Hello, and welcome to Southside Bancshares, Inc. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Lindsey Bailes, Vice President of Investor Relations. You may begin.

Thank you, Tawanda. Good morning, everyone, and welcome to Southside Bancshares' third quarter 2023 earnings call. 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 are subject to risks and uncertainties. Factors that could materially change our current forward-looking assumptions are described in our earnings release and our Form 10-K. Joining me today are Lee Gibson, President and CEO; and Julie Shamburger, CFO. First, Lee will share his comments on the quarter, and then Julie will give an overview of our financial results. I will now turn the call over to Lee.

Thank you, Lindsey. Good morning, everyone, and welcome to Southside Bancshares' third quarter earnings call. This morning, we reported net income of $18.4 million, earnings per share of $0.60, a return on average tangible common equity of 13.17%, and continued strong asset quality metrics. During the quarter, we recorded a provision for credit losses of $7 million, due primarily to increased concerns reflected in the CECL economic forecast related to the commercial real estate market and repricing risks associated with the overall higher interest rate environment. Linked quarter, we experienced loan growth of $91.6 million and deposit growth of $231.9 million. Our deposit growth was driven by higher-cost public fund deposits of $265.8 million from two of our contractual municipalities. These higher-cost deposits combined with overall higher funding cost pressure were largely responsible for the 15 basis point decrease in linked quarter in our net interest margin. During October, we swapped an additional $100 million to help mitigate further funding cost pressures. Our current loan pipeline is less robust than earlier this year. However, we still anticipate that we will end the year with high-single-digit loan growth. The markets we serve remain healthy and continue to grow and perform well. I look forward to answering your questions following Julie's remarks. I will now turn the call over to Julie.

Thank you, Lee. Good morning, everyone. Welcome to our call. We reported third quarter net income of $18.4 million, a decrease of $6.4 million on a linked quarter basis, and diluted earnings per common share of $0.60, a decrease of $0.21 or 25.9% linked quarter. We had loan growth of $91.6 million or 2.1% linked quarter, driven by a $63.2 million increase in construction loans and a $17 million increase in commercial real estate loans. The interest rate of loans funded during the quarter was on average approximately 7.6%. As of September 30, our loans with oil and gas industry exposure were $102 million or 2.3% of total loans. Our allowance for credit losses increased by $6.1 million for the linked quarter to $45.6 million. The increase was driven by our loan loss provision of $6.3 million and a provision for off-balance sheet credit exposures of $0.6 million for the third quarter, and when combined, increased $7.1 million from prior quarter. The increase in provision was driven by the increased economic and repricing concerns forecasted in our CECL model. Asset quality metrics remain strong with non-performing assets of $4.4 million or 0.5% of total assets on September 30. On September 30, our allowance for loan losses as a percentage of total loans was 0.94%, an increase compared to 0.84% at June 30 due to the increased provision. Our securities portfolio decreased $4.8 million or 0.2% on a linked quarter basis. There were no transfers of AFS securities during the third quarter. On September 30, we had a net unrealized loss in the AFS securities portfolio of $137 million compared to $69.7 million last quarter, an increase of $67.3 million, primarily in the municipal securities portfolio due to higher interest rates. As of September 30, the unrealized gain on the fair…

[Operator Instructions] Our first question comes from the line of Brady Gailey with KBW. Your line is open.

Hi. Thank you. Good morning, guys.

Good morning.

Good morning.

So the margin is still above 3%, but, you know, it keeps moving down every quarter. How - when do you think we're going to hit the bottom on the net interest margin? Do you think it dips below 3%?

Yes, we are - I mean we did swap another $100 million, so, you know, we think that'll take a little bit of the pressure off. At this point, any loans we make over $2.5 million are going to be floating or they have to be swapped. And, you know, we're looking at different funding costs and really our public fund costs to see if we just need to potentially run some of those deposits off to pick up some cheaper funding elsewhere. So I would - and answer to your - it's a long answer, but in answer to your question, you know, I think there's still some more margin compression coming. A lot of it probably has to do with, you know, how much we can have in loan growth moving forward, especially in '24. You know, this quarter, I think, you know, we'll have decent loan growth, but it's really going to be dependent on how much loan growth we have next year. But, you know, I would anticipate that, you know, we're probably looking at some additional NIM pressure, you know, and I wouldn't say just slightly below 3%. I'd say, you know, it potentially could get, you know, 25 or so basis points, you know, below 3% at some point.

All right. And then - so once the NIM hits that bottom and funding costs have plateaued, you know, there's some banks talking about asset repricing that could, you know, assuming rates are flat from here, you know, some banks are talking about asset repricing where the NIM could hit that bottom and then assets reprice and the NIM starts to inflect higher at some point next year. Do you think that is a likely scenario for Southside?

We will have some loans that reprice next year. It really just depends what the Fed does. You know, if the Fed has another interest rate increase out there, then, you know, not sure there's enough - there's a fair amount of assets that will reprice. It's possible by late next year. I wouldn't anticipate that's going to happen in the first six months. It's possible with all that asset repricing that we could see that later in the year that the NIM would actually go the other direction.

Okay. All right. And then, you know, I heard Julie talk about expenses basically being flat next quarter at this $35.5 million level. You know, as we look to 2024, how are we thinking about expense growth next year?

So...

We have not put a final budget together, I'll tell you that. I would anticipate expense growth - you know, we'll have some expense growth, but we'll probably try to keep it in the 3% realm, somewhere in that range. You know, we're going to have some higher wages and things of that nature.

And earlier in the year, in the first couple of quarters, I projected out that our budgeted expense was $35.5 million. I pretty much said that all year. And it just this last quarter has finally hit that amount. And one other thing I would add. You know, we've done a lot of the heavy lifting on a lot of the technology that's already embedded in here in these numbers. So, you know, I'm expecting to see that, you know, maybe not the steep escalation in that as much as we've seen this year.

I'll say this, we haven't - you know, two things. We haven't put the budget together. We're having a meeting this afternoon with all the executive management team, and the message Julie and I are going to deliver is, if you want to spend more money next year, explain to us how that's going to make us money, you know, where the revenue is coming from.

Yes. All right. And then finally, for me, you know, you guys have been a pretty consistent repurchaser of your shares over the last, you know, three or so years. Is there any reason to think that that would slow down here, or do you think, hey, the stock is on sale, we're going to continue to be active in the buyback, you know, as far as the eye can see?

You know, I - what I would say is we have a little over 600,000 shares left to repurchase. I don't - you know, I don't see us slowing down on repurchasing until that's used up. And then it'll - you know, we'll go to the Board and there'll be a discussion and we'll make a decision at that point if there's going to be additional purchases.

All right. Great. Thank you, Lee.

Okay. Thank you.

[Operator Instructions] Our next question comes from the line of Graham Dick with Piper Sandler. Your line is open.

Hi. Good morning, everyone.

Good morning, Graham.

So I just wanted to circle to the reserve. I know it was CECL-driven this quarter. I just wanted to hear your all's perspective on the drivers behind that. It sounded like repricing risk and some CRE-related stuff. Do you see repricing risk and CRE risk in your loan book that, you know, this CECL reserve build is effectively capturing? Or is this sort of external to your all's bank and more of a, you know, factor outside of your control, I guess?

You know, we - well, I'll tell you this. We - every six months we go through and look at all the CRE loans that are going to reprice, whether they're going to reprice next year or, you know, three years or four years from now, and we determine whether or not we feel like, you know, they're close or whether or not, you know, they're fine, if they reprice at current rates and we stress them. There's a few loans that we put on the watch list, mainly because they're close. But I will tell you that, you know, I'd like to see all the CRE loans reprice immediately. And because the few loans that are close, it just means they're close. It doesn't mean they can't chin the bar, but they're close in terms of meeting their debt service coverage ratios. A lot of these that, you know, are two years and three years out and I wish my Ouija board was good enough to know if rates are going to be higher or lower at that point in time. But, you know, what I can tell you is every six months we're going to be looking at this based on current rates and stressing them to determine, you know, if there is, you know, some risk in the portfolio. So, long story short, we're not seeing it, and - but the economic forecast is - you know, reflects concern in that arena and reflects concern around the commercial real estate market, you know, especially around office, and, you know, we're just not seeing it in our portfolio. But there's so much uncertainty out there in the overall market nationwide. We just didn't feel comfortable adjusting the economic forecast to our specific portfolio.

Okay.

Does that help answer your question?

Yes, absolutely. And so I guess as you think about the reserve from here, it sounds like the adjustments in the CECL forecast were sort of driven by the higher for longer outlook. So if we don't get any more rate hikes and really the rate outlook doesn't change materially, do you think that provisioning maybe returns to a level of, you know, more normal level, I guess, going forward? Or is there a potential for more CECL-related reserve bill to take the, you know, the ACL over 1% of loans?

You know, one thing I think that it's important to note is we have about 11% of our loans roughly are in municipal loans, and that mostly have Ad Valorem Tax pledges, and we virtually have no reserve against those under the CECL model simply because they have Ad Valorem Tax pledges. So if we normalized and took those out of the equation, we would be over 1% currently as opposed to 0.94. In answer to your question, as long as the economic forecast remains, you know, consistent where it is today, I don't see - you know, I'm - I don't see a huge build up in any one quarter like this. Now if the economic forecast changes, then, you know, all bets are off because that's the big driver in the CECL model is what the economic forecast is.

Yes. No -

And if I didn't totally answer your question, feel free to dig in some more.

Oh, no, it's perfect. All right. And I guess on loan growth, sounds like you're going to hit that target you guys set out at the beginning of the year, high-single-digit, but the pipelines are getting a bit smaller. What are your thoughts on growth in 2024? Are we talking about more of a mid-single-digit growth level or do you think you might be able to maintain the high-single-digit pace you'll see, you know, that you saw this quarter and then also that you saw for the full year?

Right now, based on where rates are and the ability of loans to meet our credit guidelines, and it's primarily the debt service coverage ratios with the current rates and how much equity needs to go into deals, I think the mid-single-digits is probably more likely for next year than what we've experienced this year. Now if things change and rates change, then, you know, our markets are strong. It's just people aren't, you know, when you go to them and tell them it's going to take 50% equity in their deal or in some cases more than that, you know, their numbers don't work on their end and, you know, for their equity folks. So that's really what we're seeing. It's not a credit concern, it's more of ability for them to cash flow at the amount of equity they want to put in the deal.

Okay. Great. That makes sense. Then I guess just lastly on the funding side. I think you guys picked up some BTFP this quarter. I'm just wondering what you guys are thinking about that right now. Maybe the potential to do more of it going forward and replace some of the higher cost borrowings on balance sheet and maybe even some broker deposits that might cost a bit more. Do you guys have any appetite for that?

Okay. You mentioned - what did we pick up? You used an acronym.

Bank Term Funding Program.

Oh. We have taken out all the Bank Term Funding Program dollars that we can. You know, we - obviously, when it gets closer to maturity, if we want to reprice that for another year, we can at that point in time. But at this point, you know, we - ours is locked in at a rate around 4.46%, and so, you know, we don't have any additional collateral that meets the threshold to take out additional funding on that. But, you know, that will - those will mature sometime in March, April, and I think there may be a little bit that matures in May, but, you know, we'll make that decision at that point in time based on what those rates are.

Okay. All right. That's helpful. And then I guess just the last question I'd have would be on the funding side. The deposit side seemed like the municipal deposits drove their growth this quarter. But just wondering if you think that, you know, you might be able to at least keep pace with loan growth on the deposit side, whether that be, you know, core deposit generation or maybe back to the brokerage side.

That is our major focus for the next quarter and for all of 2024 and maybe beyond, is, you know, mainly non-maturity deposit growth. And, you know, so that's going to be the focus. That's where incentives are going to be heavily skewed because that's what we need. And it's out there, we just have to go get it.

Okay. Understood. All right. Appreciate it, guys. Thank you.

Thank you.

[Operator Instructions] Our next question comes from the line of Matt Olney with Stephens. Your line is open.

Thanks. Good morning. Going back to margin discussion. Good morning. Deposit costs, just any updated targets or thoughts on deposit betas for the cycle? Where - given the pressure you mentioned earlier, where do you think these betas could move towards over the next few quarters?

You know, I think if we look historically, the betas, you know, continue to move up, you know, more. Where betas right now are nowhere near the historical norms of where they get to in terms of the amount of Fed increases, and - but, you know, it's different and different in each. But - so I'm not sure exactly how much that beta is going to move up, but, you know, we're going to be looking at a lot of different things. We may look at some more swaps, and we're just going - you know, we're going to look at our highest cost deposits and make a decision whether or not it makes sense to retain those or if there's a better way to go out and, you know, tie that money up some other way. So - but, you know, the beta is definitely going to go up. It's just a matter of how much and, you know, how much we can offset it and mitigate it on the other side in terms of loans and a little bit on the security side.

Okay. And then specifically on the time deposits, any color you can provide as far as the maturities that are coming up in the near term, I don't know if Julie has that for the fourth quarter volumes and repricing details behind that.

I know this quarter we have $80 million in CDs that come due, and I don't have the exact rates. Just a second they're handing it to me. Yes, it looks like the rates are on average, I'm going to say, you know, 4.80% - that was it, at the bottom. Okay. Well, I got real close 4.79%. I was looking at the three months. They have them grouped together in quarter. So there's $80.7 million that comes due in this quarter, and the average rate on those is a 4.79%. So that'll move up some, and then we have another $65 million in the first quarter, that's at a 4.91%. Another $96 million, that's almost in the second quarter. That's almost at 5%. So there'll be some repricing risk associated with those, but, you know, it's not going to be like it's going up a 1% or 2% or anything like that. We're probably looking at, you know, a quarter of a percent on average for those CDs that are going to renew. Does that help you?

Yes, that's what I'm looking for. Okay. Thanks for the color, guys. Appreciate it.

All right.

Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Lee Gibson for closing remarks.

Thank you, everyone, for joining us today. We appreciate the opportunity to answer your questions along with your interest in Southside Bancshares. In closing, we're looking forward to our prospects for the remainder of 2023, and look forward to reporting fourth quarter results to you during our next earnings call in January. Thank you again.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.