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Independent Bank Group Inc
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Greetings and welcome to the Independent Bank Group’s Third Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]
I would now like to turn the conference over to your host, Mr. Paul Langdale, Vice President, Investor Relations for Independent Bank Group. Thank you, you may begin.
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’s third quarter 2019 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 actual and expected results to differ. We intend such statements to be covered by Safe Harbor provisions for forward-looking statements. Please see page 5 of the text in the release or page 2 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.
Thanks, Paul. Good morning, everyone and thank you for joining today’s call. I will briefly cover some of the third quarter highlights, Michelle will provide detail on operating results, and Dan will discuss the loan portfolio. And I will be back at the end with closing remarks, and to open it up for questions.
Independent Bank Group had another solid quarter with adjusted earnings per share of $1.45 and adjusted return on average assets of 1.56% for the quarter. Our consistent earnings growth reflects that we operate with a focus present in four of the best markets in the country.
Organic loan growth was 5.6% for the quarter and 6.5% annualized year-to-date. Our disciplined approach to growth demonstrates a continued commitment to the conservative credit culture that has served as well for over three decades.
Asset quality metrics remain at historical strong levels with total nonperforming assets representing just 12 basis points of total assets at quarter end. Additional our deposit growth effort continues to show results with organic deposit growth of 7.7% annualized for the quarter.
I’ll now turn it over to Michelle, who will provide additional details on operating results for the quarter.
Thank you, David. Good morning, everyone. Please note that on slide 5 of the presentation includes selected financial data for the quarter. Our third quarter adjusted net income was $57.8 million or $1.35 per diluted share compared with $36.6 million or $1.20 per diluted share for the third quarter last year, and $52.9 million or $1.22 per diluted share for the linked quarter.
As you can see on slide 7, net interest income was $125.4 million in the third quarter up from $86.3 million in the third quarter 2018, and down from $129.6 million in the linked quarter.
The net interest margin was 3.84% for the third quarter compared to 4.11% for the linked quarter and 3.94% third quarter last year. Total accretion income decreased $6.4 million from the second quarter of 2019 which explains most of the decrease in NIM and net interest income. The NIM and its all purchase line accretion decreased 6 basis points from the linked quarter primarily due to lower yielding assets related to pricing competition on loans.
Total non-interest income was $27.3 million compared to $12.7 million in the third quarter of 2019, and $16.2 million in the linked quarter. The $14.6 million increase compared to the linked quarter includes $6.8 million in gains on the sale of consumer and residential mortgage loan pools which were acquired in the Guaranty deal as well as $1.5 million gain on the sale of a branch.
Mortgage banking revenue also increased by $1.1 from the linked quarter reflecting increased demand partly driven by refinance activity due to the interest rate environment. Additional increases from the linked quarter were related to mortgage warehouse, fee income and other miscellaneous fees.
Total non-interest expense was $76.9 million for the third quarter, a decrease of $1 million from the linked quarter. Acquisition expense increased by $5.7 million and includes a $6.9 million charge for Guaranty’s debit card provider contract which was terminated after the operational convergence in July. In addition, we reported impairments on a right of use asset for a closed branch and CRA investment plans totaling $12 million during the quarter. These increases were offset by $2.9 million decrease in salaries and benefits and $3.1 million decrease in FDIC insurance expense for the Small Bank Assessment Credit as well as the $1.5 million decrease in operational losses from the second quarter.
Slide 17, shows our deposit composition and cost. Total deposits were $11.7 billion as of September 30, 2019. Organic deposit growth was $225 million or 7.7% annualized for the quarter partially offset by $27.7 million transferred in connection with the branch sale on July.
The average cost of interest-bearing deposits was 156 basis points, up 30 basis points from the third quarter of 2018, and up 3 basis points from the linked quarter. While deposit costs peaked in July we started trending down the fee basis points each month in August and September. We’re actively monitoring deposits products and costs and have lowered rates on certain account costs and promotional products.
That concludes my comments, I’ll turn over to Dan to discuss credit metrics and give color on the loan portfolio.
Thanks, Michelle. Good morning. Organic loan growth was $152.9 million or 5.6% annualized for the quarter. Overall, loans held for investment not including mortgage warehouse purchasing grew to $10.9 billion at September 30, 2019, compared to $10.8 billion 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 September 30, 2019, commercial real estate makes up 51.0% loans, which has declined from 51.4% 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. Mortgage warehouse purchase loans averaged $434.1 million for the quarter ending September 30, 2019, compared to $395.9 million for the quarter ended June 30, 2019, representing an increase of approximately $138.2 million or 46.7% for the quarter. This break partly reflects seasonality and the impact of lower mortgage rates during the quarter as well as our focus on growing this line of business this year.
Credit quality metrics remain strong with total non-performing assets decreasing to $18.4 million or 0.12% of total assets at September 30, 2019, compared to $28.0 million or 0.19% of total assets at June 30, 2019.
The decrease in non-performing assets is primarily due to $4.5 in OREO sales and $5.6 million of charge-offs on two commercial credits which were partially reserved in prior periods. Despite these two specific charge-offs, overall charge-offs remain low at 0.21% annualized for the third quarter compared to 0.10% annualized in linked quarter and 0.14% annualized in the third quarter of 2019.
Provision for loan loss expense was $5.2 million for the third quarter an increase of $494,000 over the linked quarter. Provision expense is primarily reflective of the growth in our loan portfolio as well as charge-offs and specific reserves taken during the respective period. Provisional expense was elevated this quarter due to two commercial credits which were charged-off in excess of a specific reserves placed on them in the previous periods.
One of these loans is the same one that was partially reserved in the linked quarter with the other being an energy loan and that is when you should workout for several quarters. These are all the comments that I had related to a loan portfolio this morning.
So with that I'll turn it back over to David.
Thanks Dan. With the successful conversion of the Guaranty Bank Group acquisition behind us now, we are taking advantage of this period of relative quiet on the M&A front to ensure the company is well positioned for our next phase of growth. And to that end, we focused our teams on ensuring our people, processes, technology and systems are ready to take Independent Bank Group into the future. This fine tuning of our infrastructure is designed to facilitate healthy future growth while maintaining the conservative culture of risk management that has served us well for over three decades.
While we carry out this infrastructure initiative, we continue to have strategic conversations with other banks in attractive markets. We take the long view with regard to our company and believe that continuously building strong lasting relationships with customers, employees and potential partners will best serve our shareholders’ interests.
As we embark on the next chapter of our company's history, we will continue to strive and maintain the discipline, focus and forward thinking mentality that we believe will continue to create sustainable long-term value for all of our shareholders.
Thank you for taking the time to join us today and we will now open the line for questions. Operator?
Thank you. [Operator Instructions] Our first question comes from the line of Brett Rabatin with Piper Jaffray. Please proceed with your question.
Good morning, everyone.
Good morning, Brett.
I wanted to, I guess first just to talk about the charge-offs on the quarter. I mean, you guys have had better energy exposure than most of your peer banks. Can you give us maybe just a little color on the net charge-offs and then just talking about energy generally? How do you feel about the remaining portfolio that you got?
Good morning, Brett. This is Dan. I will answer that question. The two charge-offs we had during the quarter really a continuation of two that we've had previously reserved and identified as substandard non-performing lines. We had been substantially reserved and just recognized those this quarter.
I would say in this particular energy line this is the last or the ones that had some herons from the previous downturn as we book through that. As it relates to the rest of the energy portfolio, as you know, we've been in the process of continuing to look at good opportunities and bill-to-book after we added a team in January of this year and have had a really good run there.
As you know the energy portfolio is less than 2% of our book at this point and we've been very selective ensuring picking the best of class companies that we've added at this point with management teams that have proven ability to manage through the downturn, the leverage of those types of new credits being added is less than 2x with low advance rates which were very good.
That's good color. And then, I wanted to talk about the margin Michelle. Can you maybe give us some color around the cost of funds from here, in particular can you lower that quite a bit and just maybe your outlook on the margin and how you see that playing out over the next few quarters?
Yes, there's lots of moving parts and I would say this year it's been a challenge related to margin and I do think that we are going to get a benefit from being able to lower our cost of funds. We already have seen a trend, is a short trend drive in October but we have lower deposit rate significantly.
We've been aggressive working with our relationship manager trying to get those exception rates that we made as rates were going up. Lowered, we've lowered our promotional product rates and so. I anticipate that cost to deposits could go down as much as 10 basis points this quarter just based on the trend I'm seeing right now.
The other side of that though is loan yields which is really where what put the most pressure on our margin this quarter. And as I'll tell you it doesn't look like we're seeing the same at least thus far, again it's a short time frame yields going on at the rates that they were at the end of the last quarter.
So, if we can hold that up and it will get and so continue to see the yield curve when we go up. I think we'll be able to, I'd be guessing that our margin is this quarter will be stable to mid down a couple of basis points. I don’t think it's going to contract as much as it did in Q3.
And again, I'm talking what I call core margin ex all of our accretion which was down 6 basis points this quarter.
Okay.
Okay.
And then, if I can take in one last one. I'm sorry?
I was just going to address accretion. Our accretion income was a little hard than what I expected it to be this quarter. So, I still think it's probably going to run about $7 million a quarter for the next couple of quarters, anyway.
Okay, that's helpful. And then if can sneak in one last one. Obviously a lot of noise in the expense numbers, can you give us maybe Michelle like kind of a core rates going forwards or rates were in the fourth quarter?
Yes. So, if you add back the SESC credit that we got this quarter and I have that what I would call adjusted expenses were right about $68 million. And we did have some lag in cost saves on the data processing side related to guarantee. We're having to continue some of their systems to a little longer than what we expected.
We got the conversion really well but just having access to some information, so that's we weren’t able to get some of that out. That's probably $0.5 million a quarter. Legal actually was hard than what I expected it to be and then we had some more branding costs.
So, that's what kind of the expenses were a little hard and when I got it to last quarter. We are starting to make some investments in infrastructure particularly with management. Those have the same flattish going forward, a $67 million; is probably a good number for this quarter.
Going into '20, first quarters well it's a bit hard is because of comp adjustments and those have to be probably a 3% to 5% increase through '20; is a good number to give.
Okay, great. I appreciate the lot of color.
Okay, thanks Brett.
Thanks, Brett.
Thank you. Our next question comes from the line of Woody Lay with KBW. Please proceed with your question.
Good morning, guys.
Hey good morning, Woody.
And so, looking at expenses again that SCIC benefit, did you recognize the entire benefit this quarter? Could we see some more benefit next quarter?
Yes, that's it. So, going forward, lease in returns for our regular run rate which is little over a $1 million a quarter.
Got it. And then, with deposit cost, is there any opportunity to run off some higher costing deposits or will the decrease in net cost primarily just come from cutting rates across the board?
I think it would be accommodation of those things. Woody, we've been able to really hold down our rates. As Michelle said, we've lowered all our promotional rates as rates have come down. And we're seeing renewable on some of our promotional CDs in the you know 60% 70% range.
Thereby, we are running those who aren’t willing to roll are leaving and so would so that it's going to I guess you can consider that as running off some higher the yield in deposits or a higher cost deposits.
And then, as rates continue to come down, we're able to adjust and till you adjust. So, we're actually as Michelle said earlier, encouraged about our ability so far being pretty aggressive on driving those costs down. We saw some good pickups you know in the last half of the last quarter and seems to be doing even better now for getting the full benefit of that here in October.
Got it, that's helpful. And last from me. To the energy portfolio did see some modest growth. What's the sort of target your you all have for the portfolio in terms of that to represent the loan or total loans. So, I think you said it's 2% right now, do you hope to get it to 5% maybe a couple of years?
Yes. To think our view generally is as we try to grow these other verticals that are non-CRE mortgage warehouse and in energy and C&I and equipment finance and those other lines. We generally had said around 5% each, ultimately is our bucket.
So, I think energy in the 4% to 5% of total loans is at 2% now. So, but we think that's going to take some time, that's not going to be next quarter. We have is as you know we hired a team from another bank in the Fort Worth area.
Last year they got a lot of good pretty success here moving some relationships and doing as Dan said some deals that we consider to be some of the best crates we booked in you know the seven years now that we've been in the energy vending business. The stuff we're booking now is better structured, more conservatively structured the better coverage.
So, we feel good about that. We ultimately though we peaked out in 2014, good to say history of about between 7% to 8% of our loan portfolio, we did not expect it to go back to that level at least in the near term future. We'll be targeting around 5% over time, same thing with mortgage warehouse around 5% of adjusting balances of our loan portfolio feels about right to us.
Great, thanks guys.
Alright, thanks.
Thank you. Our next question comes from the line of Michael Young with SunTrust Robinson Humphrey. Please proceed with your question.
Hey good morning, everyone.
Good morning, Michael.
Moving to ask just on the total loan growth side. What is the level of payoffs and pay downs this quarter, it wasn’t called out sort of if with higher given kind of the backup in rates if you guys saw elevated levels of that?
No, it was really pretty much the way we've been seeing it around a year, nothing extraordinary new low amounts of payoffs and refinances and so constantly are 5.5% loan growth while wasn’t at the pace that we'd expect it going into the quarter or going into the year.
We're just seeing as we've talked about previously in our on in our overheard a number of our peers talking about is the competition's got really difficult out there. There's been some competition on pricing structure that we're just not comfortable with.
And so, we passed on some deals and let some deals refinance or payoff that we could have kept and will be willing to do things that are out of our normal credit policy and credit character.
So, as we look forward are really seeing probably a 6% given what the economy is now given the way you know some non-bank insurance company, non-bank lenders as well as some banks or the approach that people are taking is leading us to believe that in our markets we're still seeing big growth that's not as jubilant as loans you know a year and a half or two years ago.
But it's still very strong good pipeline of economic activity out there but we're being cost is getting where we are in this cycle and so. Yes, we're -- so well pass up a little bit this year over last year, there they've been really pretty level over the last quarter.
Okay. So, the smarter growth is really a function of the competition, it's not if we saw an ability to get cheaper deposit it's kind of into the future, would you guys look to, maybe accelerate growth a little bit to grow in a isle a little more or is that still you just kind of don't think the markets where you want it to be right now?
Yes. We feel like again, we are just trying to tell you what we see on the ground on an optimistic, as you probably remember Michael and I, I always tend to think we can weigh percent when the markets right now [Indiscernible] and so I certainly think, we can, we have a team that's built to grow the bank, more quickly grow loan portfolio, more quickly but we just haven't seen those opportunities get through the pipeline to do our credit process and get on the books as quickly as we thought they would going into the year and it's a matter of all the things we've talked about already. So it's been going forward 6% is a better target for us.
And then just on seasonal, I didn't know if you had any early thoughts around that and what that might mean in terms of one time true-up in the first quarter on the reserve or higher provisioning levels potentially in 2020?
Yes. We're still not in a position where we can disclose a number at this point that I mean, my thought process around. We don't believe it's going to be a significant number or impact to capital at this point, especially on what I would call our originated portfolio. We don't think that number is going to be significant and we'll have to take a seasonal reserve against the acquired loan portfolios which at this point, it's primarily just Guaranty. But again, we don't think that number will have a significant impact on capital at this point.
Thank you. Our next question comes from the line of Matt Olney with Stevens. Please proceed with your question.
Thanks. Good morning everybody.
Good morning, Matt.
I wanted to go back to the core NIM discussion and it sounds like Michelle, you expect the core NIM pressure in the fourth quarter to be a little bit less than we saw in the third quarter. I just want to appreciate if the Fed does move next week and cut rates again, does your commentary already assume that or if the Fed does move next week and cut rates could get the core margin compression levels in the fourth quarter approach the third quarter levels which was down I think six bips?
Yes. It doesn't really assume anything Matt, but I don't think it changes my commentary. It really probably is, it's probably more likely it would benefit us if Fed lowers rates again because then I think that gives us more opportunity to press down deposit costs while I'm not sure that on the loan yield side that will be impacted that much at this point. So I would say it's most likely going to be stable, but down a couple of basis points either way. I mean, whether they lower or whether they don't.
Okay. And then -- No I am sorry. Go ahead David.
No, I really think that as Michelle said, I think further drops by the Fed allow us a chance to lower deposit rates and loan rates seem to have hit the deck pretty early in the downturn here. And so, while rates certainly, the floating rates could continue to go down, would continue to go down by and large given the balance in our portfolio lower rating environment going forward and this allows us to catch up from this kind of whiplash we had in the second and third quarter.
And that’s why I think, as Michelle said, we think the worse in compression versus third quarter for us, it’s better in the fourth quarter eventually we should level out and that’s certainly what our model tells us and we just got surprised I think like a lot of things in this quarter with the loan pricing pressure. So we've been very happy with the success we can get and positive rates down we think that will continue, but the loan rates they're already extremely competitive and I don’t think, the floating rate loans that loan, the fixed rate core 3 to 5 years fixed rates are going to go down lower than whatever you are.
That's great and then on the fee side, it was another great quarter of fees in 3Q and even if I take out some of the items that you call out the branch sale, the loan sale, it looks like it was still a really good quarter of fees. Anything else you'd call out that was particularly ahead of even in third quarter, just trying to get a good run rate for the fees going into the fourth quarter and specifically I think in the past, in the mortgage line you've had some hedging volatility within that anything you call out within the mortgage space?
I think the hedging on the mortgage is finally stabilized. So it's really not impacting. Mortgage had a really good quarter like most banks with a great environment. They're doing really well. I think that they're probably going to be and it looks like about the same in the fourth quarter. And it maybe down just a bit, just from seasonality and we did have some good swap fee income probably $300,000 to $400,000 more than normal and then we told the Trust Department that's about a $0.5 million in fee income. So I would say maybe down $700,000 or $800,000 from where it was this format, it's probably a good run rate.
That's all for me. Thanks guys.
Thanks. [Operator Instructions] Our next question is a follow-up from the line of Brett Rabatin with Piper Jaffray. Please proceed with your question.
David, I just want to go back to a comment you made in your prepared remarks talking about M&A and wanted to hear maybe a little more color around that and wonder what you are seeing and then if you had your preference, are you expanding more in Texas, Colorado? Are you infilling your new markets? Can you give us a little color if you can on just what you want to accomplish on what you're seeing out there?
Sure. Yes and a big part of our story last six years going on seven years now Brett, has been the M&A piece and so we continue, I continue to work diligently on that both staying in close touch with the banks here in Texas that we are interested in and given the volatility in the markets, it seems like there have been some smaller deals this year and then of course the legacy prosperity deal, but what I would call the ones in between that a billion, five billion which is a lot of the banks that we're looking at talking to. This doesn't seem to be a rush right now of sellers to sell into this environment.
So I think that's going to continue to be slow for the next few quarters in my view depending what happens with the markets and the election. Then obviously, having other discussions, let me, I guess finish on that that topic first to say, it's not our intention to go outside of Texas and Colorado with any other what I’ll call downstream M&A. And so, we're not going to go buy a $2 billion bank in Arizona, Arkansas or Louisiana as the market expansion.
And then, there continues to be a lot of conversation as all companies, ours and the others are looking at a lot of M&A in the next year or two in terms of NIM compression and being calm and how are you going to drive you shareholder returns. And so, there are a lot of other discussions going on Brett, but we continue to have discussions.
We continue to be approached by people to talk about various kinds of partnerships, but as I continue to say, let me be finished with this that we very much like that we've got, we’re in Dallas, Fort Worth, Austin, Houston, and Denver, the best markets in the country and we like that a lot and we think any move materially outside of our current footprint has the risk of kind of diluting our growth story and diluting our future in some ways and so we're being cautious around that.
That's good color and then I wanted to go back to the comments you made around growth David and it sounds like you were surprised by some of the irrationality in the market, but you're expecting to be more normalized. I am thinking about the growth over the next year. Are you expecting some level of payoffs in the loan portfolio or can you give us some color on kind of how you're thinking about originations versus the existing book and kind of challenge that banks have with the payoff activity?
Let me take the last part of that first Brett. I do not expect lower the payoff, but I don't think they're down either. I think we just continue as we look ahead to expect the same kind of payoff level we've had and thanks for that we can grow around 6% our organic loan growth.
To the irrational pricing you mentioned, I don't think it's going to become less irrational, but I just don't think it will become much more irrational I guess. There's my message there. We expect to have the same kind of behavior in the market, but in the face of that we believe we can grow 6%. If they're going to be less irrational if that's proper grammar then I think, we could grow faster, but right now given the kind of the difficulty and there have been some rates within that – it’s for seven and ten years out there and we just have chosen not to do that. But I expect that to continue as long as the long into the curve as well as it is. I just don't think it's going to get worse.
So that was the point I was trying to make Brett is, we think the loans have been booked in the last quarter and that booking in this quarter that's about as low as we think rates are going to go generally and then if we can press our deposit rates down, at least, we think we have some stability or protection there on the NIM.
And then as a follow-up to that, I know you have been wanting to grow other pieces on the loan portfolio to kind of diversify away from commercial real estate to some degree. Can you just maybe talk about your expectations for equipment finance and general C&I over the next year?
Yes. We're going to continue to make progress on that. I think we did see CRE begin to come down this quarter for the first time. I think it would have been down last quarter, but we were doing stock buybacks and our capital ratio was going down, at the same time we were diversifying. But I think, we're going to see it, I think, I believe a steady drop there may be a blip here and there a quarter depending on what we do in stock buybacks and all that but I think, generally you will see it trimmed down. We've mentioned warehouse, we had some success there. We're having success in energy side, equipment finance is kind of slow but steady.
We always knew that would be a longer build-out and then our C&I team and Colorado continues to do a great job. We're looking for ways to quote that to Texas and we think again, none of these things are going to move the needle in our CRE rates are going to be dropped by [Indiscernible] in any one quarter, but if we can just chip away at it 5, 10, 15 bips a quarter, in three or four years we'll get where we want to be which is what we have been guiding to all along.
Great, appreciate all additional color.
Thanks a lot, Brett.
Thank you. Ladies and gentlemen that concludes our question-and-answer session. I'll turn the floor back to Mr. Brooks for any final comments.
I appreciate everyone dialing in this morning and that's going to conclude our earnings call. We remain encouraged about the future of the company both near and long term. Thanks for your interest. Have a great day.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.