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Independent Bank Group Inc
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Good day, ladies and gentlemen, and welcome to the Independent Bank's Second Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. And later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]
I would now like to introduce your host for this conference call, Mr. Paul Langdale. You may begin, sir.
Good morning, everyone. I am Paul Langdale, Vice President and Investor Relations Officer for Independent Bank Group, and I would like to welcome you to the Independent Bank Group second quarter 2019 earnings call. We appreciate you joining us. The related earnings press release and a slide presentation can be accessed on our Web site at ibtx.com.
I would like to remind you that remarks made today may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and expected results to differ. We intend such statements to be covered by Safe Harbor provisions for forward-looking statements. Please see page five of the text in the release or page two of the slide presentation for our Safe Harbor statement. All comments made during today's call are subject to that statement.
Please note that if we give guidance about future results that guidance will be only a statement of management's beliefs at the time the statement is made, and we do not publicly update guidance. In this call, we will discuss a number of financial measures considered to be non-GAAP under the SEC's rules. Reconciliations of these financial measures to the most directly comparable GAAP financial measures are included in our release.
I am joined this morning by David Brooks, our Chairman, CEO and President; Dan Brooks, our Vice Chairman and Chief Risk Officer; and Michelle Hickox, Executive Vice President and CFO. At the end of their remarks, David will open the call to questions.
With that, I turn it over to David.
Thank you, Paul. Good morning, everyone. I will briefly touch on some of the highlights for the quarter, and then Michelle will cover the operating results, and Dan will discuss the loan portfolio. I will be back at the end with some closing remarks, and we will open it up for questions.
Independent Bank Group had a solid second quarter. We continue to report healthy earnings with an adjusted EPS of $1.22 per share and adjusted return on average assets of 1.47% for the quarter.
We have continued to see results from our positive growth efforts, and we had good, little bit more moderate organic loan growth during the quarter. We had strong growth in mortgage warehouse, energy lending in one to four family held for investment with CRE loans decreasing as a percentage of total loans.
We successfully completed the operational convergence of Guaranty last month, and our teams did a great job ensuring the process went smoothly. We expect to recognize the full benefits of this acquisition during the second-half of this year.
Now Michelle will provide additional details on the operating results for the quarter.
Thank you, David. Good morning, everyone. Please note that slide five of the presentation includes selected financial data for the quarter. Our second quarter adjusted net income was $52.9 million or $1.22 for diluted share, compared with $32.2 million or $1.11 per diluted share for the second quarter last year, and $52 million or $1.19 per diluted share for the linked quarter. As you can see on slide five, net interest income increased to $129.6 million in the second quarter from $78.9 million in the second quarter 2018, and $121.7 million in the linked quarter.
The net interest margin was 4.11%, up six basis points from the previous quarter at 4.05%. Excluding accretion related to the Guaranty acquisition, the NIM would have been 3.72% for the quarter, compared to 3.82% in the linked quarter. This decrease is primarily related to the growth in the mortgage warehouse portfolio, which are significantly lower yields than another ones held for investment. The adjusted yields on NIM net of accretion decreased from 5.17% in Q1 to 5.11% this quarter. The NIM was also impacted by increased liquidity, lower security yields, and increased deposit cost.
Total non-interest income was $16.2 million compared to $10.1 million in the second quarter of 2019, and $16.4 million in the linked quarter. The decrease of $225,000 from the first quarter of 2019 is primarily due to a decrease of $1.2 million in other non-interest income, which is partially offset by increases of $303,000 in wealth management and trust services, and $609,000 in mortgage banking revenue.
Mortgage warehouse fee income also increased approximately $330,000 from the first quarter. The decrease in other non-interest income is primarily due to the decrease in acquired loan recoveries during the second quarter 2019 from $1.3 million to $258,000. Total non-interest expense was $78 million, a decrease of $8.6 million from the linked quarter. This includes $6 million of expenses related to the Guaranty acquisition as well as a $988,000 impairment taken on former branch locations that were closed as part of our branch realignment strategy. We also had approximately $400,000 of cost related to our re-branding and expenses related to our headquarter relocation.
During the quarter, we reported $1.4 million operational loss reserve arising from a chargeback liability on a merchant card deposit account acquired in the Guaranty deal. As of June 30, we have estimated a total loss of $5.2 million on this account, of which, we believe $3.8 million existed at close and has been recorded as an increase to goodwill.
Slide 17 shows our deposit composition and cost. Deposits totaled $1.5 billion as of June 30, 2019. Deposits grew by $291.2 million, or 2.6% for the quarter, 10.4% annualized. The average cost of interest-bearing deposits was 153 basis points, up 51 basis points from the second quarter of 2018, and up 11 basis points from the linked quarter. While the relative upward pressure on deposit rates has abated somewhat with the change in the consensus federal funds market outlook, customers continue to expect higher rates on deposits, and competition from other banks continues to make funding cost a challenge.
That concludes my comments. I will turn it over to Dan to discuss credit metrics and give some color on the loan portfolio.
Thanks, Michelle. Good morning. Organic loan growth was $175.4 million or 6.6% annualized for the quarter. Overall, loans held for investment not including mortgage warehouse loans grew to $10.8 billion at June 30, 2019, compared to $10.7 billion at March 31, 2019. Subsequent to June 30, we sold the student loan pool and our residential mortgage pool, which were acquired in the Guaranty acquisition. These loans pools, which totaled $83.5 million are recorded in loans held for sale at June 30, 2019.
Slide 10 illustrates annual loan growth comparisons. Slide 11 shows the composition of our loan portfolio and our commercial real estate portfolio. As of June 30, 2019, commercial real estate makes up 51% of loans, which has declined from 53% in the linked quarter. CRE continues to be well-diversified in types of collateral with the largest segments in office and retail.
Slide 12 further breaks down the retail CRE portfolio by property type. The ratio of total construction and land development lending to the banks regulatory capital is 106% as of June 30, 2019, which is down from 130% a year-ago. At the end of the second quarter, our total CRE to capital ratio stood at 386%. The increase in the CRE ratio was primarily due to the reduction of capital resulting from our stock repurchase this year. We continue to focus on reducing this ratio below the 300% regulatory guidance over the next three to four years as we grow other areas of the portfolio.
Mortgage warehouse purchase loans averaged $295.9 million for the quarter ending June 30, 2019, compared to $128 million for the quarter ended March 31, 2019, representing an increase of approximately $167.9 million or 131.2% for the quarter. This is reflective of our strategy to grow this line of business as well as seasonality and the impact of lower mortgage loan rates during the quarter. Credit quality metrics remain strong. Total non-performing assets increased to $28 million or 0.19% of total assets at June 30, 2019, compared to $16.9 million or 0.12% of total assets at March 31, 2019.
The increase in non-performing assets is primarily due to the transfer of six former branches to OREO as a result of our branch realignment. These properties were recorded in OREO at $6.8 million. We also placed three credits on non-accrual during the quarter, totaling $5.3 million. Charge-offs remained low at 0.01% annualized for the second quarter compared to 0.06% annualized in the linked quarter.
Provision for loan loss expense was $4.7 million for the second quarter, an increase of $1.5 million over the linked quarter. Provision expense is primarily reflective of the growth of our loan portfolio as well as charge-offs and specific reserves taken during the respective period. Provision expense was elevated this quarter due to the addition of a $1.4 million specific reserve allocated to a commercial loan in Houston. This specific reserve is due to the declining financial condition and operations of this borrower. We do not believe that this is an indication of a weakening market.
As of June 30, 2019, we have recorded a discount for the acquired loan portfolios of approximately $115.5 million, of which, $27.3 million is non-accretive. The recorded allowance for loan losses plus the remaining non-accretive discount on loans acquired is approximately 0.73% of total loans held for investment as of June 30, 2019.
These are all the comments I had related to the loan portfolio this morning. So with that, I'll turn it back over to David.
Thanks, Dan. During the first-half of the year, we focused on executing our plans for a smooth integration of the Guaranty Bank's customers, employees, and communities into our systems. We also enhanced the returns to shareholders by increasing our quarterly dividend and executing our stock repurchase plan. Through June, we've repurchased an aggregate of $49 million of our common stock. We believe the company is well-positioned for the second-half of 2019. We continue to carry out our key strategic initiatives, driving disciplined growth, delivering consistent earnings, maintaining a strong credit culture, and creating sustainable long-term value for our shareholders and our communities. We have an established platform and for the most dynamic markets in the country upon which we can continue to build into the future.
Thank you for taking the time to join us today and we'll now open it up to questions. Operator?
[Operator Instructions] Our first question comes from Brady Gailey with KBW.
Hey, good morning guys.
Good morning, Brady.
I had a question on the expense base. It seems like there is a lot of noise in expenses this quarter. As it relates to the $1.4 million loss that was from the Guaranty merchant card issue, that $1.4 million was that included in the $6 million merger charges, or is that above and beyond that $6 million?
That was not included in merger charges, Brady.
Okay, all right. So I know -- I think last quarter when we talked about expenses in the back-half of the year, we had the convergence done, you should have some positive -- some lower expenses from that, but I think we talked about an expense run rate around $64 million a quarter. Does that still feel like the right number, or could that be a little higher?
I think that run rate is going to be a bit higher. There were some other things though in the second quarter that pushed our expense run rate up in addition to that loss. Legal expenses were up, and if you guys remember, we inherited a lawsuit from Bank of Houston. That total has rammed up. So, we are going to expect additional legal expenses going forward for that of close to $400,000 or $500,000 a quarter. So that's going to be in addition to that run rate I had given you guys last time.
We also had some expenses related to branding and moving to our new location of $400,00 to $500,000 this quarter that I don't expect will repeat, but I would say, I would push that run rate with 64 up to 65.5 just given the legal and some other things we are doing. Even though we will get the cost saves on the Guaranty transaction, we have had some other expenses that have come into our run rate not related to that.
Okay, all right. And then yield accretion was up notably from 1Q, that went from $7 million last quarter, was little over $12 million this quarter. I know that's very hard to predict, but I think I remember you guys saying that number should be around $6 million going forward. What are your thoughts on how that number trends in the back-half of this year?
Right, you are right. That number is hard to predict, especially right in the very beginning before we do our convergence. So -- and first part, we really probably had about $1.7 million of accretion income that should have been recognized in the first quarter just we were conservation with our estimates. I think going forward if you are looking at the second-half of this year Q3 and Q4, accretion income should be about $7 million, and then it's going to -- we have about $88 million total that's going to come in the income over the next four years. So, it will trend down from there over those next three years if that makes sense.
All right. And then David, on the buyback, it was great to see the elevated buyback this quarter. If you look at year-to-date, you guys have repurchased little over 2% of the company. How do you think -- do you think this level of buyback will continue at this pace, or do you think that this was more of an opportunity to buy your stock and you don't anticipate repurchasing at such a big level going forward?
Yes, it would be the latter, Brady. We were opportunistic in the second quarter purchasing at prices when it dipped, and the $39 million we purchased in second quarter after a $10 million in the first quarter. I would say I will look right now for the second-half would be closer to what the first quarter was as opposed to what second quarter was, but we will continue to be. We have some other levers we could pull if we -- be more aggressive, but I think our outlook right now is a more limited buyback in the second-half of the year compared to the first-half.
Great. Thanks, guys.
Thanks, Brady.
Our next question comes from Brad Milsaps with Sandler O'Neill.
Hey, good morning.
Good morning, Brad.
Michelle, just a follow-up on Brady's question around accretion, in the release you give the core NIM excluding the marks related to Guaranty. I know those are the biggest marks that they have left, but I was just curious do you have the total accretion number for the quarter, the core loan yield of $511 would imply maybe a little bit more than the $12.3 million that you disclosed the release. Just want to get a sense of total accretion for the quarter.
Are you talking about -- well, that number doesn't -- there is some what we call non-core accretion that we pull out of our adjusted net income. That was about $2.8 million.
Okay, so the $12.3 million doesn't include the $2.8 million?
That's right, yes. That really includes the amounts what I call the interest rate mark if that makes sense.
Okay, that's helpful. So that would align more what you have in the queue every quarter, okay. Thanks for that. Just a follow-up on the margin, what -- it obviously appears we are going to get a rate cut this month, maybe more coming. How do you guys feel about kind of how you are ready for lower short-term interest rates and how the NIM might respond?
I think a cut from the Fed actually will help us. I think the outlook on our margin I am going to get away from predicting exactly how much I think it could go down. I don't think we are going to get the same compression of 10 basis points like we did this quarter, but if run rates continue to be competitive and [indiscernible] cost on our deposits, the increases has abated from where it was last year. That's still very competitive as well. So, if that continues, we will see some compression in our margin a few basis points for the rest of this year. I think if Fed cuts rate that will help on some of the pressure on some of our deposits specifically like our specialty treasury. Some of those are tied to Fed funds. So that will help us. So, I guess the way to put it is we are going to have to some compression with a Fed decrease that will be a little less than what I would expect today.
Brad, I would add in that the loan pricing competition was stiffer in the second quarter than we had expected. And so we were not able to -- the loans that we booked the assets we booked we are not able to get the same kind of pricing that we were getting in the fourth quarter last year and first quarter of this. So, it has come back a little bit. And I think part of that just expecting the rate decrease that we are expecting here in the second-half of the year.
And then just we had loan demand the economies the full markets we are in, in Dallas, Austin, Houston, and Denver are all doing well at the core, but the demand has been good but probably not as robust as it was in year -- 18 months ago. And then consequently the banks that hustling for loan growth are all competing for little bit smaller pie right now and that's driving down pricing. We are passing on some loans that's really the number one reason why our loan growth is 7% first-half of the year as opposed to 8% to 10% as we have been guiding to for the year because the competition has been difficult around pricing and a little bit around structure.
We are seeing lot of cash out refinances on commercial real estate which we are not generally big fans of. And so, a little bit of structure but more pricing has driven that. And that obviously translates into the NIM that Michelle was talking about. So where we felt like we were going to fairly stable, we just didn't -- the asset side that didn't hold up in the second quarter.
And the other comment I would make to that is that we did see significant growth in our warehouse portfolios. And you guys know the yields on those. While we get fee income and non-interest income, the yields on those are about 100 basis points lower than our other loans held for investments. So that impacted our overall loan yields as well. I don't think we anticipate warehouse is going to grow at that same rate this quarter. So, that would be a positive to the loan yield.
Great. Thanks for the color.
Great. Thanks, Brad.
Our next question comes from Brett Rabatin with Piper Jaffray.
Hey, good morning everyone.
Hi, Brett.
Wanted to first ask just on credit, you guys still have really good credit metrics, but just wanted to get little more color if we could on the one loan that $1.4 million reserve was made on or specific reverse was made on, any thoughts on the industry or any color on what was occurring with that particular credit?
Brett, just in the normal course doesn't really fit right in there. It's a loan that we had identified as a substandard loan before we ought to had a reserve loan we just boosted that reserve in the second quarter in anticipation of resolving it, but I would say no trending -- that particular industry was a medical-related facility, a C&I credit not real estate, but just a one-off credit I would describe it as.
Okay. And then the other question was just back on growth. And David, you've been talking about kind of 8% to 10%, given your comments, should we assume more of a mid single digit pace from here or can you give us some color on what you think the market might give you?
Looking at the pipeline and talking with our lending team and our Chief Lending Officer this past few weeks as we evaluated the second quarter and looking at the pipeline going forward, we still feel good about our pipeline and our demands out there, expecting price to continue to be difficult. I still think it's the low-end of what we've been guiding to. The 8% to 10% is where we expect to be in the second-half. Something more like 8% as opposed to as opposed to 6% or 7%, and also as opposed to 9% or 10% if that makes sense of kind of you know, in that 7%, 8%, we're still encouraged that we can do something around 8% in the second-half of the year depending again the economy, and politics, and all those things.
Okay. And then maybe just one last one around fee income, you have positive momentum in a couple of line items. Any thoughts on the back-half of the year, I know mortgage is somewhat tough to forecast, but any thoughts on fee income generally?
No, I don't think you're going to see a significant change on our fee non-interest income line for the back-half of this year.
Okay, great. I appreciate all the color.
We are somewhat encouraged that obviously low rates should generate more residential activity. We've seen some momentum there on our residential mortgage side, but we'll see how material that is here as the year progresses.
Okay. Great, thanks.
Thanks, Brett.
Our next question comes from Michael Rose of Raymond James.
Hey guys, just following up on the growth outlook for 7% to 8%, (a) does that include the outlook for the warehouse, and then (b) if we do get a couple of rate cuts here, would those cash out refies continue and pressure loan growth? And as I look at C&I ex-energy looks like balances were down, so, maybe if you can just give some commentary there? Thanks.
Yes, I think just some hesitancy, if people -- last for the first, Michael, I think there is some hesitancy that we're seeing -- we haven't seen the level of outstanding on our lines of credit and things that are out there. We've also been cautious about any leverage lending in those types of things that could drive that core C&I number, but we do think that energy will be a big part of the C&I growth story going forward. So we've been pretty clear about that.
The 8% loan guidance does not include the warehouse. That's our held for investment loans. Although we are encouraged about the success we've had, we hired a new team in our mortgage warehouse, and we saw the benefit here in the second quarter of some relationships and things. They've been able to move over and things they've been able to change and do, but we expect that to moderate that growth rate anyway to moderate here in the back-half of the year. We had communicated I think our target on the mortgage warehouse was to get that up to $500 million in the $11 billion portfolio. So, somewhere in that range, and that's where we still see it being here by the end of the year.
Okay. As a follow-up, Michelle, you talked about 46% efficiency ratio by year-end, it seems like the accretion income is going to be a little bit higher. I understand the loan growth outlook maybe the expense run rate a little bit higher than expected fees kind of flattish from here. Does that 46-percent-ish range still feel good at this point?
I think it can be a little higher than that but I do think it's going to be sub-47%, so somewhere in that range, 46% to 47%.
Okay and maybe one final one from me, David, you talked about energy lending being a big part of the growth driver moving forward. We have seen some negative migration on the energy side, is there any hesitancy to grow, or go after that segment at this point in the cycle?
We've been quite cautious, I'll let Dan to speak to the credit metrics here, but part of our strategy we had gotten that book down to such a low level, Michael, that the growth that we've had is really out of pretty low base, and so while percentage is little high, we think it's really a pretty measured approach we've got to growing at -- from a high-level we did see progress not only in -- with warehouse, energy, single-family, loans, software investment, equipment finance continues to build out. So we're seeing some positive progress overall in our strategy. CRE loans were down couple of percent this quarter from 53% to 51%, I think of the total portfolio. So we're making progresses we've indicated we would on our strategy to bring that CRE number down with the stock buyback, obviously our capital was down a little more than we had planned for the quarter, net growth of percentage of CRE loans not to come down as much, but we think that will continue to migrate in the right direction over time.
Dan, you want to talk about the energy?
I'll add to David's comments, I think we mentioned before, we hired an additional energy lending team around the first of the year and loan that were booked in the second quarter really resulted that we're seeing some very nice opportunities there, and the quality of those credits is very hard. So, we're certainly very confident, and if we continue to see that kind of quality then we will have an opportunity to continue to book very comfortably.
Okay, thanks for taking my questions.
Thanks, Michael.
[Operator Instructions] Our next question comes from Matt Olney with Stevens.
Hi, thanks. Good morning, guys.
Hey, good morning, Matt.
Good morning.
I guess, similar to Michael's question on energy, but just a little bit broader, we've seen some of your Texas peers reports on challenging credit results so far this year. So I'm just curious what you're seeing on the ground in Texas, and does that make you rethink your growth outlook of continuing them at that high single-digit pace? Thanks.
Good morning, Matt. This is Dan. We'll certainly continue to see some nice opportunities in there, and really across the tax of loans that we do. As you know, we're not a large leverage lender, and we're not big a buyer of cynics. As you know, that's been our history, and so therefore, we've not experienced some of the credit difficulties that some of our peers have apparently in those categories. So I think we expect the credit quality to continue to be as good as it has been, and continue to hold up.
So we're not really seeing that, and Dan had spoken about this last week, we're not seeing any fundamental change in our capacity loans or customer reporting bad results or the things that you normally see if you are expecting to see deterioration in credit, and we're not seeing that. What I am seeing is as I mentioned earlier on the call, Matt, we're not seeing really robust growth. In all sectors, we saw 18 months ago, but we're still seeing very good solid loan demand, smart deals being done, we're getting a chance to participate in, and we're not seeing -- you know, in our core lab or our core customer base the -- any credit deterioration or any signs of real concern on the ground.
Okay, understood. And then I guess, circling back to the margin discussion, Michelle, I wasn't quite clear on your point on -- if the fed does cut next week, are you saying that the core NIM is under pressure currently, and if the fed does cut, that margin pressure would ease somewhat or whether that accelerate, I was little confused about that?
Yes. I think I said fed cut helps us, because I think that will help us on our deposits funding side.
So you're saying -- I think you are saying that the margin remains under pressure, but if the fed does cut that pressure will be somewhat mitigated?
Right, yes. I think it will be under pressure regardless, Matt, a few basis points, but I think it will be better with the fed cut.
Less pressure.
Yes, less pressure.
Got it, understood, thank you.
Okay. Thanks, Matt.
Our next question comes from Michael Young with SunTrust.
Hey, this is Brandon King on for Michael Young.
Good morning.
Good morning.
Good morning. Yes, I wanted to discuss your M&A outlook. I know you discussed previously that in 2019 you're focused on integrating Guaranty, but with the large deal announced in your state last month, I was wondering if that outlook has changed or what you're seeing now as far as opportunities.
No. Obviously the bank stocks had been under pressure, Brandon, and so the traditional M&A that we've been successful with in our history and particularly last six years since the IPO, we think that's going to be difficult year. For the foreseeable future to speak as so our expectations continue to be high for high-quality franchises and then the stock prices are still trading at really relatively low prices. Given where Texas banks have traded in last five years, it numbers of 13, 14, 15 times earnings we're now -- most are trading in the 10 to 12 times earnings. So that makes the smaller M&A little challenging.
The deal that was announced couple weeks ago here in the market was a larger deal, and obviously more -- it wasn't MOE, although there is a lot of MOE discussion, but it was a larger bank acquiring other larger bank, and so that's a little different dynamic, and there is a lot of footprint overlap there. So, there is some cost save opportunities that digest there. So no, it really hasn't changed on my outlook, we continue to try to look around, we know a lot of people, we continue to talk and create relationships in Texas and in our region, and there's a lot of dialog, a lot of people looking for how do you grow earnings per share, how you grow your shareholder value going forward in these markets that we're in. We continue, as I said, at the end of our prepared remarks we continue to really good about the four markets that we're in where we've got material footprints and for the best seven/ten markets in the country, and we think we got really good growth prospects year, but the traditional M&A acquiring smaller banks will come back around and be possible. In the future, this doesn't look very promising at the moment.
Okay, that's all I had. Thank you very much.
Thank you.
And I'm not showing any further question at this time. I'd like to turn the call back over to our host.
Well, thanks. We'll conclude the second quarter call, I am sorry, and quarters go by fast. We appreciate you being part of it today. If you have any questions, obviously feel free to reach out to Michelle or I or Paul with anything we can provide for you. Hope everyone has a great day. Thanks.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.