Independent Bank Group Inc (IBTX) 2022 Q3 法說會逐字稿

Greetings. Welcome to Independent Bank Group's Third Quarter 2022 Earnings Call. The question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll now turn the conference over to Ankita Puri, Executive Vice President and Chief Legal Officer. Ankita, you may begin

Good morning, and welcome to the Independent Bank Group Third Quarter 2022 Earnings Call. We appreciate you joining us. A related earnings press release and investor presentation can be accessed on our website at ir.ifinancial.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 is a statement of management's beliefs at the time the statement is made, and we assume no obligation to publicly update guidance. In this call, we will discuss several 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'm joined this morning by our Chairman and Chief Executive Officer, David Brooks; our Vice Chairman, Dan Brooks; and our Chief Financial Officer, Paul Langdale. At the end of their remarks, David will open the call to questions. With that, I will turn it over to David

Thank you, Ankita. Good morning, everyone, and thanks for joining the call today. For the third quarter, we announced adjusted earnings of $1.33 per diluted share and strong loan growth of 10% annualized for the quarter, excluding mortgage warehouse and PPP. Our markets across Texas and Colorado are exhibiting resilience in the face of macroeconomic uncertainty, and we continue to see healthy demand from relationship bars across our footprint. We were pleased to see a continued increase in net interest income during the quarter as floating rate loans adjust and our short duration CRE loans begin to reprice. Net loan growth was $326 million during the quarter, but we saw nearly 3x that amount in total new production. At the same time, we have been able to reprice loans upward while effectively playing both offense and defense in managing the funding side of the balance sheet. As Dan will discuss, credit trends are stable, and we remain cautiously optimistic about the ability of our 4 resilient markets to outperform and we're shaping up to be a complex and dynamic macro environment. With that overview, I'll turn the call over to Paul to discuss the financials.

Thanks, David, and good morning, everyone. Third quarter adjusted net income totaled $54.9 million or $1.33 per share, an increase of $1.6 million over the second quarter. Net interest income before provision increased 6.7% or $9.3 million from the prior quarter to $147.3 million. The increase in interest income versus Q2 was driven by floating rate loans repricing, representing 17% of the core loans held for investment book as well as net loan growth combined with new fixed rate production funded during the quarter to replace normal amortization, paydowns and payoffs. The growth in interest income was partially offset by decreases in acquired loan accretion by $203,000 and in PPP fees by $494,000. As of September 30, $18.5 million of acquired loan accretion and $159,000 of PPP fees are left to be recognized. The overall yield on interest-earning assets jumped from 3.83% in the second quarter to 430 in the linked quarter. This was an increase of 47 basis points, representing an overall earning asset beta of 31%. The core average loan yield, net of accretion and PPP income was 4.62% in the third quarter, up 44 basis points from 4.18% in the second quarter.

The total cost of all deposits was 57 basis points in the third quarter compared to 22 basis points in the second quarter. This was an increase of 35 basis points, representing a deposit beta of 23%. The cost of all interest-bearing liabilities was 102 basis points in the third quarter, up from 50 basis points in the second quarter. This was an increase of 52 basis points, representing an interest-bearing liability beta of 35%. As Slide 20 shows, we have been successful in playing both defense and incremental offense in our core deposit book with both noninterest-bearing and interest-bearing branch deposits up slightly from year-end 2021 balances. Year-to-date fluctuation in specialty verticals is mostly a function of managing liquidity needs strategically in the current interest rate environment. In that vein, we are managing rate-sensitive brokered, specialty and public funds balances in line with liquidity needs, while our focus remains to grow the core branch deposit base to fund growth on the margins.

We are beginning to see increased competition for deposits in the marketplace, and we are simultaneously being nimble, opportunistic and deliberate in managing the deposit portfolio. Deposits are likely to be challenged by higher betas in the short term, which will be a headwind to near-term NII growth while the Fed rapidly spreads up the forward curve. Over the medium term, however, our loan book should continue to serve as a tailwind even after deposit costs peak. As David mentioned, net loan growth totaled $326 million for the quarter, but gross new loan production totaled roughly 3x that amount. As of today, this new production is coming on in the mid-6s, with new business being quoted in the low 7s. It is worth noting that while the net growth number represents the iceberg above the ocean surface, the bulk of fixed rate repricing activity remains out of side. To that end, the bread and butter of our loan book is a 5-year fixed rate CRE loan that has consistently experienced a weighted average life of between 2 and 3 years.

As this book reprices over the next 8 to 12 quarters, it should present a consistent tailwind to interest income growth in the base case scenario where the Fed reaches the terminal rate by year-end and holds flat by -- through 2023. When the Fed eventually pivots, we have a built-in put option via fixed rate refi penalties to carry forward interest income versus a floating or swap alternative. All in, the composition of our loan book positions the NII line or through cycle performance even in the face of near-term headwinds on funding costs. Provision for credit losses was $3.1 million for the third quarter. Looking ahead, we are budgeting for provision that represents about 1% of net loan growth with the caveat that this assumes all else being held equal in the CECL model and that there will be no material changes to the macroeconomic forecast or other model factors. Noninterest income decreased $400,000 compared to the second quarter, mostly driven by lower net revenue from our mortgage and wealth businesses due to lower mortgage warehouse mortgage volumes across the industry and lower fees build on AUM, respectively. For the fourth quarter, we expect mortgage fee income to be slightly down and for warehouse volumes to decrease about 15% from Q3 levels.

Offsetting the declines in noninterest income was stronger other fee income, which was primarily driven by higher earnings credits on interest-bearing deposits held to correspondent banks. Noninterest income was $91.7 million for the third quarter, which includes $3 million of non-GAAP adjustments driven by separation expense and the impairment of the lease right-of-use asset related to moving employees from an operations facility into a new headquarters campus. This was offset by a onetime economic development employee incentive grant related to the construction of our headquarters campus. On a core basis, noninterest expense was $88.7 million for the third quarter, an increase of $3.9 million versus the linked quarter, primarily related to increases in salaries and benefits expense as well as increased occupancy expenses. Looking ahead, we are deliberately focused on driving incrementally positive operating leverage in 2023. We are mindful of the moving parts of this equation, and we will be focused on pulling the levers that provide the greatest benefit to our shareholders going forward.

As we wrap up the 2023 planning cycle, we recognize the pursuit of this goal will require stricter discipline in managing the expense base, and we anticipate being able to realize savings through targeted efficiency initiatives over the coming quarters. To that end, we expect expenses to peak in Q4 and to be able to manage expense growth to net neutral in 2023 as a base case, with further updates to be provided on the fourth quarter call in January. Slide 22 shows consolidated capital levels over time. All capital ratios, including the TCE ratio increased slightly from the linked quarter and capital levels remain well above regulatory well-capitalized minimums. These are all the comments I have today. So with that, I'll turn the call over to Dan.

Thanks, Paul. Loans held for investment increased to $13.3 billion in the third quarter. As David and Paul discussed, loan growth, excluding mortgage warehouse and PPP loans, totaled $326 million or 10% annualized for the quarter. New production during the quarter was well distributed both geographically and by product type with no single category of loans accounting for more than 18% of new commitments. Average mortgage warehouse purchase loans decreased to $402.2 million in the third quarter, down from $467.8 million in the prior quarter. The upward pressure on mortgage rates more broadly has resulted in decreased demand, lower volumes and shorter hold times across the mortgage industry. Credit quality metrics remain healthy.

Total nonperforming assets decreased slightly to $81.1 million or 45% of total assets at quarter end. Other real estate owned increased to $23.9 million during the quarter due to the foreclosure of a hotel property in the Colorado market. Net charge-offs totaled 4 basis points annualized during the quarter. Overall, credit trends remained stable, and our loan book continues to be bolstered by a multi-decade history of strong underwriting as well as the underlying strength of our markets in Texas and in Colorado. Even so, we are continually stressing our portfolio for the impacts of higher rates and mindful of the evolving macroeconomic situation. These are all the comments I have related to the loan portfolio this morning. So with that, I'll turn it back over to David.

Thanks, Dan. We are encouraged by the strength and resilience of our markets across Texas and Colorado, and we've been pleased to see sustained demand for high-quality business from our long-time customers even as rates continue to march higher up forward curve. While we are mindful of the risks present in today's environment, we are committed to our continued pursuit of through-cycle performance and growth. As Paul mentioned, we are sharply focused on ensuring our organization is geared to be a high-performance company in 2023, which means that as we work through budget season, we are both underwriting new investment decisions with an eye toward expense discipline and re-underwriting old investment decisions with an eye toward results. Our priority remains to deliver value for our shareholders through creating a high-performance, purpose-driven company to serve our customers and communities each day. Thank you for taking time to join us today. We'll now open the line to questions. Operator?

Thank you. We'll now be conducting a question-and-answer session. (Operator Instructions) Participants that are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Brady Gailey with KBW

Thank you, good morning guys. I wanted to start on the expense question. Paul, I think you said expenses would peak next quarter. Is that off of a reported expense base or more of an adjusted expense I know you had some onetimers in 3Q. And then I think you said in 2023, it will be neutral. Are you talking about year-over-year or more from that 4Q kind of quarterly run rate?

So that's an adjusted number, Brady. So that would be -- we think we're 88.7% this quarter. We probably see that go to about 90% in the fourth quarter. And our base case estimate right now is to hold that flat. But of course, as I mentioned and David mentioned, we're taking a hard look at the expense base, just trying to make sure that we're set up for the through-cycle performance that we've had in the past. And I would expect that to be kind of our current estimate, and we'll provide an update on the fourth quarter call in January.

Okay. All right. And then in your comments, you mentioned that as rates continue to move higher, deposit betas will be a headwind. Maybe just update us on kind of how you guys are thinking about what deposit betas could be as rates continue to rip higher here?

It's hard to give an exact estimate. We're certainly seeing increased competition in the marketplace. We've had a little bit of tailwind so far in the fourth quarter. We've had some of our public funds clients do some bond issuances, which has helped a little bit. And obviously, property tax is a cyclical positive thing in the fourth quarter and a little bit in the first quarter on a public funds portfolio. But our estimate is that we're certainly going to have to face some hand-to-hand combat for deposits in the marketplace as the Fed races up toward the terminal rate, but we expect that sort of rationalized in the first quarter, although it's hard to give an exact guide on where we expect betas to go from here just slightly incrementally higher, I'd say, from where they were in the third quarter.

Okay. And then finally for me, for David, kind of a bigger picture question. I've heard you guys mention a couple of times that you're really focused on being a high-performing company. When I look at consensus estimates out there, your ROA of 120 basis points or a little better than that, it's kind of in line with peers. So when you think about high performance, do you think about it in terms of profitability? Is it credit? Like what's the -- in your mind, what are you focused on when you're looking at being a top-performing company

That's a great question, Brady. Thanks. Certainly, ROA is what a lot of folks look to and we look to as well. So in terms of ROA, I think we would want to be above peers. So as you said, if 120, 125 is peer, we would like to be better than that. We pay attention to ROTCE as well, and we pay a lot of attention to efficiency ratio, the efficiency ratio because of the infrastructure bill we've been doing the last few years has gone up, not down, which has not historically been the case with us. And so that's something we want to get a better handle on, as Paul has alluded to, going into next year. We think we do have some room on the expense side to just take a look at what we've done so far, and we have a lot of the infrastructure build-out projects are behind us now. We still got -- obviously, we'll continue to invest in our franchise and processes and procedures and things.

But we -- and then I think also, Brady, to make just certain when we think about a high-performing company, and that is to be a top performing company from a credit standpoint through cycle that we make sure that when investors look at our company, they understand that our commitment to underwriting to the details, which I won't bore everyone with because if they met with us, they've heard them a number of times. But the principles upon which we've underwritten the principles upon which we try to run a conservative down the middle of the fairway credit book, I think it's going to serve us well in the period that's coming up. So I think that's a part of it as well, Brady. So yes, performance on the traditional metrics, but also positioning the company to perform well as we come into a down cycle here next year

Our next question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Good morning. Paul, I wanted to maybe stick with the margin for a moment. You guys did get a little bit of lift in loan yields on a linked quarter basis. You talked a lot about the fixed rate repricing. Is the relationship between kind of the change in Fed funds of what you saw in the change in your loan yield a pretty good correlation going forward. I think the beta was maybe somewhere around 30%. In your mind, is that a pretty good number to stick with in terms of loan beta?

It is. That's consistent with our expectations as we kind of look forward up the Fed forward curve. -- for margin specifically as we think over the next couple of quarters, with the rising deposit competition, we'll probably see a flattening of the margin here over Q4 and maybe in Q1, but we will have some serious incremental lift in Q2 -- starting in Q2 of '23 and then in Q3 and Q4 as well because we'll see that benefit of our fixed rate loan book repricing, as I mentioned in the commentary.

And David, as you think about loan growth going into next year, can you kind of talk about how you guys are thinking about that? And then Paul, in terms of how you fund it, do you think you can do a lot of it out of the investment portfolio or do you feel like you'll need to maybe go to the wholesale borrowing market a little bit more to kind of fund kind of what you see coming down the pipe?

Yes. So loan growth, Brad, we -- where we were right a little better than we'd expected here in the third quarter. But the pipeline looks good. I'm saying we're thinking fourth quarter here is probably a little back of the 10% in the third quarter, so maybe 8-ish percent. And then as we look into next year, our base case is for loan growth in the 6% to 8% range. Obviously, if the Fed were able to navigate a soft landing, it should be better than that. If it's a -- our base case is for a mild to moderate recession in that case, we have been a through-cycle growth company, Brad, as you know. And so our customers in our markets are well capitalized, well positioned. So if there's difficulty, which is in our base case of some sort of recession next year, our customers will be able to take advantage of that.

Companies will buy other companies, people will continue to invest in strong real estate, well-positioned real estate. So we'll continue to grow the portfolio. And then as our base case rate, as Paul was talking about, with the Fed recent terminal rate in the fourth quarter or in the first quarter of next year, then we think at some point in there, the deposit pressure will abate at whatever level that is. And then our portfolio will continue to reprice all during the year next year. So that will be one of the benefits of the structure of our portfolio, and we should get some NII as well as NIM lift, as Paul said in the last 3 quarters. And even with a 6% to 8% kind of loan growth, we'll have, again, assuming that we can moderate our expense situation, then I think we'll be in pretty good shape second, due to fourth quarter next year.

Yes. Speaking to the funding side, Brad, we've really invested deliberately over the last couple of years in our retail and our treasury platforms, and we really do have a pretty strong team there that we think is going to be able to generate some incremental deposit growth for us to fund growth on the margins over the next, call it, 3 or 4 quarters. Anything -- if you look at the brokered and specialty buckets that we have, our utilization there is kind of at historic lows relative to where it has been in the past at this point in the cycle. So we feel that we can be a little nimble and opportunistic in attacking the brokered market or the FHLB market when you have kind of these temporary dislocations in the curve. So we'll continue to try to layer that in on the balance sheet. But really, our preference is to fund as much growth as possible through the core deposit base..

Thanks, guys. Appreciate it.

Thanks, Brad

Next question comes from the line of Brandon King with Truist Securities. Please proceed with your questions.

Thank you, good morning. I want to get thoughts on the loan-to-deposit ratio. I know it's above 90% and you previously said you comfortable with like kind of low 90s, 90% lotto-deposit ratio. So I just want to get your thoughts on where you could see that trending near term and through next year and how that kind of plays into your deposit strategy? Do you think you might become a little more aggressive pricing deposits to kind of keep pace with loan growth as far as matching that with deposit growth?

Good question, Brandon. We continue to believe that we can grow our core deposits, as Paul said. We think the loan growth will slow a little bit under our base case scenario for next year. And given that, we believe that our core deposit growth and then as Paul said, we can be opportunistic. So I don't expect our loan-to-deposit ratio to go outside of the 90% to 95% kind of range that we've guided to, and we'll do that. As Paul said, Plan offense and defense, protecting our core base, growing our core base and then using more wholesale or specialty treasury to fill in the gaps where we need to. But our deposit base is really stronger. Our noninterest-bearing deposits have grown this year, which is, I think, a good sign. Our core deposit base is stronger than it's ever been.

Okay. And then also in the quarter, I saw that cash balances were lower and that was used to fund loan growth as well. And I was curious, is currently sitting a little above $500 million. Is there a certain floor level that you're comfortable running the balance sheet at?

So the way we look at that, Brandon, really is 3% to 5% of the deposit base, so not necessarily assets. But I guess you could say either look at it in terms of 3% to 5% of the deposit base or 3% to 5% of tangible assets, either way I would kind of use that as a guide

Okay. And just lastly for me on the expense commentary, just a follow-up on that. as far as the goal to potentially hold expenses flat in 2023, I know there's still ongoing discussions, but I was just curious if you could provide any more details on how that could be achieved given inflation will be slowing but still be a little elevated while also investing in the business for growth and particularly having good performance next year with bonus cools and things of that nature.

Sure. It will be a challenge, Brandon we've had really a lot of continued growth, as you know, even during the pandemic. And so as we had a lot of -- as we built out our infrastructure and back of house, Brandon, because we had to do that quickly and because we have run a lean organization historically in the past, we had to use a lot of consultants and a lot of consultant spend on an annualized basis. Now as we get to the back end of that kind of initial wave, if you will, we'll be much more judicious in how we use consultants going forward. We have built out. So we've been both at the same time, adding people and building out that capacity to -- I'll give you an example, internal audit is something that we had primarily outsourced up until 2 or 3 years ago. And then we have built out our entire internal audit department continue to grow it here as we finish scaling it to where it needs to be. But in the meantime, we've got to use a lot of consulting expense to continue to supplement that.

So as we look forward, we believe in the areas that we've been able to scale to scale, we won't need the consulting expense. And then always, as you're going into a time of economic slowdown and challenge, I think it's just good business to take a hard look at all of everything we've invested in the last 3 years kind of re-underwrite it, if you will, look at everything that we're thinking about doing in the days ahead and underwrite that with a lot of rigor focused on what's the absolute return on that need to be for us to make those kinds of investments in this economy. So I think you'll just see us be much more judicious around that. We've historically been strong on expenses and -- but we've had a lot of work to do the last few years. We've got some of that done. We've still got something to do, but hopefully, that's the kind of color. We'll be able to give a lot more detail, I think, Brandon, on the fourth quarter call as we give more detail then on how we're seeing for 2023, but we've got some work to do here in the fourth quarter as we continue to work on that equation.

Very helpful. Thanks for taking my questions.

Thank you. The next question is from the line of Matt Olney with Stephens. Please proceed with your questions.

Hey, good morning. Just one follow-up on the margin discussion, Paul, I think you said that the net interest margin could flatten out in the near term in 4Q and 1Q and then potentially improve in 2Q and 3Q as the loans were priced. Can you help me translate that into net interest income in the near term? Do you still expect this momentum to continue into 4Q and into 1Q?

Yes. I think we'll continue to see net interest income growth as we grow the balance sheet, right, Matt. And so our expectation is to continue to push net interest income up. But obviously, we'll see the biggest part of the lift starting in 2Q of 23.

Got it. Okay, thanks for clarification. And then with respect to capital, we saw capital levels build slightly in the third quarter, and I'm just thinking more about your outlook for balance sheet growth. It seems like we're going to see capital levels continue to build into 2023. Am I thinking about this the right way? And then I guess, what's the appetite for a stock buyback given your base case scenario of economic pressure that you highlighted?

Matt, as we think about 2023, we do think that our capital account will continue to grow. We think it's prudent at this point in time. We pushed our dividend up pretty maturely over the last couple of years. That's always the bias of our Board would be to continue to return excess capital to the shareholders. But I think in this economic environment, also how aggressive we were earlier in the year in repurchasing our stock that we would continue to let some earnings accrue to the capital account here. We do have capacity in our buyback. We're going to be opportunistic. Obviously, there's a lot of uncertainty out there around the economy. And so if the stocks were to dislocate materially, then we'll be opportunistic and smart about how we use it. But again, with another eye toward the economy and making sure that we have all the capital we need, which we believe we do

Okay. I appreciate that, David. And then just lastly on M&A. There hasn't been much talk on these calls of the last week or 2 on M&A, but there has been kind of a flurry of activity in your Texas markets. Curious kind of what you're hearing with respect to M&A in Texas right now?

Yes. I think it's a really tough environment right now, Matt, as we've continued to talk about, I think the more uncertainty there is. I've heard a number of people say that that the possible range of outcomes for 2023 is much wider than it has been in a long time. So I think that uncertainty doesn't help. I think -- and also the volatility you've seen in bank stock prices this year, even from week to week, has been really pretty interesting to watch. So I think that doesn't do anything to help sellers think about sellers of high-quality companies. And so we've been very, very clear, I think, transparent about how we think about it, Matt, and that we want high-quality companies in the high-growth markets in Texas and Colorado. And we've got a list of those companies that we admire, that we think are well managed, well run, that are growth companies that have great deposit bases that are in the Dallas-Fort Worth, Austin, Houston, San Antonio, Denver, Front Range markets. And we're going to be disciplined to those companies.

So there are certainly opportunities to buy banks around the state. And if you wanted to go out of state, et cetera, we just continue to choose not to do that. We don't think now is the time to do that. And we're doing, as we've mentioned earlier, pretty well with our deposit base in these major markets, even though the pricing is more competitive admittedly in some of these fast-growing markets, but I think it's just a better long-term core franchise value strategy to continue to add market share in the major growth markets than to deviate at this point from our long-term strategy. And there's going to be a great opportunity in the future, Matt. But I think it's probably on the back end of whatever this upcoming economic dislocation is.

Thanks guys.

Thanks a lot, Matt.

Thank you. (Operator Instruction] The next question is coming from the line of Michael Rose from Raymond James. Please proceed with your questions

Just a couple of quick follow-up questions for me. Just as it relates to the commentary on the margin, is that based off of the core margin ex the accretion of 359 you're talking about the next couple of quarters and then rising through the back half of the year. And then if you can just kind of outline what your interest rate assumptions are that are behind that outlook

Correct. That's the core margin x the accretion. And really what we're looking at a federal funds curve that really peaks in the end of Q4, beginning of Q1 of next year and then kind of holds flat through '23. So that's our assumption for market yields.

Okay. So the current forward curve is essentially what you're using?

Correct.

Okay. And then secondarily, you talked about the warehouse being down about 15%. Is that on an average balance basis or off of the period end number?

Yes, that would be on an average balance base. What we've seen is -- and Dan can give some more commentary around this, but we've seen a few customers kind of pull back on the non-QM side. We've been really focused on positioning that book for what we think is kind of a through cycle level

Okay. Perfect. And then just kind of back to the expenses. You mentioned in the press release that you filled a bunch of positions. Were those -- can you just describe what kind of positions those were? And as you balance some of your strategic initiatives to kind of keep the expense base flattish next year, what does that kind of encompass for ongoing hiring efforts, particularly on a front-line basis to kind of help you continue to generate high single-digit loan growth?

Yes. We have continued to hire producing lenders even through this quarter Michael. And I think we'll continue to be opportunistic there. The -- we have had a terrific year in terms of attracting talent and leadership to the company and have invested a lot there. But we have plenty of capacity in our system right now to grow loans in the manner that we've spoken about. And so not concerned at all about that. And then we'll just continue to watch the market. But we have not had- certainly, it was expensive to do so. Everyone's talked a lot about salary and wage inflation this year, and we've seen that along with our peers. But we think that we're kind of getting into a more balanced situation here going forward.

Okay. Great. Thanks for taking my questions

Thank you... At this time, we've reached the end of the question-and-answer session. I'll turn the floor back to management for further remarks.

Thanks, Michael. I want to say thanks to all of our colleagues, 1,600 strong across Texas and Colorado who make it happen every day at the customer level, we continue to get terrific feedback from our customers on that. We're sober about the reality of where we are, but we remain optimistic and encouraged in our markets and with our customers are in really good financial shape. So we think 23 shapes up to be an interesting year. We're all anxious to see it, but we feel positive about where we're positioned and how it looks for the future. So thanks for joining in today, and we look forward to seeing you out at conferences and on the road.

This will conclude today's conference. Thank you for your participation. You may now disconnect your lines at this time.