Q3 2022 Independent Bank Group Inc Earnings Call
Greetings and welcome to the independent Bank group's third quarter 2022 earnings call.
At this time all participants are in a listen only mode.
A question and answer session will follow the formal presentation.
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Please note this conference is being recorded.
At this time I'll now turn the conference over to and keyed up Perry Executive Vice President and Chief Legal Officer, and Peter you May begin.
Good morning, and welcome to the Independent Bank Group third quarter 2022 earnings call. We appreciate you joining us.
The related earnings press release, and Investor presentation can be accessed on our website at IR Dot I financials dotcom.
I would like to remind you that remarks made today may include forward looking statements.
These statements are subject to risks and uncertainties that could cause actual and expected results to differ.
We intend such statements to be covered by safe Harbor provisions for forward looking statements.
Please see page five of the text in the release or page two of the slide presentation for our Safe Harbor statement.
All comments made during today's call are subject to that statement.
Please note that if we give guidance about future results that guidance is a statement of managements 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 S. E T pool reckon.
Reconciliations of these financial measures to the most directly comparable GAAP financial measure are included in our release.
I'm joined this morning by our Chairman and Chief Executive Officer, David Brooks, Our Vice Chairman and Brock 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.
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 P. P. P. R.
Our markets across Texas, and Colorado are exhibiting resilience in the face of macroeconomic uncertainty and we continue to see healthy demand from relationship borrowers across our footprint.
We were pleased to see a continued increase in net interest income during the quarter as floating rate loans adjust in our short duration CRE loans begin to reprice.
Net loan growth was $326 million during the quarter, but we saw nearly three times that amount and told me production.
At the same time, we have been able to reprice loans upward while effectively play 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 four resilient markets to outperform and what is shaping up to be a complex and dynamic macro environment.
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 six 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 203000 and in PPP fees by 494000.
As of September 30th $18 5 million of acquired loan accretion and 159000 of PPP fees are left to be recognized the overall yield on interest earning assets jumped from 383 in the second quarter to $4 30 in the linked quarter. This was an increase of 47 basis points, representing an overall, earning asset beta of 31%.
Our average loan yield net of accretion and PPP income was $4 six 2% in the third quarter up 44 basis points from $4, one 8% 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.
3% 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 in interest bearing liability beta of 35%.
Slide 20 shows we have been successful in playing both defense and incremental offense and 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 need strategically in the current interest rate environment in that vein, we are managing right.
Sensitive brokerage specialty in 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 sprints 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 three times that amount as of.
Today. This new production is coming on in the mid sixes with new business being quoted in the low sevens. 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 sight to that and the bread and butter of our loan book has a five year fixed rate CRE loan that has consistently experienced a weighted average life of between two.
In three years as this book repricing over the next eight 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 carryforward interest income versus a floating or swapped alternative all in the composition of our loan book position to the NII line through for 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 on the seasonal model and that there will be no material changes to the macroeconomic forecast or other model factors.
Noninterest income decreased 400000 compared to the second quarter, mostly driven by lower net revenue from our mortgage and wealth businesses due to lower mortgage warehouse, while mortgage volumes across the industry and lower fees billed 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 a correspondent banks noninterest.
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 a lease right of use asset and related to moving employees from an operations facility into our new headquarters campus. This was offset by a one time 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're mindful of the moving part.
It's a 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 a stricter discipline in managing the expense base, and we anticipate being able to realize savings through targeted efficiency initiatives over the coming quarters.
And 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 our fourth quarter call. In January slide 22 shows consolidated capital levels overtime, all capital ratios, including the TCE ratio increased slightly from the linked quarter and capital levels remain well above regulatory.
Tori 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.
David and Paul will discuss 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 and 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 four 5% 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 four basis points annualized during the quarter.
Overall credit trends remain 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're continuing.
Continually stressing our portfolio for the impacts of higher rates and mindful of the evolving macroeconomic situation.
These are all the comments I had related to the loan portfolio. This morning, so with that I'll turn it back over to David.
Thanks, Dan.
We're 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 longtime customers even as rates continue to March higher up forward curve.
While we are mindful of the risks present in today's environment, we're 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 the budget season, where both underwriting new investment decisions with an eye toward expense discipline and re underwriting old investment decisions with an eye toward results are.
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 well now be conducting a question and answer session.
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One moment. Please so we pull for questions once again Thats star one thank you.
Yeah.
Our first question comes from the line of Brady Gailey with Keyw. Please proceed with your question.
Thank you good morning, guys.
Good morning, everybody.
Wanted to start on the expense question.
Paul I think you said expenses would peak next quarter. There was that is that also a reported expense base or more of adjusted.
So I know you'll have some some one timers in <unk> and then I think you said you're in.
In 2023, it'll be neutral or are you talking about year over year or more from that for Q kind of quarterly run rate.
So that's an adjusted number Brady so that would be.
We think were $88 seven 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, you know 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 you know I would expect that to be kind of our current S.
And we will provide an update on our fourth quarter call in January .
Okay, Alright, and then in your comments you mentioned that you know as rates continue to move higher deposit betas will be a headwind, but maybe just update us on kind of how you guys are thinking about what deposit betas would 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 taxes as cyclical a positive thing in the fourth quarter and a little bit in the first quarter on the public funds portfolio.
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 raises up toward the terminal rate, but we expect that sort of rationalize 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 from me for David.
Kind of a bigger picture question that I've heard you guys mentioned a couple of times that you're really focused on being a high performing company when I look at consensus estimates out there.
ROA of.
120 basis points or a little better or not it's kind of in line with peers. So when you think about high performance.
Do you think about it in terms of profitability as a credit like what 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 our way is is what.
A lot of folks look to and we look to as well. So in terms of our way I think we would want to be above peers. So you know as you said. It was 121 25 is purely we'd like to be better than that.
We pay attention to our O P C E as well and we pay a lot of attention to efficiency ratio the efficiency ratio because of the.
Infrastructure Bill we've been doing in the last few years has gone up not down which is not historically been the case with us and so that's something we want to get a better handle on is as Paul has alluded to going into next year.
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 will continue to invest in our franchise and processes and procedures and things, but we but we.
And then I think also Brady.
Certainly 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 you know when investors look at our company they understand that our commitment to two underwriting to the details which I won't.
What are the one with because if they've met with as they they've heard of them a number of times, but.
The principles upon which we've we've underwritten the principles upon which we are.
<unk> tried to run a consorted move you down the middle of the Fairway credit book I think it's going to serve us well.
A period, that's coming up so.
I think that's a part of it as well Brady So yes performance in the traditional metrics, but also.
Positioning the company to perform well as we come into a down cycle here next year.
Alright, great. Thanks, guys, Hey, Thanks Bruce.
Yeah.
Our next question comes from the line of Brad Millsaps with Piper Sandler. Please proceed with your question.
Hey, good morning.
Hey, Brad good morning.
Paul 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 or what you saw in.
The change in your loan yield you 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.
At that forward curve you know for.
For margin specifically as we think over the next couple of quarters, you know with the rising deposit competition will 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 'twenty three and then in Q3 and Q4 as well because we'll see that benefit.
Our fixed rate loan book repricing them as I mentioned in the commentary.
Yeah.
And David as you think about loan growth going into next year can you kind of talk about how are you guys thinking about that and then.
You know Paul in terms of how you fund. It do you think you could 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 mark a little bit more to kind of fund kind of what you see coming down the pipe.
Yes, so long they are Brad we.
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 you know eight ish percent and then as we look into next year. Our base case is for loan growth in the 6% to 8% range odd.
See if if.
If the fed were able to navigate a software and it should be better than that if it's a.
Our base case is for us.
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 position. So if there's no difficulty which is in our base case.
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 will continue to grow the portfolio and then.
As you know our base case rate as Paul was talking about with <unk>.
With the fed we Couldnt terminal rate you know in the fourth quarter or in the first quarter of next year.
Then we think you know it.
At some point in their deposit pressure will abate.
At whatever level that is and then you know our portfolio will continue to reprice all during the year next year, so that would 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 three quarters, and even with a 6% to 8% kind of loan.
Wow.
Again, assuming that we can that we can moderate our expense situation and I think we'll be in pretty good shape.
Second through the fourth quarter next year, Yeah speaking to the funding side, Brad you know, 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 you know over the next call it three or four quarters.
You know anything you know if you look at the brokered and specialty buckets that are that we have you know our utilization there is kind of 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 FHL be.
Market when you have kind of these temporary dislocations in the curve. So we will 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 I appreciate it.
Thanks, Brett.
Our next question comes from the line of Brandon King with Truth Securities. Please proceed with your question.
Thank you good morning.
Good morning, Brian .
See I wanted to get thoughts on the loan to deposit ratio is above 90, and previously you said you're comfortable with like kind of a low ninety's, 90%, mostly deposit ratio. So I just want to get your thoughts on where you can see that trending.
Near term into next year, and how that kind of plays into your deposit strategy. Thank you might become a little more aggressive pricing.
Pricing deposits to kind of keep pace with loan growth as far as matching that with deposit growth.
Okay.
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 I don't expect our loan.
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.
You play.
Playing offense and defense are protecting our core base growing our core base and then using your more wholesale we were especially 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.
It was 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.
James Hennen little above 500 million is there a certain floor level that you're comfortable running the balance sheet.
So the way we look at that brand and 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 three to five per cent 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 follow up on that.
As far as the go to potentially hold expenses flat in 2023, and 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 you know inflation will be slowing, but it's still be a little elevated.
While also investing in the business for growth.
And particularly having good performance next year with the bonus accruals and things of that nature.
Sure it wouldn't be a challenge Brandon.
We've had really a lot of continued growth as you know even during the pandemic and so as we we had a lot of.
As we built out our.
Structure and back of house, Brandon because we had to do that quickly and because we have run a lean organization you 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 into.
Of that kind of initial wave if you will would 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 too.
I'll give you an example, our internal audit.
Something that we had primarily outsourced up until two or three 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 got US a lot of consulting expense to continue to supplement that with so as we look forward.
We believe in the areas that we've been able to scale to scale, we won't need to 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 three years kind of re underwrite. It if you will look at everything.
We are thinking about doing in the days ahead, and underwrite that with a lot of rigor focused focused on what's what's the absolute return on that need to be for us to make those kinds of investments in this economy.
I think you'll just see us be much more judicious around that.
Historically been a strong you on expenses and and.
We've had a lot of work to do the last few years.
But again with another eye towards the economy, and making sure that we have all the capital we need which we believe we do.
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.
Et cetera, we just said continue to choose not to do that we don't think now's the time to do that and.
And we're doing as we mentioned earlier pretty well with our deposit base in these major markets, even though the pricing is competitive admittedly.
Some of these fast growing markets, but.
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 that's going to be great opportunity in the future, Matt, but I think it's probably on the back end of whatever you know this upcoming economic dislocations.
Thanks Scott.
Hey, Thanks, a lot Matt.
As a reminder, you May press star one to ask a question. The next question is coming from the line of Michael Rose from Raymond James. Please proceed with your questions.
Hey, good morning, everyone. Just a quick follow up questions for me.
Just as it relates to the commentary on the margin or is that based off of the core margin ex the accretion of $3 59, you're talking about the next couple of quarters and then.
Rising through the back half of the year and then if you could just kind of outline what your interest rate assumptions are that are behind that outlook. Thanks.
Correct, that's the core margin ex the accretion and really what we're looking at federal funds curve that really peaks and you know the end of Q4 beginning of Q1 of next year, and then kind of hold flat through 'twenty three so that's our assumption for market yields.
Okay. So on the current forward curve is essentially what youre using.
Correct.
Okay, and then secondarily talked about the warehouse being down about 15% is that on an average balance basis. After 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 pulled 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 had filled.
A bunch of positions where those can you just describe what kind of positions those were in.
And you know as you balance you know 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 our frontline basis.
To kind of help you continue to generate.
High single digit loan growth. Thanks.
Yes.
We have continued to hire are producing lenders even through this.
This quarter.
Michael and I think we will continue to be opportunistic there.
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 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 it will just continue to watch the market we.
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.
You know, we're kind of getting into a more balanced situation here going forward.
Okay, great. Thanks for taking my questions.
Thanks, Michael.
Thank you at this time I appreciate the question and answer session I will turn the floor back to management for further remarks.
Hey Wanna.
Say, thanks to all of our colleagues 1600 are strong across Texas, and Colorado, who make it happen everyday at the customer level, we continue to get terrific feedback from our customers on that.
We're 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 'twenty three shapes up to be an interesting year, we're all anxious to see it.
But we feel positive about where we're positioned and outlooks 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.
Yeah.