Independent Bank Group Inc (IBTX) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Independent Bank Group's Third Quarter 2018 Earnings Conference Call. (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 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 actual and expected results to differ. We intend such statements to be covered by safe harbor provisions for forward-looking statements.

Please see Page 4 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 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 '18 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've 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 9 months, which is consistent with our outlook for full year 2018. Asset quality metrics continue to be at historically strong levels with nonperforming 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 operational conversion for Integrity -- 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, we'll turn it over to Michelle to provide more details on operating results for the quarter. Michelle?

Thank you, David. Good morning, everyone. Please note that Slide 5 of the presentation includes selected financial data 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 7, net interest income increased to $86.3 million in the third quarter from $72.9 million in the third quarter 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 yields 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 noninterest income increased to $12.7 million compared to $12.1 million in the third quarter last year and from $10.1 million in the previous quarter. Third quarter mortgage banking revenue and other noninterest income includes a 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 lines 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 noninterest expense increased $4.8 million from the third quarter 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 401-K 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 acquisitions.

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 decreased 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 nonperforming assets at 0.16% at September 30, 2018. Charge-offs increased this quarter but continued to be low at 0.14% annualized for the quarter. The 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 decreased 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 the 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 3 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 a 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?

(Operator Instructions) Our first question comes from Brady Gailey of KBW.

It's Mike Belmes on for Brady. So we saw some really nice deposit growth this quarter. Could you maybe give some color on what the drivers maybe specialty treasury and promotion activity during the quarter?

Yes, Mike. We did have a strong deposit growth quarter, and 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 combined approximately $0.25 billion of growth in the quarter.

Got you. So -- 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 talked about this before is that, as we get closer to an expected 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 treasurers start getting requests from our markets on, can we match this account? I have a customer that is -- 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, if you notice, we also had 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 -- it was 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. We 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 basis 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 beta is deposit funding cost. One thing that we are 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 in the past 2 quarters. So that could help us manage our costs. But I generally think you could still save 2 to 3 more basis points of compression in our margin.

Our next question comes from Michael Rose of Raymond James.

So I 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 the 9% to 11% range. It seems like that could be challenging given the persistent pay-downs 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 continued to sell assets into a strong demand from investors. So we saw -- even though we had expected some payoffs that got pushed in the second quarter to third quarter payoffs, we're really at a record all-time high given we think that's seasonal as much as anything it has to do with kind of the 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 our 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'll be working and are working currently. So we are starting 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 expect fourth quarter to be consistent with that. But we're really looking out now given your size, given where we are in the economy and what we're seeing in credit. Probably 10% yield growth where we had said 10% to 12%, expecting 12% or better. I think it's now in our view a little closer to a 10% run-rate going forward is what we expect, and plus or minus a little.

And that's inclusive of Guaranty as we go into next year?

Correct, yes. And I know they've traditionally run at kind of a 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 piece, is 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 31, January 1. 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 for year-end. And -- but then we'll get a better feel, Michael, for second quarter next year once we're -- once we have them integrated in and the lending team is integrated in. We'll get a better feel for that in 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. A 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, do 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 average 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 '17. 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 aspired 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 3 years, depending on the market, we can get it to that $500 million range. But that's a 3-year objective now I suppose. I thought we could do it more quickly originally.

Great color. And maybe just one more for me, for Michelle. Sounds like there's some one-timers or maybe nonrecurring expenses this quarter, some bonuses. Looks like health care costs were a little elevated. Should we expect expenses to actually be down quarter-on-quarter?

I think on a quarter basis, Michael, and I went and looked at the details. There's 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's probably $0.5 million in that number that's not going to recur. So there's a couple of other things that is, generally, I think it's around $1 million. So I think, normalized run-rate would be closer to $49 million, which is about $0.5 million more than what I had guided last quarter.

(Operator Instructions) Our next question comes from Matt Olney of Stephens.

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 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 time, we refer to that as December 31. We typically though close it after the close of business, December 31, so that we don't -- we kept -- keep clean years. We don't have to do a partial year for either entity. So that would be effectively a January 1 closing. And then we expect all of our conversion activities on bigger deals like this, Matt, we were 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 3 or 4 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 it's the 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 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 save 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. I would say it's been very positive as far as confirming where we are on the cost saves. I think the other benefit is that Guaranty actually has been outperforming what we expected them to do. They've 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 talked about the efficiency ratio over time. I've seen some improvements of that, especially with the combination of Guaranty and associated cost-saves. So can you just kind of help us out as far as expectations for efficiency as we march through 2019?

Yes. The thing -- I talked about this before. 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 turn 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 trim down to maybe 46. It's maybe my expectation at this point.

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.

Hey, 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, in 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 on today's conference. This concludes this program. You may all disconnect.