Independent Bank Group Inc. (NASDAQ:IBTX)
Q3 2013 Earnings Conference Call
October 29, 2013 8:30 a.m. ET
David Brooks – Chairman & Chief Executive Officer
Torry Berntsen – President & Chief Operating Officer
Michelle Hickox – Chief Financial Officer & Executive Vice President
Robb Temple – Executive Vice President
John Pancari – Evercore Partners Inc.
Brady Gailey – KBW
Brad Milsaps – Sandler O'Neill
Good day ladies and gentlemen and welcome to the Independent Bank Group Third Quarter 2013 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we’ll conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder this conference is being recorded.
I will now turn the call over to your host, Robb Temple, Executive Vice President. Please go ahead, sir.
Good morning everyone. Welcome to the Independent Bank Group Third Quarter 2013 Earnings Conference Call to discuss financial results for the third quarter 2013. I’m Robb Temple, Executive Vice President of Independent Bank and we’d like to thank you for joining us this morning. I’ll go over a few housekeeping items then hand it over to David Brooks, our Chairman and CEO to lead the presentation.
We issued our earnings release this morning and a copy is posted on our website, www.independent-bank.com. We will be going over much of the release on this call. If you’re having trouble accessing it, please call Eileen Ponce at 469-742-9437 and we will email or fax you a copy.
Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. We intend such statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the act. Please see page of the text of in this morning’s release for additional information about the risks associated with these statements. Please also note that if we give guidance about future results, the guidance will be only a statement of management’s beliefs at the time the statement is made. Predictions that we make may not continue to reflect management’s belief and we do not publicly update guidance.
In this call, we will discuss a number of financial measures considered to be non-GAAP under the SEC’s rules. Reconciliations of these non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are included in our release. At the conclusion of our remarks, we will open the telephone lines for questions. At that time, we’ll provide instructions for submitting your questions.
With those reminders out of the way, I would like to outline the agenda for this call. David Brooks will open with his thoughts regarding the third quarter results, followed by Michelle Hickox, our Chief Financial Officer who will lead you through the quarter’s operating results. Torry Berntsen, our President and Chief Operating Officer will cover the balance sheet highlights. And then David will close the presentation with an outline of the Live Oak acquisition and then open the phone lines for questions.
I will now turn it over to David who will begin the discussion of our third quarter results.
Thanks Robb. Good morning and welcome to the Independent Bank Group’s Third Quarter Earnings Conference Call. To set the stage for our presentation, I would like to remind everyone again of our key strategies. They are to grow organically, grow through acquisitions and improve efficiency and increase our profitability. We believe that our third quarter results, coupled with the announcement of two acquisitions reflect the continued successful execution of these strategies.
With that said, highlights from our recent quarter results include the following. Our core net income showed good growth during the third quarter. Core earnings were $4.6 million compared to core earnings of $4.1 million for the second quarter of 2013, an increase of 12.2%. Our organic loan production continues to grow, with loans held for investment increasing 2.9% during the quarter. This represents annualized loan growth of 11.5%. More importantly, our annualized loan growth for the first nine months of the year was 18.2%, consistent with historical trends. While the pace of our loan growth moderated from the second quarter, we are very confident about the fourth quarter. Our pipeline remains strong.
As expected, we maintained minimum compression in our net interest margin during the quarter. On a core basis, our net interest margin was 4.16% in the third quarter versus 4.20% in the second quarter. In addition, as previously mentioned, we continued to maintain proceeds from the initial public offering and low yielding accounts. As we deploy this capital to complete our current and any other future acquisitions, we believe our net interest margin and overall earnings will be positively impacted.
Our core efficiency ratio is becoming stronger with a ratio of 64% in the third quarter of 2013 compared to 65.9% at the end of June. We continue to see the benefits of leveraging our infrastructure. Importantly, asset quality remains very solid. We fully understand that a strong credit culture is a key component to our overall operations. The credit team continues to closely supervise underwriting, monitor asset quality and maintain effective credit administration.
Our non-performing asset and non-performing loan ratios remain at historically low levels. We are very pleased with our earnings performance and believe we are poised for a strong fourth quarter. Also, we remain on target to close our two acquisitions in the fourth quarter, which will further enhance our year end position.
Those are my thoughts about the third quarter highlights. At this time, I would like to ask Michelle to go over our operating results. Michelle?
Thank you, David, and good morning everyone. David previously noted that our third quarter core net income was $4.6 million, or $0.38 per diluted share, which compared favorably to core net income of $4.1 million for second quarter or $0.34 per diluted share and $3.3 million for third quarter 2012, or $0.42 per diluted share which was prior to shares issued in the IPO.
The reconciliation of non-GAAP financial measures is included at the end of the financial table that are part of the earnings release. We believe that core earnings provide meaningful information that can be useful in evaluating period over period comparisons. Our primary driver of overall operating income is net interest income. In reviewing an income statement, you should note the following.
Net interest income was $18.9 million for third quarter 2013 compared to $17.9 million for second quarter 2013 and $15.2 million for third quarter 2012.
The net interest margin was 4.20% for third quarter 2013 compared to 4.16% for second quarter 2013 and 4.49% for third quarter 2012. Excluding recognition of income from the repayment of acquired loans and the write-off of the unamortized debt origination costs related to previously issued warrants, the net interest margin was 4.16% for third quarter 2013 compared to 4.20% for second quarter 2013 and 4.48% for third quarter 2012.
The yield on interest-earning assets was 4.85% for third quarter 2013 compared to 4.92% for second quarter 2013 and 5.46% for third quarter 2012. The earning assets yield continues to be affected by the investment of the proceeds of the initial public offering in lower yielding assets pending deployment for acquisitions. The yield was also affected by a 15 basis points decline in average loan yields, reflecting reduced rates in the competitive landscape experienced in our markets during the quarter.
The average balance of total interest-earning assets grew by $67.3 million or 3.9%, 15.5% on an annualized basis, from the end of second quarter 2013 and totaled $1.79 billion compared to $1.72 billion at June 30, 2013 and compared to $1.34 billion at September 30, 2012. The year over year increase in interest-earning assets is due in part to the acquisition completed in the fourth quarter of 2012 as well as the proceeds received from the initial public offering.
Total noninterest income decreased $281,000 compared to second quarter 2013 and increased $364,000 compared to third quarter 2012. The decrease in 2013 is due to $140,000 reduction in mortgage fee income, resulting primarily from the recent increase in rates. In addition, there was a $148,000 gain on the sale of other real estate in the second quarter 2013. There were no sales of ROE in the third quarter.
Total noninterest expense increased $1.3 million compared to second quarter 2013 and increased $2.9 million compared to third quarter 2012. The increase in noninterest expense compared to second quarter 2013 is due primarily to increased acquisition expense of $483,000 for the Collin and Live Oak transactions. There was also a net increase in the FDIC insurance assessment expense of $511,000 resulting from a $253,000 expense in the third quarter compared to a $258,000 credit related to a prepaid assessment refund in the second quarter.
The increase in noninterest expense compared to the prior year period is primarily related to increases in compensation and occupancy expenses resulting from the acquisition completed in October 2012, the hiring of new lending teams and the opening of the Dallas and Austin branches. Acquisition expense also increased $268,000 over that time period.
Provision for loan loss expense was $830,000 for the quarter, a decrease of $249,000 from the second quarter of 2013 and a decrease of $183,000 from the prior year third quarter. The decrease provision reflects continued stellar asset quality as well as reduced loan growth compared to the linked and prior year quarters.
Finally I would like to remind you of a couple of things regarding income taxes. As mentioned last quarter, the company was an S Corporation until April 1, 2013 and the company had no federal income tax expense for the reported period prior to that date. Now that the company is a C corporation, 2013 second and third quarter earnings include federal income tax expense. For comparability, the financial statements also include pro forma net income for third quarter 2012 to record federal income tax expense. As if the company had been a C corporation for that period.
Also as a reminder, in connection with the change in tax status, we recorded a deferred tax asset as of April 1 which resulted in a onetime credit federal income tax expense of $1.8 million in the second quarter of this year. Year to date net income as of September 30, 2013 includes income tax expense only for the period subsequent to April 1, 2013, the day of the S corporation revocation.
That covers the highlights for operating results. So I will turn it back over to David.
Thanks Michelle. I would like now to turn your attention to third quarter 2013 balance sheet highlights and I will ask Torry to go over those highlights with you. Torry?
Thank you, David, and good morning to everyone. Once again loans and deposits increased during the third quarter and year over year from third quarter 2012. Let me provide you with some color of this growth.
Regarding loans. For the third quarter, loans held for investment grew 2.9% or 11.5% on an annualized basis. We did see some slowdown in the quarter, some of which was seasonal in nature. More importantly, our annualized growth at the end of the third quarter was 18.2%, in line with our historical trends and our pipeline for the fourth quarter is strong. The composition of the overall loan portfolio remains consistent with past reporting periods. Since third quarter 2012, loan growth has been centered in commercial real estate $183 million, C&I $88 million, and residential real estate $45 million. I also want to highlight that C&I now represents 13.4% of the portfolio. It is the highest percentage that it has been in an area that we continue to focus on.
As our loans continue to grow, our strong credit culture has allowed us to maintain outstanding asset quality. A few things to note. Total nonperforming assets remain low and stable at $24.7 million, or 1.26% of total assets at September 30, 2013, compared to 1.27% of total assets at June 30, 2013. It should also be noted that this ratio was $ 2.30% at September 30, 2012. Total nonperforming loans remain low at $6.7 million or 0.43% of total loans at September 30, 2013, the same percentage at June 30.
Our deposits continue to grow and our cost of funds has slightly improved. Specifically, total deposits were $1.54 billion at September 30, 2013 compared to $1.49 billion at June 30. The average cost of interest earned deposits declined by four basis points during the third quarter to 54 basis points compared to 58 basis points during the second quarter 2013 and declined 27 basis points compared to 81 basis points during the third quarter 2012. We repaid $8.8 million of our subordinated debt in the third quarter, $4.2 million in August and the remainder at the end of September.
Finally, return on average assets and return on average equity on an annualized basis were 0.81% and 7.30% respectively for third quarter 2013 compared to after tax returns of 1.25% and 11.11% respectively for second quarter 2013. For third quarter 2012, pro forma after tax returns were 0.81% and 10.82% respectively. I want to highlight again that we received a deferred tax credit leading to a reduction in tax expense in the second quarter of this year.
On a core pretax, pre-provision basis, return on average assets and return on average equity on an annualized basis were 1.56% and 14.05% respectively for third quarter 2013 compared to 1.54% and 13.63% respectively for second quarter 2013. For third quarter 2012, these returns were 1.57% and 20.84% respectively. IPO proceeds are only reflected in 2013 second and third quarter numbers.
That concludes my outline of the highlights of our balance sheet. David?
Thank you, Torry. I would like to conclude our presentation with a brief overview of the Live Oak acquisition since we’ve not previously discussed it. As you know, on August 22, we announced the execution of a definitive agreement to acquire Live Oak State Bank, which had total assets of $122.9 million, total deposits of $103.2 million, and total equity capital of $13.9 million at June 30, 2013. Live Oak is a full service commercial bank with one office located east of downtown Dallas near Baylor Hospital.
The acquisition adds to our presence in the Dallas community and Live Oak has a proven track record of loan growth in its marketplace with a good deposit base. Additionally, the bank has a strong medical presence which adds to our expertise in that area. Live Oak also has a very strong balance sheet in terms of asset quality and on a pro forma basis will also improve our loan to deposit ratio. I should point out again that end market acquisitions create many synergy opportunities.
In terms of the definitive agreement, the total consideration to be paid by us is valued at approximately $20.5 million, $10 million in cash and the remainder in IBG stock. We anticipate the acquisition will be accretive to earnings immediately and dilutive slightly to our tangible book value at closing with the dilution earned back in less than two years. Similar to the Collin transaction, Live Oak is expected to close this quarter. We’re excited about both of these acquisitions.
In summary, we are pleased with the recent quarter results. Based on our historical trends, we are optimistic that our growth will not only continue, but accelerate for the remainder of the year. We know that there are competitive challenges ahead, but we believe that our strong financial position and commitment to our proven business model, communities and employees will yield positive results and enhance shareholder value.
With that, we’ll open the call to questions. Robb, if you will explain the procedure for submitting a question.
Sure, David. The operator will next come online and open the call for questions. You’ll be notified when it is your turn to ask a question. Please state your name and firm prior to your question.
(Operator instructions). Our first question comes from John Pancari with Evercore. Your line is open.
John Pancari – Evercore Partners Inc.
Could you give us a little more color on the loan growth in the quarter, both on the C&I side and commercial real estate, and particularly around CRE because it looks like it came in a little bit better than what we were looking for this quarter.
John, our C&I growth was in the energy side as we’ve talked about primarily. And then our CRE, actually just I think an improvement overall in the economy is leading to transactions and we’re also finding that on the other side in terms of payoffs just from our customers selling their properties. But overall it was a little better than we thought it was going to be for the third quarter and rates were – the rate environment while competitive is still holding up broadly the way we’ve been talking about it.
I think John – it’s Torry, we had that very robust second quarter with the annualized over 27% which we said was above what typically we’d expect. But overall we did see some good pickup on the energy side as David talked about and as well our pipeline on the CRE side continues to remain strong and with those loans likely closing even more in the fourth quarter.
John Pancari – Evercore Partners Inc.
That’s helpful. And then given that color, David, are you still confident in your target for $2.4 billion in total assets by the yearend?
That will come down a lot, John, to what our deposits do in the fourth quarter. But it’s going to be in that 2.3 to 2.4 range it looks like right now based on our balance sheet where we are today, but in the 2.3 to 2.4 range.
John Pancari – Evercore Partners Inc.
And then on the loan yield side, it looks like the underlying core loan yield experts of accounting seem to have come in a little bit better than what I was looking for. Can you give us a little bit of color on what you’re seeing in terms of competition and maybe some color on where your new money yields are coming in on C&I and CRE?
I think as we’ve said on that, John, we were at 4.16 on a core basis. I think we indicated we would be close to where we were in the second quarter which is what came in. you have to remember we’ve also taken our core funding a little bit from the 58 to 54 basis points. Also when you look at that NIM going forward, it’s a big thing we pointed out in the press release and actually on the call that that sub debt was that $8.8 million of sub debt was paid off in the third quarter, but it was in two increments, but half of it being paid off right at the end of September. So we haven’t even seen the full benefit on that. But going forward to what you’re talking about on the NIM, we see the NIM for the fourth quarter being in the neighborhood of where it was for the third quarter. We see the CRE and then those loans in line with what we’ve seen in the third quarter as well.
Our next question comes from Brady Gailey with KBW. Your line is open.
Brady Gailey – KBW
I know it’s volatile quarter to quarter, but 27% loan growth in 2Q was a great number. 11% was a little less than I was thinking. But when you take a step back and look bigger picture over the next two, two and a half years, I’m modeling loan growth in the high teens to low 20% range. Is that a fair number or do you think that’s a little too aggressive?
No, Brady. Year to date it does bounce around quarter to quarter as you’ve said and that’s just the nature of having a $2 billion balance sheet. But we think – if you look through three quarters 18, a little over 18%. Our fourth quarter looks like it’s going to be significantly better than the third quarter in terms of loan growth. We’re still very confident in that 18% to 20%, low 20s range for this year. And then as we look out the next couple of years, again we have the same economists as everyone else and we think the economy is slowly getting better. In Texas it’s better than the rest of the country. So we hired four new lenders in third quarter. So we’re continuing to add lenders, add talent and look at expanding the lines of business we’re already in. I feel very good in that 18% to 20%, 21% range over the next couple of years.
Brady Gailey – KBW
And then the reserve, as you look back last year, it’s really been around that 84, 85 basis point range. Do you think that percentage will grow over the next couple of years or do you think that’s a pretty good level as far as you can see out?
I think two things about that, Brady. One is, as the general posture, we’ve been contributing to our loan loss reserve at a rate of approximately 1% for all of our loan growth, plus any charge offs of charge downs we take during the quarter. That’s been a broad rule of thumb our board has been utilizing. So mathematically that should drive the number 84, 85 up over time as we grow more towards the 90 bps and towards 1%. The challenge we’ve got as we’ve always had and the reason it’s 85 and not 1% already is acquisitions. The acquisition accounting I know there are proposals to change that going forward. But right now in these two acquisitions we’re going to do in the fourth quarter, we’ll bring on approximately $150 million or more of new loans. We can’t bring a reserve over with it from an accounting standpoint.
So unless we make a decision to hit earnings for some extraordinary charge and meanwhile as we’ve talked about previously, you put aside specific reserves against those loans. There’s another bucket if you will. If you think of it there’s another bucket over here of reserves for acquired loans that’s not included in that 84, 85 basis points. We’ve talked pretty consistently about it. If you look at our originated loans, our reserve to our internally originated loans is around 1%. If you look at it in terms of all of our loans and take the loan loss reserve we have plus the bucket of money we have for those acquired loans and specific reserves, that is about 1%. So we think about it and look at it as we’re about 1% and again because we continue to add 1% for our new loans, we think that’s broadly where we are. But the cover number, Brady may well go down in the fourth quarter because when we add $150 million of loans and don’t add reserve with it, that reserve is off in another bucket, it may drive it down a few basis points.
But we’re perennially working to get it up. The regulators have – we just finished an exam in the third quarter. The regulators like our formula. They like the way we think about it. Obviously underneath all of that is our asset quality. So we could have a reserve like this because we’ve had historically very good asset quality through the downturns and our asset quality continues to improve. So we feel good about where it’s at. From a sticker standpoint, Brady, it may drop as we make acquisitions. Until unless and Michelle, would you comment, Michelle, briefly on what the new rule is thinking about and what the timeline might be on that for acquisition accounting on loans?
My understanding is that the rule that would be considered is that you would be able to carry over at least a portion of an acquired bank’s reserve. But that got it from [indiscernible] has not been finalized and is still out for comment. So most likely the earliest would be ’15.
We’re hoping for that. We think that makes more sense, /Brady for banks that are acquiring other banks. When you bring over a portfolio, even if it’s clean you might have a little reserve against it. But right now we just have to use the rules that are in place.
Brady Gailey – KBW
And then lastly on M&A, you had two deals pending. It sounds like they’re about to close, both of them around that $100 million to $200 million in size. As you look out, obviously you guys would have liked to continue with the acquisition strategy. Do you think the future deals will be the smaller under $300 million in asset size? Or are you open or are you possibly looking at banks that would be closer to the over $500 million up to $1 billion in size?
Brady, that’s a great question. It did work out that these first two acquisitions that we’ve done since we went public are below $200 million. We see a pretty significant increase in activity and discussions and things in the banks in the $300 million to $1.5 billion range. We’re certainly active in that, in those discussions as well as continuing discussions for banks under $300 million. There’s always a lot of discussion and strategy and things going on that sometimes leads to announcements and sometimes doesn’t. You can’t really predict the future of what’s next up for us, but just to say that the activity the last six months has increased to a higher level today than it was six months ago. Maybe that’s a better way to say it. And it’s banks from $100 million to broadly $1.5 billion.
(Operator instructions). Our next question comes from Brad Milsaps with Sandler O'Neill. Your line is open.
Brad Milsaps – Sandler O'Neill
Just curious just back to the loan growth question, do you guys have a sense for maybe the number or amount of commitments you made during the quarter but maybe they just didn’t fund for whatever reason, maybe just for whatever timing or maybe it came late in the quarter. Looks like a lot of your growth did. But just a sense maybe for new customers, new relationships et cetera that may help you out as you move through the next couple of quarters.
Brad, I think what did happen as you’re alluding to is we had a lot of activity toward the end of the third quarter, a lot of new requests, a lot of big loan approvals. I don’t have a specific number in front of me. But I would say probably $40 million or $50 million of loans that we were looking at had been approved or were in final negotiations that just didn’t close in the third quarter. So the 11% annualized growth rate in the third quarter was a little less than we’d anticipated really up until the very end of the quarter just because we thought some of those loans might close. But they’ll close in the third quarter – I mean the fourth quarter. And we continue to feel good as I said earlier about an 18% to 20% plus growth organically year over year going forward. We think that the fourth quarter will certainly be stronger than the third quarter and will keep us in line in that 18%, 20% range for the year.
Brad, it’s Torry. Those loans came in, whether on the real estate side where equity was being used and on some of the new bills and equally on the energy side where a number of those deals have unfunded commitments and still those. So our fee line was strong just on the unfunded, but again there were unfunded commitments, especially on the energy side.
Yeah. Both energy as Torry said and the big construction loans, Brad that you book. Obviously they – and we have a number of significant construction projects that are just starting in the fourth quarter that really won’t fund up until 2014.
Brad Milsaps – Sandler O'Neill
And I’m sorry if I missed this color, but the four new hires you made during the quarter from larger banks, similar size to you guys. Just a sense of maybe the type and size of business they could potentially bring over, over the next 12 months.
They’re broadly from other regional banks, Brady – I mean Brad. I’m sorry. I’ve got names written on my page here. We continue to hire primarily from other regional banks, Brad and I see that continuing going forward. Most of these adds were adds to existing teams. So they’ll just pitch in incrementally on top of our strategy, a couple in the Austin market and a couple up here in the Dallas area. I don’t have a projection for what those specific lenders will do. But again it’s all part of our strategy to grow our target of growing 20% every year.
Brad Milsaps – Sandler O'Neill
And then just final question, I appreciate the detail you guys give towards in your release on breaking out some of the miscellaneous expenses, but a couple of specific items. Will the stock ranch, is that something that is going to continue to recur at that level from quarter to quarter? And then second question would be, I know we’re moving closer to your guys’ self-imposed deadline on Adriatica. Did you expect those expenses to tail off as you get later into 2014/ just any thoughts there on what’s roughly, I don’t know $600,000 of quarterly expenses potentially going away.
Brad, as it relates to the IPO, since it show up in that core earning schedule, about half of that is not going to continue. It was related strictly to bonuses and with specific grants related to the IPO. About half of it is going to be ongoing amortization of those grants.
So what was in for the third quarter, half is non-recurring and half will recur.
And then as it regards Adriatica, Brad, we are working hard to liquidate most, if not all of that holding in the fourth quarter. Don’t hold me to that because that’s a difficult negotiation transaction to put all that together. But yes, we hope that the Adriatica and expect that the Adriatica carrying expenses on a quarterly basis will go down dramatically in 2014. And if we can liquidate all those assets in the fourth quarter and move them off the balance sheet, then the expenses would go to zero for ’14.
I’m showing no further questions. I will now turn the call back over to management for closing remarks.
I appreciate everyone today. That will conclude our third quarter 2013 earnings conference call and appreciate everyone’s support. Thank you.
Ladies and gentlemen, that does conclude today’s conference. You may all disconnect and have a wonderful day.
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