Independent Bank Group, Inc. (NASDAQ:IBTX) Q4 2022 Earnings Call Transcript

Independent Bank Group, Inc. (NASDAQ:IBTX) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Greetings and welcome to the Independent Bank Group’s Fourth Quarter 2022 Earnings Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ankita Puri, Executive Vice President and Chief Legal Officer for Independent Bank Group. Thank you. You may begin.

Ankita Puri: Good morning and welcome to the Independent Bank Group fourth 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.ifinancials.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.

David Brooks: Thank you, Ankita. Good morning, everyone and thanks for joining the call. In 2022, we reported full year adjusted net income of $209.7 million and adjusted earnings per share of $5.02. Reflecting on 2022, we’re pleased that our results illustrate the through cycle nature of our business model of healthy loan growth, strong earnings and excellent credit quality. We are in 4 of our nation’s strongest markets and we remain encouraged by the economic fundamentals in both Texas and Colorado. For the fourth quarter, we reported adjusted net income of $49.4 million and adjusted earnings per share of $1.20. During the quarter, we were able to achieve continued loan growth across our markets, while simultaneously maintaining resilient credit quality metrics.

Though deposit costs remain a near-term headwind, the sustained repricing of our fixed rate book should provide consistent tailwind to the interest income as rates remain elevated over time, even as payoffs and pay downs slow. Notably, we entered the quarter with a deliberate focus on achieving better expense discipline. In pursuit of that objective, we undertook targeted expense reduction initiatives across our business to position the organization for an uncertain economic environment. We will continue to focus on strategically managing expenses into 2023. The strategic focus on discipline is consistent with our long-standing history of conferring macroeconomic challenges early on and conservatively positioning the bank to perform throughout the cycle.

We also announced yesterday that our Board of Directors declared a dividend of $0.38 per share and reauthorized our stock repurchase plan for an aggregate amount of $125 million for 2023. We believe these capital actions are consistent with our owner-led mentality of providing consistent returns to our shareholders. With that overview, I’ll now turn the call over to Paul to discuss the financials.

Paul Langdale: Thanks, David and good morning, everyone. As David mentioned, full year 2022 adjusted net income was $209.7 million or $5.02 per share and fourth quarter adjusted net income was $49.4 million or $1.20 per share. There were several onetime items during the quarter embedded in the non-interest expense line that I’ll discuss momentarily. Net interest income before provision decreased by 3.7% or $5.5 million from the prior quarter to $141.8 million. While interest income increased by $16.1 million from the prior quarter, funding costs increased by $21.6 million versus Q3. This more pronounced increase in funding costs drove the bulk of the differential in net interest income over the linked quarter as the FOMC raised rates 275 basis points in the last 155 days of the year.

The increase in interest income versus Q3 was driven by floating rate loans repricing as well as net loan growth combined with new production funded during the quarter to replace normal amortization, paydowns and payoffs. Payoffs and paydowns slowed modestly in the fourth quarter but the consistent repricing of maturing loans should continue to provide a sustained tailwind to interest income even as deposit costs are expected to peak shortly after the FOMC reaches the expected terminal rate. Our assumptions for modeling NII in 2023 include a peak in the Fed funds rate toward the end of the first quarter, consistent with the FOMC’s dot blot, we expect the Fed funds rate to subsequently hold flat through year-end. In this scenario, our NII line should benefit from sustained fixed rate repricing dynamics throughout the year even as deposit costs present a near-term challenge.

The overall yield on interest-earning assets jumped from 4.30% in the third quarter to 4.67% in the fourth quarter, an increase of 37 basis points. The core average loan yield, net of accretion and PPP income, was 5.01% in the fourth quarter, up 39 basis points from 4.62% in the third quarter. The total cost of all deposits was 112 basis points in the fourth quarter compared to 57 basis points in the third quarter, an increase of 55 basis points. The cost of all interest-bearing liabilities was 181 basis points in the fourth quarter, up from 102 basis points in the third quarter, an increase of 79 basis points. As Slide 20 shows, we have been successful in playing both defense and incremental offense in our core deposit book, maintaining branch deposit balances despite a slight shift of noninterest-bearing balances to interest-bearing balances.

Year-to-date fluctuation in specialty verticals is mostly a function of managing liquidity needs strategically in the current interest rate environment. Deposit competition remains intense as we near the Fed funds terminal rate and we will continue to remain nimble and opportunistic in funding the balance sheet. Deposits are likely to continue to be a headwind near term to near-term NII growth until the terminal rate is reached. Still, over the medium term, our loan book should continue to serve as a tailwind even after deposit costs peak. Provision for credit losses was $2.8 million for the fourth quarter and looking ahead, we are budgeting for provision that represents about 1% of net loan growth. This assumes all else being held equal in the CECL model and no material changes to the macroeconomic forecast and other model factors.

Non-interest income decreased by $2.3 million compared to the third quarter which was mostly driven by lower net revenue from our mortgage warehouse — mortgage businesses due to lower mortgage volumes across the industry as well as lower other income. For the first quarter, we expect mortgage fee income to remain flat at current levels. Adjusted non-interest expense was $88.3 million for the fourth quarter which was down approximately $386,000 from the linked quarter. Adjusted non-interest expense excludes approximately $10.4 million of onetime charges related to the targeted expense reduction initiatives undertaken during the fourth quarter. Of this, $7.1 million is related to severance and accelerated stock listing and $3.3 million is related to the write-off of certain assets related to discontinued technology projects as well as the termination of a correspondent banking relationship.

The fourth quarter’s expense reduction initiatives will help us achieve our goal of holding the quarterly expense run rate flat through 2023. As we enter the new year, we remain focused on strategically managing the expense line and we will explore additional opportunities to realize savings over the coming quarters. 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.

Daniel Brooks: Thanks, Paul. Loans held for investment increased to $13.6 billion in the fourth quarter, up from $13.3 billion in the linked quarter. Loan growth, excluding mortgage warehouse and PPP loans totaled $320 million or 9.6% annualized for the quarter. New production during the quarter was well distributed, both geographically and by product type and we continue to underwrite with the same discipline that has guided us through past economic cycles. Average mortgage warehouse purchase loans decreased to $297.1 million in the fourth quarter, down from $402.2 million in the prior quarter. Volatility and interest rate increases more broadly have resulted in decreased demand, lower volumes and shorter hold times across the mortgage industry.

Our expectation is for this business to remain flat at current levels through early 2023. Credit quality metrics saw a notable improvement during the quarter with several large commercial credits achieving final resolution with minimal losses. Total nonperforming assets decreased to $64.1 million or 0.35% of total assets at quarter end. Other real estate owned was flat at $23.9 million during the quarter. Net charge-offs totaled just 2 basis points annualized during the quarter. 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 Colorado. Even so, we are continually stressing our portfolio for the impacts of higher rates and mindful of the evolving macroeconomic situation.

Currently, we remain very confident in the strength of our underwriting and the ability of our borrowers to navigate the current environment and we remain ever vigilant against emerging risks in the economy as we enter 2023. 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.

David Brooks: Thanks, Dan. As we enter 2023, we continue to be very encouraged by the strength and resilience of our markets across Texas and Colorado and we have been pleased to see sustained demand for high-quality business from our long-time customers even as the FOMC approaches the expected terminal rate. This sustained borrower demand, combined with our strategic focus on the disciplined management of our expense base, helps fuel our continued pursuit of through-cycle performance and healthy growth. Our priority remains to deliver value to our shareholders by running a high-performance, purpose-driven company dedicated to serving our customers and communities each day. Thanks again for taking time to join us today. We’ll now open the call to questions. Operator?

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Q&A Session

Operator: Our first question comes from the line of Brad Milsaps with Piper Sandler.

Brad Milsaps: Maybe, Paul, I wanted to start with the margin and net interest income. You kind of offered a lot of color there on kind of how you guys are thinking about it. Just maybe bigger picture, do you think most of the significant margin compression is behind you? And is there a chance that you could start to see maybe NII begin to trend up maybe in the back half of the year based on some of the fixed rate asset reprice you have? Just kind of wanted to get a better sense of kind of how you’re thinking about the trajectory of the NIM and NII as you move through ’23.

Paul Langdale: That’s exactly the right way to think about it, Brad. As we went into the fourth quarter, we were really trying to play incremental defense and offense in the deposit book. So if you look at Page 20 in our slide deck, we were really focused on ensuring we were able to grow those branch deposit balances, even though we knew there would be a bit of remix from noninterest-bearing to interest-bearing. We were successful in doing that and preserving our contingent liquidity options going into 2023. So as we look through the directionality of NIM in 2023, we expect it to bottom out at current levels flat to down just a couple of basis points for the first quarter. And then we should see that dramatic inflection in the second quarter accelerating through the third quarter as those fixed rate repricing dynamics should offer us some significant lift in NIM for the year.

Brad Milsaps: And just maybe as my follow-up, on the fixed rate loan repricing, where are you seeing those new loans and those loans to reprice to in terms of rate. Just wanted to kind of get a sense of the potential pickup. And maybe David or Dan, how are those new rates may be impacting loan demand out there in terms of where I think you’ve sort of guided to 7-, 8-ish percent type loan growth. Just kind of curious what — how those rates are impacting appetite out there?

David Brooks: Sure. Brad, this is David. I’ll talk about from a high level, we’re seeing rates come on in the mid-7s, upper 7s now in the current environment. And we expect that will slow. The Fed will likely accomplish their purpose of slowing the economy. So that’s kind of in our thinking that overall loan growth will slow a bit as we head into 2023 here. One of the things and I think you’re alluding to it and I’ll let Dan speak to this but one of the challenges will be if there are loans in the low 4s rolling to the mid-7s or upper 7s or 8s if the Fed continues on here, then that might pose one-off challenges for certain borrowers and cash flows and things. I’ll let Dan speak to the credit aspect of it.

Daniel Brooks: Yes, I think really, I would think about it this way. Conservative underwriting on the front end is really the best defense against that risk. And so we have put material interest rate shock tests in our underwriting, even a year — 4 years ago when rates are in the 4s and now they’re rolling up for maturity. But we’re looking at every credit that’s maturing in the next year and stressing it for impact on higher rates. Our early look at those has been that we see very few issues. For the few credits where a conversation will be required, we’ll do what we always have and we’ll get in front of it with our borrowers early on.

Operator: Our next question comes from the line of Brady Gailey with KBW.

Brady Gailey: So if loan growth is going to slow a bit here, what does that mean for 2023? Are we thinking more of like a mid-single-digit level potentially for this year?

David Brooks: Well, it’s seasonal as well so it’s a little tricky to try to forecast. I think 6% to 8% which is the guidance we gave at the end of the third quarter, still looks about right to us for the entire year. But it may be a little slower in the first quarter, just a lot of people are looking around here trying to figure out what their plan is for ’23. We’ve got good demand and good pipeline but I expect, based on what we know today, Brady, that we’ll probably start out with a mid-single digit here in the first quarter and then accelerate a little bit, a little bit, emphasis on little, in that 6%, 7%, maybe 8% range. And look, there’s a wide range of possibilities for 2023 and what happens with the economy. And as we’ve said over and over again and I don’t want to say it had nausea and maybe we do but the markets we’re in should give us some insulation, right, even if it’s a pretty difficult overall economic slowdown, we still expect our loans will grow and it just becomes a magnitude of how much.

Brady Gailey: Okay. All right. And then the decisions that were made on the expense base, what was the impact of those decisions? Like how much annualized expenses were taken out of the bank?

Paul Langdale: So Brady, this was really a prerequisite for us to meet our expense guidance of holding expenses flat from that run rate. So if you think about expenses, heading into 2023, I would expect them to remain in that $89 million to $90.25 million range. And this was a crucial part of heading off some of the expense headwinds we’re going to have in terms of increased FDIC assessment and things like that in 2023.

Brady Gailey: Okay. And any — should we expect you guys to consider continued changes in the expense base? Or do you feel kind of good with where expenses are at this point?

Paul Langdale: We’re going to continue to look across the footprint for opportunities to have targeted reduction of expenses. I wouldn’t expect anything programmatic like we did in the fourth quarter. But obviously, as we as we navigate, what David mentioned, is shaping up to be a very uncertain economic environment, we want to be really mindful and disciplined about managing the expense base on an ongoing basis.

Brady Gailey: All right. And then so the $125 million of buybacks, the stocks at $1.9 million at tangible book value, tangible common equity is kind of in the high 7% range, do you expect to be active on that $125 million this year?