Independent Bank Group Inc
NASDAQ:IBTX
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Independent Bank Group Inc
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Good day ladies and gentlemen and welcome to the Independent Bank Group’s Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]
I would now like to turn the conference over to Mark Haynie, Executive Vice President, General Counsel for Independent Bank Group. You may begin.
Good morning and welcome you to the Independent Bank Group third quarter 2018 earnings call. We appreciate you joining us. The related earnings press release and a slide presentation can be accessed on our website 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 the actual and expected results to differ. We intend such statements to be covered by Safe Harbor provisions for forward-looking statements. Please see page four 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 managements' 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 will turn it over to David.
Thank you, Mark. Good morning. We appreciate all of you joining us for today's call. As always I will briefly touch on some highlights for the quarter, then Michelle will cover the operating results, and Dan is here to cover the loan portfolio. I'll be back at the end with some closing remarks and to open it up for questions.
Positive profitability trends continued through the third quarter with adjusted net income of $36.6 million, which is a 13.5% increase from second quarter 2018 and a 47.4% increase from third quarter 2017. Adjusted return on assets at 1.45% and adjusted return on tangible equity at 18.47% are again record levels for the company.
As we had indicated last quarter, loan growth moderated this quarter to 4% annualized, given our strong growth in Q1 and Q2 annualized growth is 12.6% year-to-date through nine months, which is consistent with our outlook for full year 2018. Asset quality metrics continue to be at historically strong levels with non-performing assets at 16 basis points and our conservative underwriting standards remain intact. We did recognize a partial charge-off on energy loan that has been a problem asset since the energy downturn. The expected loss had been fully reserved and did not impact third quarter earnings.
We successfully completed the operation conversion for the Integrity acquisition in August and integration of their branches and employees has gone well. We're happy to have them join the Independent Bank team.
Now, I will turn over to Michelle to provide more details on operating results for the quarter. Michelle?
Thank you, David good morning everyone. Please note that slide five of the presentation include selected financial datas for the quarter. Our third quarter adjusted net income was $36.6 million or $1.20 per diluted share compared to $24.8 million or $0.89 per diluted share for the third quarter of last year and $32.2 million or $1.11 for the linked quarter.
As you can see on slide seven, net interest income increased to $86.3 million in the third quarter from $72.9 million in the third quarter of 2017 and from $78.9 million for second quarter 2018. The net interest margin declined to 3.94% for the quarter down 3 basis points from the previous quarter at 3.97%. The adjusted margin net of acquired loan accretion was 3.89% compared to 3.93% in the second quarter.
Average loan yield for the quarter net of accretion income was 5.28% and benefited from increases in the bank’s target loan rates as well as increases in variable loan rates following the Federal Reserve rate increases.
Total non-interest income increased to $12.7 million compared to $12.1 million in the third quarter of last year and from $10.1 million in the previous quarter. Third quarter mortgage banking revenue and other non-interest income includes the fair value adjustment to the mortgage portfolio and interest rate hedge of approximately $1.6 million due to the implementation of a mortgage hedging program. We do not anticipate this income to recur in future quarters at these levels. The increase from prior quarter is also related to various loans with a $309,000 difference in gain on sale of premises and equipment, as well as a larger earnings credit on a correspondent account.
Total non-interest expense increased $4.8 million from the third quarter of last year and increased $3.5 million from the prior quarter. The increase from prior year is primarily related to increases in salary and benefit expense related to the integrity acquisition and organic growth.
The increase from the linked quarter is primarily due to increased salaries and benefits of $3.3 million due to increased health insurance costs of $1.3 million, increased 401k expense of $400,000 and increased salaries for former Integrity employees. Acquisition expenses decreased from $3.4 million to $1.7 million and are related to both the Integrity and Guaranty acquisition.
Deposit composition and costs are illustrated on slide 16. Deposit growth was good for the quarter, increasing by $250 million, including a $64 million increase in noninterest bearing balances and $122 million in retail time deposits.
Noninterest-bearing accounts make up 28.7% of the deposit mix at September 30, 2018 and have remained stable this year. The average cost of interest-bearing deposits has increased to 126 basis points up from 66 basis points at September 30, 2017 and up from 102 basis points for second quarter 2018. Deposit pricing and competition continues to be a challenge in our markets.
That concludes my comments this morning. So I'm going to hand it over to Dan to discuss credit metrics and give color on the loan portfolio. Dan?
Thanks, Michelle. Good morning everyone. As anticipated organic loan growth was muted this quarter with loans held for investment not including mortgage warehouse growing $74 million or 3.9% annualized. Third quarter has historically been a seasonally low quarter for growth and was also impacted by payoffs. Some expected that carried over from Q2 and some unexpected.
Slide 10 illustrates annual loan growth comparisons. Slide 11 shows the composition of our loan portfolio and our commercial real estate portfolio. As at September 30, 2018 commercial real estate makes up 51.7% of total loans and has remained consistent in 2018. As represented in the graph, 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. Slide 12 also shows the trend of CRE concentrations to capital. Total CRE to bank’s regulatory capital decrease to 385% at September 30, 2018 from 398% at June 30, 2018. Mortgage warehouse purchase loans averaged $136 million during the quarter ended September 30, 2018, compared to $124 million for the quarter ended June 30, 2018.
The small increase is primarily due to seasonality of the mortgage business and incremental growth in customer base. Credit quality metrics continue to be strong with total non-performing assets at 0.16% at September 30, 2018. Charge-offs increased this quarter, but continue to be low at 0.14% annualized for the quarter. A charge-off of $2.5 million was recorded on the energy loan that David referred to earlier, this has been fully reserved prior to this quarter.
Provision for loan loss expense was $1.5 million for the quarter, a decrease of $348,000 from the third quarter of 2017 and $1.2 million from the linked quarter. Generally, provision expense correlates with net loan growth, which was much lower than Q2 and the level of previously unreserved charge-offs or specific reserves during the quarter.
Slide 14 illustrates our provision expense and charge-offs in each reported period. As a result of the energy loan charge-off, the allowance for loan loss decrease to 56 basis points from 58 basis points as of June 30, 2018. As of September 30, 2018, we have recorded a discount for the acquired loan portfolios of approximately $29.6 million. The recorded allowance for loan loss plus the remaining fair market value discount on loans acquired is approximately 0.95% of total loans held for investment as of September 30, 2018.
Those are my comments I’ve related to loans this morning, so I will turn it back over to David.
Thanks, Dan. We are pleased -- we’re very pleased actually with our financial results for three quarters of the way through 2018. Earnings per share has increased 35% and tangible book value has increased 16% since September 30, 2017. These significant increases continue to reflect our commitment to enhancing shareholder value. Our teams are busy taking steps to ensure the integration and execution of the Guaranty acquisition goes well. We expect the year end close and look forward to expanding our position in Denver and Front Range Colorado markets.
Thank you for joining us today and we will now open the call to questions. Operator?
Thank you. [Operator Instructions] Our first question comes from Brady Gailey of KBW. Your line is now open.
Hey, good morning, it's Mike Belmes, on for Grady.
Good morning, Mike.
Good morning. So we saw some really nice deposit growth this quarter, could you maybe give some color on what are the drivers maybe specialty treasury and promotion activity during the quarter?
Yes, Mike, we did have a strong deposit growth quarter which we feel really good about, about 75% of that came through our branch retail network and was not related to specialty treasury and about 25% of it was our specialty treasury area for a combined approximately $0.25 billion of growth in the quarter.
Got you. And on the growth as it relates to pricing there was comments about competition remains intense, have you seen the intensity of the competition increasing relative to the prior quarters or kind of stable?
I think generally what we see Mike, and I’ve talked about this before is that as we get closer to an unexpected Fed increase we start hearing a lot of noise in our markets. We do seem to have competitors that will go out and proactively raise their rates on promotional products, money markets index funds. And so really it’s anecdotal evidence that that’s when my team, my treasurer starts getting request from our markets on can we match this account. I have a customer is they’re going to move money, has more money they can bring to us, what can we offer them. So you really start seeing a lot of that.
We put a promotional CD out there at the end of June to try to grab some funding and that’s where some of this funding came from. But what it allowed us to do was that if you noticed we also have about $400 million in FHLB advances that we let go this quarter. And so that deposit growth allowed us to let some of those short-term advances go and replace it with this term money, which is about the same cost. So it doesn’t immediately help our NIM, but it should help us going forward.
Got you. And I guess one last one for me, saw some nice expansion in loan yields and I know you guys talked about kind of the timing differences of when loans get funded versus deposits repricing. But as I kind of think about just the core NIM and putting everything together, do you kind of anticipate maybe a few more basic points of compression or more of a stable NIM kind of looking into fourth quarter?
I still think we could see similar compression to this quarter and really a lot of that depends on we are seeing increases in our asset yields. So really the betas deposit funding cost one thing that we’re trying to do this quarter we are trying to manage our balance sheet. So that we stay below $10 billion at year end now that we know that the Guaranty acquisition is not going to close until the end of the year because that saves us $5.5 million of Durbin revenue.
So we’re probably not going to be as aggressive at going out and getting deposits in the fourth quarter as what we have been the past two quarters. So that could help us manage our cost, but I generally think you could still see 2 to 3 more basis points of compression in our margins.
Got you, thanks for taking my questions.
Thanks, Mike.
Thank you. Our next question comes from Michael Rose of Raymond James. Your line is now open.
Hey, guys. How are you?
Good morning, Michael.
So just wanted to dig into the loan growth a little bit. So looks like energy like several of the other Texas banks was pretty good this quarter, but if I exclude that looks like core commercial was down. Wanted to get some color there and you guys have previously talked about a range of loan growth inclusive of Guaranty somewhere in the I believe it was 9% to 11% range, seems like that could be challenging given that persistent paydowns that don’t seem like they’re going to go away anytime soon. So just any sort of updated color there would be great?
Sure, Michael, we -- the loan growth for the quarter was a little slower than we had expected coming into the quarter, and really related to some asset sales from some of our customers that we bank for a long time that continue to sell assets into a strong demand from investors. So we saw -- even though we had expected some payoffs that got pushed from the second quarter to the third quarter, payoffs were really at a record all time high again we think that's seasonal, as much as anything, it has to do with the kind of current economic environment.
And then our loan growth was front loaded into the early in the year, it seems like a lot of our customers are out purchasing assets and family offices purchasing assets and they closed a lot of them in the second quarter, we had a 18.5% loan growth. So, it's a little lower than we had expected, but we certainly expected a kind of a middle single-digit growth.
We are seeing some traction in energy, we have already booked one deal in Denver that is a deposit customer of Guaranty, so we're seeing some opportunities there. We think there are other opportunities similar to that in Denver as well that we will be working -- are working currently. So we are starting to get a little traction on energy. The rest of our growth as you point out was primarily real estate some single family and some CRE.
But again I don't think you can read too much into this quarter our -- we have guided in the past to 10% to 12% is our expected ongoing run rate, we're sitting at about 12.5%, I think year-to-date we'll expect fourth quarter to be consistent with that. But we really look at now given our size and given where we are in the economy and what we're seeing in credit, probably 10% growth where we had said 10% to 12%, expecting 12% or better. I think it's now in our view a little closure to the 10% run rate going forward is what we expect and plus or minus a little.
And that's inclusive of Guaranty as we went into next year?
Correct, yes. And I know they've traditionally run at kind of more of a 6% to 8% growth rate. But they've been pretty restrictive on a couple lines of business that we have as an expertise. And so we think that we'll be able to do a little better than that and we've got some teams that we hired as well this year in Colorado that are just starting to produce. So we think that will help the Guaranty piece once it’s consolidated with our total pieces more lenders on the ground, if you will. But I think we'll get a better feel over the next few quarters once we close on that which we do expect, and Michelle mentioned a moment ago we do expect the closing on the Guaranty deal to be end of the year December 31st, January 1st.
And as such, we're going to manage our balance sheet, which we think -- believe we can successfully do to keep it below $10 billion per year-end. And -- but then we'll get a better feel Michael first, second quarter next year once we have them integrated in and the lending team is integrated in we'll get a better feel for that. And an overlay, whatever the economic environment is and we'll continue to try to give you our best read on where we are. But today that's 10% over the next few quarters.
Okay. Maybe just a follow-up. David, I feel like I've asked the warehouse question every quarter, very challenging business, some of the bigger players clearly grabbing some market share. I know you have this goal of trying to hit $500 million. I guess my question is, how do you think about that business as we move forward? I mean, it's obviously a very small piece with Guaranty layered in. I mean, you still think it's even worth being in at this point?
We do, Michael we're getting a little bit of traction. We've kind of been growing those averages balances about 10% a year. Now to your point at 10% a year on $130 million or $140 million base, it would take a while to get to $500 million, which was our target, when we did the Carlile deal back in 2017. I think given the environment we're in, it's going to take us longer to get there, but I do think we'll get there. We have reorganized a little bit here internally and we've hired a new executive in that area as well this quarter.
And so we'll see, we feel optimistic, but as you said it's a tough slog in that business and we never aspire for it to be a big $2 billion or $3 billion $4 billion piece of our balance sheet. But I do think over the next three years depending on the market we can get it to that $500 million range, but that's a three year objective now as opposed to how we get to it more quickly originally.
Great color. And maybe just one more for me for Michelle. Sounds like there are some one-timers or maybe non-recurring expenses this quarter and bonuses. Looks like healthcare costs were a little elevated. Should we expect expenses to actually be down quarter-on-quarter?
I think on a core basis, Michael, when I went and looked at the details, there is probably close to $1 million of expenses in the third quarter that shouldn't recur in the fourth quarter. Some related to what you said not necessarily. If you look at our non-GAAP reconciliation, we do pull out the severance and bonuses related to Integrity, but not just their normal run rate salary. So we had some of those people through August that are no longer with us.
As you mentioned, our health insurance was outsized, that was probably the biggest surprise to me. It was about $1.3 million more than it was last quarter. Some of that just has to do with the fact that it’s the end of the year, so we have more claims. But a good portion of it is just the fact that we rolled the Integrity employees into our plan and we are self-insured. So there is probably $0.5 million in that number that's not going to recur. So there is a couple of other things, but it's generally I think it's around $1 million.
So I think normalized run-rate would be closer to 49, which is about $0.5 million more than what I had guided last quarter.
Okay. Great. Thanks for taking my questions, guys.
Thanks Mike.
Thank you. [Operator Instructions] Our next question comes from Matt Olney of Stephens. Your line is now open.
Hey, thanks. Good morning, guys.
Good morning, Matt.
Just calling for an update on the Guaranty deal, I think you mentioned not closing until early 2019. Just give us an update on the conversion timing, the cost save timing. I think in the past you've talked about that deal being about 5% accretive to your annualized earnings. With the increased competitive environment do you still feel like that's a reasonable expectation as far as EPS accretion?
Great questions, Matt. We do expect the year-end closing on Guaranty. So a lot of times we refer to that as December 31st. We typically though close it after the close of business December 31st, so that we don't -- we keep clean years, we don't have to do a partial year for either entity. So that would be effectively a January 1st closing. And then we expect all of our conversion activities on bigger deals like this, Matt, we’re very focused on getting this right.
We've had a huge internal team here on our side and I know on the Guaranty side that have been working closely for since we announced this deal in May. But really particularly focused the last three or four months on the integration and the conversion. We're really focused first of all on getting it right. And when we make a larger acquisition like this, our history tells us that our success rate and likelihood of a really good conversion and combination is better if we don't rush the data conversion and if we don't rush the name change.
And so our expectation is a June, an early June I think first weekend in June, Michelle is that right? First weekend in June conversion on the data systems. That will drive virtually all the other cost saves, Matt. So we expect to have not much of a cost saves will happen in the first quarter. We'll get some in the second quarter as we do the data conversion, but a lot of those people will stick around through June 30. And so really our first clean quarter of run rate will have most of the expenses out by June 30 so we’ll have a clean run rate by third quarter of 2019.
Then on the accretion side I’ll let, Michelle can speak more directly to it, Matt. But I think we’ve done the heavy lifting behind the scenes working with the Guaranty team and we feel good about the projections that we gave when we announced the deal in May, both on the cost safe side and on the earnings accretion side. And we haven't seen anything that's dissuaded us at all, that we're going to be able to deliver on those numbers. But Michelle do you…
Yes, so I would say it's been very positive as far as confirming, where we are on the cost safe. I think the other benefit is that Guaranty actually has been outperforming what we expected them to do. They've had a -- they had a really good third quarter, so and expect to continue that going forward. So, I don't -- at this point, I don't really see any reason that we wouldn't expect to get that accretion.
Okay, that's helpful. And then Michelle, you've talked about the efficiency ratio over time seen some improvements there, especially with the combination of Guaranty and associated costs save. So can just kind of help us that as far as expectations for efficiency as we march through 2019?
Yes, I think I've talked about this before, our -- actually our efficiency ratio was a little better this quarter than what I expected. I thought it would be a little over 50%. It will -- it should be down just a bit this quarter in the fourth quarter, probably closer to 49%, the way we calculate it. It will trend back up in Q1 and Q2 of next year, just simply because of the things David talked about.
We're really not going to get -- we may get a few cost saves in Q1 and Q2. But the branch rationalization or consolidation is not really going to occur until May, right before we do conversion. And so really, you're not going to see a trend down in our efficiency ratio really until you get to third quarter of next year. And I think by third and fourth quarter of next year, it could trend down to maybe 46% is maybe my expectation at this point.
Okay. Very good. Thank you, guys.
Thanks, Matt.
Thank you. And this does conclude our question-and-answer session. I would now like to turn the call back over to David Brooks for any closing remarks.
We appreciate everyone's attendance this morning, no further questions we’ll conclude the call. We feel as you've heard us say this morning, very good about where we are excited about the upcoming Guaranty merger. And we have a great plan I think and strategy to continue our performance on into 2019. I hope everyone has a great day and a great rest of the week. Thanks.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect.