit services income that I mentioned. We would have been around $30,000,789 and that does include the one-time bonuses that was around $744,000 in a branch closure. So right there's $1 million, we're thinking - we talked a little bit about that yesterday 30 to 31 probably. And we would expect it to go down further as your progresses probably more in the third quarter even. We'll have some expense related in the second quarter probably to conversion, additional travel and just all the expenses that come along with that function. So we’re thinking somewhere in the 30.8 range to 31 probably.

Okay. That's helpful. And I was writing quickly during your kind of discussion of all the movement in the balance sheet with the bond portfolio? Can you give us a maybe a little additional color and I apologize if I miss this kind of what drove the big change between the label for sale and the elder maturity, it look like you kind of swapped one for the other? Just kind of walk you through kind of what you're thinking there and kind of the relative size that bond portfolio. It sounds like you want to continue to bring that down, but I always try to get all the moving parts rate with that?

Right there was a new accounting for announcement that allowed us to transfer some things. Transfer anything out of HTM that we wanted into AFS and we felt like with the changing interest rate environment it made sense for us to move some of the – a lot of those items out of HTM to AFS. So that we can restructure the securities portfolio as we deem appropriate in this in this higher interest rate environment right now. So that's what drove that. And it basically we transferred $740 million in securities out of HTM to – and they were all callable securities at our HTM to AFS.

Got it, would you anticipate you would have more kind of wholesale restructuring going on over the next couple quarters or is it just kind of a more of a wait and see and you have the flexibility if you get the right environmental raises?

Yes, I think it's more of the wait and see in case it's dependent on the interest rate environment. We're actually glad to see interest rates move up and that's one of the reasons we saw a lot of securities and about half of that was in the first month of this first quarter. So we do feel like we have a lot of additional flexibility and hand we're going to continue to look at potential restructuring going forward.

Okay, great. Thank you.

Thank you. [Operator Instructions] The next question comes from Brady Gailey of KBW. Please go ahead.

Hey, good morning guys.

Good morning.

Good morning.

So it sounds like one of the CRE loan was probably in Fort Worth from the OmniAmerican deal. But what was the geography of the other CRE loan?

The geography of the other CRE loan is in Little Rock.

Okay. So that's obviously outside of your home markets. So is that – how did you get Little Rock exposure?

It's actually participation and what ended up happening was in the – I guess it was in January or February, I can't remember which month it was Toys “R” Us announced that they were going to be closing all their locations in the United States and it had a Toys “R” Us combined with the Babies"R"Us and basically they invest in the debt service coverage – covenant ratio, and so we felt it appropriate to put it on non-accrual status.

So it's participation, so that was a shared national credit own?

That is correct.

Okay, what's the balance of your total shared national credit portfolio?

Just one second, I’m – Brady, we're going to have to get to that number. It’s not that significant. There's not a lot of it.

Okay. All right and then…

And that particular line is $13 million.

All right and then so accretive yield was $1.2 million this quarter. I know you had $330 million roughly that was kind of unexpected. So you backed that out that's around $900,000. Is that absent any sort of one-time payoffs that might push that number up. Do you think $900,000 is around a good run rate for your accretion for the next few quarters?

And I was looking at the Omni accretion. It's gone down, but it's pretty flat the last three quarters. It went – it only went down around $9,000 this quarter from the fourth quarter. So I expect it to trickle down a little bit more. But overall I do think between $8,000 and $9,000. There will be the payoffs and there's just no way to predict those at this point. Well at any point actually. And that I do think that's reasonable.

Okay. I then said if you just the one point two million out of the reported margin that take sure kind of core margin down to around $311,000. So how do you think your core margin trends for the next few quarters? Is there – do you think the bond book will continue to go down that remix will continue to happen and the core margin could see some additional lift from this level?

Hi, Dave, I think there is potential for some additional lift especially given the fact that the Fed’s planning on raising interest rates at least two more times this year.

All right. Great. Thanks for the color guys.

Thank you.

Thank you. Our next question comes from Brian Zabora of Hovde Group. Please go ahead.

Hi, guys. Good morning.

Good morning.

Just a question on fee income, how much of the reclassification legally impacted the – where you did impacted the fee income this quarter?

Well, the total was around $950,000, $796,000 was related to debit card and $151,000 was related to brokerage services. So our deposit services still increased, if you look at the year-over-year and that's a result of having the acquisition largely and then the brokerage services even with the – you will notice that it decreased because of the netting, but if you add back to $151,000 essentially to that, you'll see an increase because the prior periods do not have it netted out. And that should be fairly – I would expect that to be fairly consistent. And this was our first full quarter with Diboll and activity in it. We just had one month of activity in the fourth quarter, so probably we will be able to have a better feel for what that run rate on the debit card expense will be after another quarter.

Understood. And then just maybe all of those payoffs that you have this quarter, maybe just give a kind of the percentage wise, can you give us a sense – give us a sense on how was the magnitude of the increase that you saw this quarter versus last or maybe year-over-year?

The magnitude of the payoffs?

The loan book is bit higher this quarter.

Gosh, I'd have to go back to fourth quarter and see what the payoffs for them, but I do think we did experienced higher payoffs this quarter than we did in the fourth quarter, and certainly higher than what we had in the third quarter last year, but I’d have to go back and check the exact dollar amounts.

Do you think you still have kind of payoff activity kind of going forward or do you think it slows a bit or it’s still kind of hard to determine at this point?

It really is hard to determine. The two markets that we've lend a lot of money into the Austin, and the DFW markets continue to be very, very healthy and there's a lot of continued sales of different properties that take place. And as I tell the loan officers, we agonized over, they are going to payoff, and then we get upset when they do payoff. So it's just part of a healthy economy I think that we are experiencing payoffs.

Great. Well thanks for taking my questions.

You bet. End of Q&A

Thank you. I show no further questions in the queue at this time. I’d like to turn the call back to Lee Gibson, President and CEO for closing remarks. Please go ahead sir.

Thank you. We believe Southside is well positioned for the future and look forward to reporting the results for the remainder of 2018. Thank you for being on the call today and we look forward to hosting our next earnings call in July.

Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect. Good day.