Independent Bank Group Q3 2023 Earnings Call Transcript

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October 24, 2023

There are 9 speakers on the call.

Operator

As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Ankita Puri, Executive Vice President and Chief Legal Officer. Please go ahead.

Speaker 1

Good morning, and welcome to the Independent Bank Group Third Quarter 2023 Earnings Call. We appreciate you joining us. The 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 We intend such statements to be covered by Safe Harbor provisions for forward looking statements.

Speaker 1

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.

Speaker 1

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. And with that, I will turn it over to David.

Speaker 2

Thank you, Ankita. Good morning, everyone, and thanks for joining the call today. 3rd quarter earnings totaled $32,800,000 or $0.79 per diluted share. During the quarter, we were pleased to see healthy organic core loan growth of 4.5% annualized as demand began to pick up in our markets. While we did see some additional uptick in deposit costs due to the intra quarter Fed increase, we are pleased that our overall Loan book yields continue to march upward.

Speaker 2

As at this point, we believe that we are around the bottom We also were able to decrease our loan to deposit ratio to 92.7% atquarterend compared with 95.1 percent at prior quarter end by growing our certificates of deposit and paying off some short term FHLB advances and borrowings. At quarter end, our balance on FHLB advances outstanding was lower than the end of last year. This comfortably positions our balance sheet to navigate an environment with sustained macroeconomic uncertainty and allows us to continue to serve our customers and communities throughout the economic cycle. Fee income remained stable both quarter over quarter and year over year. In addition, Our focus on expense discipline resulted in total non interest expense declining to $81,300,000 for the quarter.

Speaker 2

As Dan will discuss, credit metrics remain excellent and low non performing assets and net charge offs totaling just 1 basis point annualized for the quarter. While we remain watchful for any signs of stress in our markets, credit trends indicate that we continue to be supported by the strong foundation of conservative underwriting that we have maintained over 3 decades. Capital ratios ended the quarter in a healthy position with the Tier 1 capital ratio At 10.21%, the total capital ratio at 11.89%. Notably, our TCE ratio also remains strong at 7.35 percent as of September 30. With that overview, I'll now turn the call over to Paul to give some more details on the financials.

Speaker 3

Thanks, David, and good morning, everyone. Net income for the quarter was $32,800,000 or $0.79 per diluted share compared to $33,100,000 or $0.80 per diluted share in the linked quarter. Net interest income was $109,000,000 for the 3rd quarter compared with $113,600,000 in the linked quarter. During the quarter, we saw incremental upward pressure on deposit costs due to the Fed hike, as well as incremental non interest bearing attrition. These factors were partially offset by increases in loan units.

Speaker 3

Net interest margin was 2.60 percent for the 3rd quarter, down 11 basis points from the linked quarter. NIM was primarily impacted by the attrition of non interest bearing deposits as well as higher rates paid on interest bearing balances, which were not offset by a corresponding increase in earning asset yields. While NIM came in at the lower end of our expectations, we are encouraged that our modeling and trends indicate a likely bottom for NIM around these levels. Thus we expect NIM to further stabilize in the Q4 and we expect that NIM should begin expanding in the Q1 of 2024 as earning assets continue to reprice. The exact trajectory of NIM will be influenced partially by external factors, but we are encouraged by the stabilization of non interest bearing deposits following quarter end and the healthy sales pipelines we are seeing for both higher yielding loans and lower cost deposits.

Speaker 3

Total adjusted uninsured deposits declined in the 3rd quarter to 29.9% from 31.1% in the linked quarter. Uninsured deposits are currently paid highly competitive rates, limiting additional downside risk to deposit costs for the bank as short term rates peak. We also continue to pay down our higher rate borrowings such as FHLB advances and our holding company line of credit in the 3rd quarter, while increasing broker deposits, which remain less expensive than short term borrowings at this point in the cycle. Total borrowings were just $546,600,000 September 30, lower than the total borrowings were at year end 2022. The substantial contingent funding capacity available to us and the low level of borrowing utilization strengthens our balance sheet against any subsequent shocks and positions us well to capitalize on sustained growth and earning asset yields.

Speaker 3

To that end, contractual maturities of our fixed rate loans are poised to grow in 2024 even as payoffs remain at low levels. This should provide a consistent tailwind to loan yields and help support NII even if near term rates remain at their peak. Provision expense was $340,000 for the 3rd quarter, which was impacted by improvements to Moody's macroeconomic scenarios. Going forward, we expect provision that represents about 1% of total loan growth. This is of course dependent on all else being held equal in the CECL model, which could of course be impacted by further changes to the macroeconomic forecast or any specific reserves.

Speaker 3

Non interest income was $13,600,000 for the quarter, down slightly from adjusted non interest income of $14,100,000 for the linked quarter. Non interest expenses totaled $81,300,000 for the quarter, down from $85,700,000 in the linked quarter. 3rd quarter non interest expense was partially impacted by a $2,200,000 reduction in expenses related to executive compensation. We continue to pursue expense discipline and gear the organization appropriately for the current environment. These are all the comments I have today.

Speaker 3

So with that, I'll turn the call over to Dan.

Speaker 2

Thanks, Paul. Core loans held for investment excluding mortgage warehouse loans increased by $154,700,000 or 4.5 percent annualized in the 3rd quarter. New loan production came in roughly in line with our expectations as deal activity has started to pick up across our markets in Texas and Colorado. Average mortgage warehouse purchase loans were $425,900,000 for the quarter, up from $413,200,000 in the prior quarter. We saw relative stability in these balances on a month to month basis and we currently anticipate these balances to remain stable in the Q4 despite the seasonality.

Speaker 2

Credit quality metrics continued to remain strong during the Q3. Nonperforming assets totaled just 33 basis points of total assets at quarter end and the bank had just Single basis point of annualized charge offs for the quarter. Overall asset quality trends remain stable. And while we are always vigilant against emerging risks, we currently do not see any areas of concern across the loan portfolio. These are all the comments I had related to the loan portfolio this morning.

Speaker 2

So with that, I'll turn it back over to David. Thanks, Dan. As we enter the Q4, we remain encouraged by the trends we are seeing in our business. Healthy loan growth has returned. The NIM seems to be stabilizing at its bottom, our fee income remains consistent, credit trends remain strong and we continue to exercise discipline We are especially encouraged by the continued strength of our 4 high growth markets across Texas and Colorado, Most of all though, our success in growing the bank in this challenging environment is made possible by the incredible team we have across our footprint.

Speaker 2

I'm especially grateful to every one of our employees who show up each day to carry the torch of the culture that we've built over these 3 decades and who never stray from the mission of providing exceptional service Thank you for taking the time to join us for the call today. We'll now open the line to questions. Operator? Thank you.

Operator

We'll now be conducting a question and answer session. Our first question is coming from Brady Gailey from KBW. Your line is now live.

Speaker 4

Thanks. Good morning, guys.

Speaker 2

Hey, good morning, Brady.

Speaker 4

So I just wanted I mean expenses came a lot better than I think you guys had previously expected. I think I saw in the release there was some maybe incentive reversals and some other noise in the quarter. So I was just wondering as you look at Forward expenses, especially as we head into next year, how are you thinking about the run rate and our expenses Stable here? Are they modestly growing?

Speaker 3

Yes. Thanks for the question, Brady. We certainly are continuing to focus on expense discipline across the company and just mindful of really gearing the company for the current environment. You noted a couple of one time items in the 3rd quarter, but I think $83,000,000 to $84,000,000 is a good run rate for non interest expenses for the Q4 and beyond, we do expect to be able to hold expenses down in 2024. We will have some growth, but we will have some offsets on the other side.

Speaker 3

So we're confident in being able to hold that flat at that 83%, 84% rate for at least a few quarters.

Speaker 4

Okay. All right. And then credit quality remains just so clean for you guys. I think the market does see the above average commercial real estate exposure and they're just a little nervous. I know you guys have looked at stress testing and when you have a rate reset that goes notably higher, what that does to cash flow and etcetera.

Speaker 4

So maybe just give us an update on how you guys are thinking about the health of the commercial real estate Portfolio as we head into 'twenty four.

Speaker 2

Hey, good morning, Brady. This is Dan. I would say, we gave some good color at the last The quarterly call, but we continue to feel very good about the book that we have. And as we've discussed before, that is related to just Sticking to the core philosophies that we've had over the years and that would result in the granularity we've seen with average sizes of $2,000,000 or less in the CRE book, in strong markets where we've had strong NOI growth. And as you know, we've been a high CRE bank Over the last 30 years through each cycle with the same type of discipline that we've employed over the last 5 years In particular, as we've headed into the current conditions, and we believe that will continue to serve us well.

Speaker 2

Grady, this is David. One additional comment. Just our structure is a little different. Here, our credit and The lending teams work together as a team. Credit is not a support to our growth function.

Speaker 2

It is Part and parcel to how we grow our bank and credit and risk sits at the table on all The decisions and has a bigger hand in our company that I think is typical across our regional bank competitors. So It just puts a little different inflection on our risk filter and how we structure deals and how we don't Stray from what we've done for the last 30 plus years.

Speaker 4

Yes. Okay. And then finally for me, So the margin will be flattish next quarter and then in 2024, it should start to increase just from the Loan yield going up and deposit and funding cost staying flat. Any idea how to think about the magnitude of how much Upside could be in the margin next year?

Speaker 3

Yes. It's going to depend a lot on factors and specifically rates and what happens there. I'd say in a flat rate environment, if you assume that the Fed holds Overnight rates where they are right now and we continue to gain a little bit of pricing power due to where the longer durations of the curve are going or at least heading for the last quarter, we would expect to be able to see some nice expansion in 2024. It's going to be more gradual on the way up obviously than it was on the way down. But we do expect, especially given what we have re pricing and what's in the pipeline to see some nice lift in the margin, especially in this back half of twenty twenty four.

Speaker 5

Yes, Brady, Paul and I

Speaker 2

were talking about this yesterday actually and It's we know pretty well contractually what's going to reprice We can we know kind of what we think our loan growth is going to look like, all those things. Where we had a challenge, I think our the entire Markets had a challenge has been predicting deposit costs, right? Predicting deposit betas and what's going on with Petition and what the Fed is going to do and the long end of the curve coming up and all those things that we don't control. Yes, we're just being a little bit cautious. We do know the nimble and flat positively in 2024.

Speaker 2

But really the things as Paul said that rates and deposit pressure and all that, Yes, we believe it's leveling out. It appears to be leveling out, but it's been pretty dynamic in the changes this year.

Speaker 3

I will add though, Brady, that we have a nice setup for the 4th quarter. The bulk of our loan production came in the last 2 weeks of the quarter. We're already up for the Q4 about $100,000,000 in loan volume. So we're pretty optimistic about our ability to see that stability and that inflection in 2024.

Speaker 4

Okay. All right, great. Thanks for the color guys.

Speaker 2

Hey, thanks, Brie. Thank you.

Operator

Next question is coming from Stephen Scouten from Piper Sandler. Your line is now live.

Speaker 3

Hey, good morning everyone. Appreciate

Operator

it. Thank you. Good morning, Steve. You guys just spoke to kind

Speaker 6

of your The contractual repricing on your loan book, could you give any detail in regards to the magnitude of those Expectations in 2024 that might help us kind of do the math a little bit better for the potential upside to the NIM?

Speaker 3

Yes, absolutely. So we had about $442,000,000 Stephen of gross loan production in the Q3. I expect that to go up to be a little above $500,000,000 in the 4th quarter and we expect over $2,000,000,000 of contractual roll in the 4th sorry, 2024. And so I think if you look at pay downs, payoffs, where the cash flow coming off the book is, you should have anywhere between $2,000,000,000 $3,000,000,000 of repricing activity in 2024 for our latest models.

Speaker 6

Okay. And on the average, what sort of the kind of roll off, roll on yield there? What kind of spread are you picking up over The old loans versus the new loans?

Speaker 2

Hi, Stephen. This is Dan. I'll answer that one. We're seeing pricing averaging the high 7s on new and renewed credits. And honestly, with the long end of the market up, we expect to continue to be smart on adjusting rates according to that As we move forward, I'd say high 7s is the quick answer to that today versus rolling off around 4.

Speaker 2

Yes. 4.5, yes.

Speaker 3

Around 4.5.

Speaker 6

Okay, great. That's fantastic. And then maybe just the last thing for me. I think you guys kind of spoke to some stability you're seeing on the non Maybe even since quarter end. So how I guess, what are you seeing there specifically?

Speaker 6

And maybe do you think that can stabilize or do we still likely have just a decline, but a slower pace of decline?

Speaker 3

Yes. As David noted, Stephen, it's really difficult to predict The directionality of non interest bearing deposits, but from what we've seen since quarter end, quarter to date for Q4, We were within $10,000,000 $11,000,000 of our balances at quarter end. So we've seen very good stability there this quarter. And we're obviously optimistic that we'll be able to notch some wins in our deposit sales pipeline as well. Our treasury teams are working very hard on making sure that they're getting in front of the customers and that we're winning business.

Speaker 3

It's a very competitive environment. But we feel pretty confident in where we are for the Q4. But far as a long term trajectory, it's difficult to ascertain given there's so many exogenous factors going on this cycle.

Speaker 6

Yes, absolutely. Understood. Well, thanks for all the color. Appreciate it, guys.

Speaker 2

Thanks, Steve.

Operator

Thank you. Next question is coming from Michael Rose from Raymond James. Your line is now live.

Speaker 7

Hey, good morning guys. Thanks for taking my questions. Just wanted to start with the bond book. I noticed That the duration is now up to 7.7 years. Just given where your capital levels are, I mean, is there a thought process around restructuring The bond portfolio and maybe using some of the excess cash that will roll off the loan and the securities book here to do that or just Wondering to get some general thoughts just given the duration has continued to extend out.

Speaker 3

Obviously, Michael, we've looked at different scenarios, but as it stands today, we don't have any intention of pursuing a bond portfolio restructuring. I don't think that's something that we would consider. We're in a mode to really preserve and accrete capital at the moment. We think that's the right place to be at this point in the cycle. And so that's not a utilization of capital that I think is high on our priority list, even though you would get some meaningful NIM benefit from it.

Speaker 7

Okay. Appreciate that, Paul. And then just as a follow-up, just wanted to talk about the warehouse. The balances came in, I think a little bit higher than what we've seen from some of the other players that are in the space. Just with average balances actually being up Q on Q, just wanted to get any sort of outlook you might have for the warehouses as we move forward?

Speaker 2

Michael, this is Dan. I'll take that one as well. I think we communicated last quarter that we expected them to be Certainly flat at these higher levels that we have experienced early part of the year. We continue to think that's going to be the right look as we move forward into 2024. We have had the opportunity to pick up some new really nice customers in that space.

Speaker 2

You have some normal seasonality that takes place in the Q4 and Q1, but on average we expect 24 to be at

Speaker 7

And then maybe just a quick one finally for me. Just on the office book, I appreciate all the color you guys continue to provide in the slides. Do you have a sense for what the reserve allocation is

Speaker 2

CRE book to the extent there are any downgrades or issues that come up on that, it Picked up in the CECL model, but there's not a separate allocation for that.

Speaker 7

Were there any downgrades in that portfolio this quarter?

Operator

Your next question is coming from Brandon King from Truist Securities. Your line is now live. Hey, good morning. Good morning, Brad.

Speaker 5

So I'm trying to put together the pieces for how we think about NIM going forward. And if you could just give us your thoughts on loan yields and how they're projecting going forward, could we see similar increases quarter over quarter over the next couple of quarters as we saw in the 3rd quarter?

Speaker 3

I would expect the increase in the loan yield to actually expand. As I mentioned earlier, Brandon, the bulk of our loan production for Q3 came in the last 2 weeks of nicely for Q4 to see some more expansion in loan yields. We would also expect that $100,000,000 plus of production we've seen of net growth that we've seen so far this order will set us up nicely to see the loan yields continue to expand. And as Dan mentioned, we're constantly looking at the curve and looking at where competitive pressures are. Obviously, having some other banks go to the sidelines gives us some opportunity on the pricing side to push rates up a little bit.

Speaker 3

So We're being very deliberate and we're being very forceful in making sure that the bank is being fairly compensated for the It's taking and originating these loans. And so we feel comfortable with the directionality of loan yields at this point, more so than I think you saw in Q3.

Speaker 5

Okay. And I'm not sure if you've done this exercise, but could you give us a sense of when you think that rate of change in loan yields would peak, I guess sometime in 2024.

Speaker 3

Oh, gosh, that would be it's again so dependent on external factors. I wouldn't want to give you a guide and then have a rate cut come and blow it up, but we certainly would expect that that rate of change will continue at least through 2024.

Speaker 5

Okay. Okay. And then how are we thinking about how are you thinking about deposit growth from here, I know the loan to deposit ratio declined in the quarter, it's at 93%. Do you think you can maintain kind of that level?

Speaker 2

I think our

Speaker 6

Brandon, I think

Speaker 2

our loan growth will continue on and thereby we need to To grow the deposits is part of our relationship strategy. So we'll we think we'll continue to grow deposits and loans at Equal rates in the mid single digits going forward.

Speaker 3

Yes. And I'll just note Brandon, really during the Q3 that push for the loan to deposit ratio to come down That was a real deliberate strategy that we employed to trade a little bit of earnings for some balance sheet strength, which we think positions us very nicely to capitalize on the growth opportunities that we've seen. We feel really comfortable with where the loan to deposit ratio is right now and we feel very comfortable with where the balance sheet is right now. We think it gives us a lot of optionality at this point in the

Speaker 5

Okay. I'll hop back in the queue. Thanks for taking my questions.

Speaker 2

Thank you.

Operator

Our next question is coming from Matt Olney from Stephens. Your line is now live.

Speaker 8

Hey, thanks. Good morning, guys.

Operator

Good morning, Adam.

Speaker 8

On the margin, Paul, you gave us some good commentary about some tailwinds for the margin throughout the quarter. I think you mentioned some better loan growth at the end of 3Q and Some better loan resets over the last few weeks of 3Q. Do you happen to have that margin by month in the Q3 just to help us get more comfortable with that margins stabilizing even more so in the Q4?

Speaker 3

Yes, the margin, I don't have the numbers right in front of me, Matt, but I will tell you that the margin went up From August to September. So we did see a little bit of expansion intra quarter.

Speaker 8

Okay. That's great.

Speaker 6

That's what I was

Speaker 8

looking for. And then what about a lot of commentary on the margin. What about the NII? Anything unique there as we think about our forecast? Or should it follow the margin as far as being stable in the Q4 and then expanding it early next year?

Speaker 3

I think given where we're holding cash levels, I'd expect NII and margin to be correlated pretty much. Obviously, that will depend on the magnitude of balance Growth we get, we do certainly expect NII to be stable in the Q4 and then to see some expansion in 2024 and throughout 2024.

Speaker 8

Okay, great. And then on the deposit costs, you mentioned that's obviously the big variable here. Those deposit costs went

Speaker 2

up a little bit more than

Speaker 8

I was Back then in 3Q and a little bit more than we've seen our peers. Any more commentary on kind of what we just saw in the Q3? And remind us of your deposits that are indexed that have automatic resets if the Fed moves. Any commentary on that as we think about forecast for next year?

Speaker 3

Yes, absolutely. A couple of notes on deposit costs from the Q3, primarily flipping from borrowings into deposits. Obviously, increased deposit costs more than it otherwise would have. But again, we were pretty deliberate about reducing those borrowings. So I think on an aggregate, when you look at funding costs, while we did see we did take a little bit more expense to pursue that balance sheet strength, we're comfortable with the position that we have.

Speaker 3

As it pertains to index deposits, we've been much more deliberate about that this cycle. We have $3,000,000,000 to $4,000,000,000 of indexed deposits that will move immediately with the Fed. We would expect to be able to move rates pretty quickly if the Fed cuts. So in any scenario where you see Fed cuts in 2024 that's going to materially help us in terms of the income statement NII in the NIM.

Speaker 8

Okay. And Paul, that last point was kind of my follow-up there. Maybe expand on that as far as kind of The ideal scenario for Independent Bank's margin NII's with respect to the Fed next year. What's Lots of variables out there, but what do you prefer to see?

Speaker 3

Well, we certainly are trying to position the bank for any scenario. So we I'll just make a broad comment that we're trying to make sure that the balance sheet is well positioned to weather whatever the macro throws at it. That's our objective 1st and foremost. As it pertains to what benefits us the most, obviously, the positive slope in the curve and some big cuts they're going to help us meaningfully. I think they're going to help us more meaningfully than they've ever helped us before as a company.

Speaker 3

And that gives us some optimism and some hope that as we start to see the macro stabilize and evolve and you start to see the long end of the curve If the Fed is active in cutting next year, that's going to be really good for us.

Speaker 6

Okay. Thanks guys. Appreciate it.

Speaker 2

Thanks Matt.

Operator

Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over

Speaker 3

to David for any further or closing comments.

Speaker 2

Thank you, Kevin. I appreciate it. Appreciate everyone dialing in this morning. We continue to, as Paul emphasized today, position the company for whatever The future brings and we're in a good position. We feel good about the growth and And so thanks for joining us today and we look forward to seeing you out on growth.

Speaker 2

Take care.

Operator

Thank you. That does conclude today's teleconference webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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Independent Bank Group Q3 2023
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