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Southside Bancshares Inc (SBSI) Q1 2019 Earnings Call Transcript

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Southside Bancshares Inc  (NASDAQ: SBSI)
Q1 2019 Earnings Call
April 26, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Southside Bancshares' Inc First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to disperse this conference call. Lindsey Bib you may begin.

Lindsey Bibby -- Vice President and Investor Relations Officer

Thank you, Kevin. Good morning, everyone and welcome to Southside Bancshares first quarter 2019 earnings call. A transcript of today's call will be posted on southside.com under Investor Relations. During today's call and in other disclosures and presentation, I will remind you that any forward-looking statements made are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described in our earnings release in our Form 10-K.

Joining me today are Lee Gibson, President and CEO; and Julie Shamburger, Senior Executive Vice President and CFO. Our agenda today is as follows; first, you'll hear Julie discuss an overview of our financial results, including loan loss provision and an update on our non-performing assets. Then, Lee will share his comments on the quarter, including financial performance and an update on our securities portfolio.

I will now turn the call over to Julie.

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

Thank you, Lindsey. Good morning, everyone and welcome to Southside Bancshares first quarter 2019 earnings call. We are pleased to report net income of $18.8 million for the first quarter, an increase of $1.4 million, or 8.3% on a linked-quarter basis and $2.6 million, or 15.8% compared to the same period in 2018. For the quarter ended March 31, 2019, our diluted earnings per share increased $0.10 or 21.7% to $0.56 per share compared to the same period in 2018 and increased $0.06 per share or 12% on a linked quarter basis.

During the first quarter, we experienced a decrease in loans of $7.7 million or 0.2% on a linked quarter basis. During the first quarter, we sold three commercial real estate loans that totaled approximately $16.7 million that were placed in non-accrual status during the first quarter of 2018. In connection with the sale, we charged off $1.2 million and recorded a partial reversal of loan loss provision. Total non-performing assets decreased $4.8 million or 11.2% to $38.1 million or 0.61% of total assets at March 31, 2019 compared to $42.9 million or 0.7% of total assets at December 31, 2018.

Non-accrual loans decreased $18.1 million or 50.5%, primarily a result of the loan sale previously mentioned. Restructured loans increased $5.6 million, due to the restructure of a commercial real estate loan. Additionally, during the first quarter, our accruing loans past due 90 days or more included a $7.9 million loan relationship that was in the process of collection and subsequently paid off in full on April 15, 2019. The allowance for loan loss decreased by $2.9 million on a linked quarter basis, primarily driven by the charge off related to the non-accrual loans sold in the first quarter in the partial reversal of provision.

Our securities portfolio decreased $128.7 million or 6% for the quarter ended March 31, 2019. Throughout the month of March 2019, we sold approximately $524 million of our lower yielding securities, consisting primarily of municipal securities into a lesser extent, lower yielding mortgage backed securities and replaced a portion of the securities sold with higher yielding Texas municipals and mortgage backed securities. Subsequent to March 31, 2019, we have purchased approximately $183 million in additional securities. We expect a positive impact on our net interest margin in future quarters, as a result of the securities purchase in the first quarter and subsequent to quarter end.

At March 31, 2019, we had a net and realized gain in the securities portfolio of $7.7 million in a duration of 6.5 years, an increase from 5.5 years at year end. The result of the sale of lower yielding in shorter duration securities in the first quarter of 2019. The mix of our loans and securities shifted slightly to 62% loans and 38% securities at March 31, 2019 compared to a 61% and 39% mix at year end, a direct result of the sale of selected securities during the first quarter.

Our net interest margin for the first quarter of 2019 decreased 14 basis points to 3.07% from 3.21% in the previous quarter, which was the result of higher rates paid on interest bearing liabilities, the increase in average wholesale funding during the quarter and a loss on a fair value hedge interest rate swap of $509,000 recorded in interest income. Loan accretion recorded this quarter was $597,000, an increase of approximately $132,000 from the prior quarter.

For the first quarter, we recorded a partial reversal of loan loss provision of $918,000 compared to $2.4 million of provision expense in the previous quarter. The reversal of provision was largely related to the first quarter sale of the non-accrual loans mentioned earlier. Linked quarter, our non-interest income excluding net gains on available for sale securities decreased $791,000 or 7.9%, due to a decrease in deposit services income and a partial loss recorded at $427,000 on a fair value hedge instrument, in which the hedge relationship was discontinued due to the sale of the hedges items and the subsequent fair value loss after the sale was recorded in non-interest income.

During the first quarter, we recorded a gain on the sale of available for sale securities of $256,000, an increase of $195,000 on a linked quarter basis. During the quarter ended March 31, 2019, our non-interest expense decreased $569,000 or 1.9% from the previous quarter. Linked quarter, the efficiency ratio increased to 53.66% compared to 52.18%, due primarily to the decrease in net interest income. Income tax expense increased $616,000 compared to last quarter in the effective tax rate for the first quarter with 14.3%, an increase from expectations due to the lower tax income as a percentage of pre-tax income. At this time, we're estimating non-interest expense of approximately $30 million for the second quarter and an effective tax rate for that same period of 14.5%.

Thank you very much and I will turn the call over to Lee.

Lee R. Gibson -- President and Chief Executive Officer

Thank you, Julie. I would like to thank everyone for joining us this morning. We had an excellent first quarter highlighted by a 15.44%, return on average tangible common equity, 15.8% increase in net income and 21.7% increase in diluted earnings per share. During the quarter, non-performing assets declined 11.2% to 0.61% of total assets due to the sale of three non-performing loans. And as Julie, discussed another 21% of the non-performing assets at quarter end paid off in April. The charge off associated with the sale of these non-performing loans was less than originally anticipated and resulted in a net reversal of $918,000, an allowance for loan losses. Our net interest margin reflected a decrease of 14 basis points on a linked quarter basis, primarily due to higher funding costs and a loss of $509,000 on hedges recorded in municipal income.

During our last earnings call, I mentioned that due to the Fed clarifying their stance on the interest rates you would likely see, an increase on a linked quarter basis in the size of the securities portfolio. While, we were non-anticipating much of an increase in long term interest rates during the first quarter, we did not anticipate the significant decrease in long term interest rates that occurred during March. As a result of the change in interest rates, we proactively sold more than $520 million of lower yielding securities. Over $390 million of the securities sold were lower yielding municipal securities with shorter calls. Throughout the quarter, we purchased over $420 million of securities with higher yields than those sold.

Subsequent to quarter end, we've purchased more than $180 million in additional securities. The restructuring of the securities portfolio will positively impact the overall yield of the securities portfolio in the second quarter. Economic conditions in our markets remains positive, as both job and population growth are continuing. Our average loans on a linked quarter basis increased however, linked quarter total loans decreased $7.7 million, due to the sale of the non-performing loans during the last half of the quarter. We also experienced other large loan prepayments during the first quarter. Our pipeline looks solid, and other than the non-performing loan that paid off in April, at this time, we are not aware of many large loan payments during the second quarter.

At this time, we will conclude our prepared remarks and open the lines for your questions.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from Brady Gailey with KBW.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Hey. Good morning, guys.

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

Good morning.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc. -- Analyst

So I appreciate all the color on what you all have done with the bond book last quarter and even quarter to-date. As we look at, I don't know, if you want to talk about it in terms of the bond book yield or the overall net interest margin, but how much do you think we could see asset yields rebound in 2Q with these restructurings like, how much upside to NIM would you expect in 2Q?

Lee R. Gibson -- President and Chief Executive Officer

Just in the securities portfolio, we're estimating that the net interest income -- or the interest income in the securities portfolio will probably be up somewhere close to $1 million in the second quarter. And then, of course, we'll have the non-performing assets that were sold, that were non-accrual loans that were sold in March and those obviously become earning assets and so that will have a nice impact in the second quarter as well.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Okay. And then, when you look at loan growth, balances are obviously down a little bit this quarter due to the factors that you talked about the -- the sales of the non-performing loans etc. I know in the past, we've talked about a 4% loan growth rate being the right forward run rate for you all. I mean does that, I know you had another large pay down so far this quarter and the second quarter, but outside that you think 4% is a good run rate for loan growth for you all?

Lee R. Gibson -- President and Chief Executive Officer

I do, the loan pay down we had this quarter so far is only $8 million and we've had some good funding so far this quarter. And so I do think that 4% is very achievable for the year.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc. -- Analyst

All right. And then finally for me, the duration of your bond book has gone up a lot over the last year or two. I mean it's now it's 6.5 years that's above average. So how do you think about the trend of the duration of that bond book going forward?

Lee R. Gibson -- President and Chief Executive Officer

I don't see it going up from here. I think, we will see some pickup in repayments on mortgage backed securities, so that will have some impact on the duration as well as the yield. And so we've tried to calculate that in as well and the bonds we've been buying are not at huge premiums, so the pickup in prepayments isn't going to have that big of a change on the yields, but it will obviously affect the duration.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc. -- Analyst

All right. Great. Thanks, guys.

Lee R. Gibson -- President and Chief Executive Officer

Okay.

Operator

Our next question comes from Brad Milsaps with Sandler O'Neill.

Peter Ruiz -- Sandler O'Neill & Partners LP -- Analyst

Hey. Good morning, guys. It's actually Peter Ruiz on for Brad.

Lee R. Gibson -- President and Chief Executive Officer

Hi, Peter. How are you doing?

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

Good morning.

Peter Ruiz -- Sandler O'Neill & Partners LP -- Analyst

Good. I just wanted to maybe get some clarification on just the, the fair value hedge interest rate swaps. So if I have it right, there is $0.5 million in net interest -- in interest income that you're pulling out there and then there's an additional $0.5 million within fees, do I have that right?

Lee R. Gibson -- President and Chief Executive Officer

That is correct. And what let me, I'll explain that. We sold three municipals that a had a hedge on it and so the loss on the hedge at that point in time goes through interest income. And then you fair value the hedge at the end of the quarter and the -- any change in that fair value from the point of sale to the end of the quarter is reflected there in non-interest income. I will tell you that we did unwind at the swap as interest rates increased a little bit in April, and we have a -- I think around $180,000 gain on the unwinding of that swap that will be recorded in the second quarter.

Peter Ruiz -- Sandler O'Neill & Partners LP -- Analyst

Great. Appreciate the color. And maybe just following up on just the non-accrual loans that were sold. Can you give us an idea of what the original balance was for those and just any additional color there?

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

The balance on those loans at December 31 were around $16.7 million. And they placed in non-accrual those three particular loans replacing non-accrual in the first quarter of 2018. And the balance changed somewhat over the course of the year, but that was the balance at December 31.

Peter Ruiz -- Sandler O'Neill & Partners LP -- Analyst

Okay. So, if I remember correctly, were those the memory care facilities the previously mentioned?

Lee R. Gibson -- President and Chief Executive Officer

That is correct. And we put them out for sale and the bids that came in the first quarter were much better than what we had anticipated based on the reserve we had at year end.

Peter Ruiz -- Sandler O'Neill & Partners LP -- Analyst

Great. Appreciate the color for -- with everything guys, I'll step back for now. Thanks.

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

Thank you.

Lee R. Gibson -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Bill Curtis with Hovde Group.

Bill Curtis -- Hovde Group -- Analyst

Hey, good morning.

Lee R. Gibson -- President and Chief Executive Officer

Good morning, Bill.

Bill Curtis -- Hovde Group -- Analyst

Wanted to follow up on the securities restructuring and are you able to share what the difference in yield was there from what you guys sold and bought?

Lee R. Gibson -- President and Chief Executive Officer

On the municipal securities the yield was around -- and this was the tax effective yield was around the 2.92% and that was a little over $390 million, and on the taxable securities there were a little over $132 million of those, and the yield on those was around 2.32%. What we purchased on average probably has a yield of around 3.5% to maybe 3.60% somewhere in that range, and it somewhat depends on what the prepayments come in.

Bill Curtis -- Hovde Group -- Analyst

Okay. Thank you very much. Also wanted to ask about the fee income expectations. I suspect the seasonality played a role with the service charges, but just any thoughts on how you see fees trending this year would be helpful.

Lee R. Gibson -- President and Chief Executive Officer

I would think deposit service fees would increase in the second quarter compared to the first quarter simply because of the number of days, and we also -- and right and we did raise a few of our fees, so we expect to see some increase as a result of that.

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

And those increases were affected beginning in April, so they would not have been reflected in any form in the first quarter.

Bill Curtis -- Hovde Group -- Analyst

Okay. That's it for me. I appreciate the color. Thanks.

Lee R. Gibson -- President and Chief Executive Officer

All right. Thank you.

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

Thank you.

Operator

And I'm not showing any further questions at this time, I'd like to turn the call back over to Lee Gibson.

Lee R. Gibson -- President and Chief Executive Officer

All right. Thank you. I am very pleased with our first quarter earnings. Given the restructuring of over $520 million of securities at higher yields, potential second quarter loan growth combined with the reduction in non-accrual loans. We are looking forward to reporting second quarter results in July. Thank you again for joining us this morning.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect. Have a wonderful day.

Duration: 20 minutes

Call participants:

Lindsey Bibby -- Vice President and Investor Relations Officer

Julie N. Shamburger -- Senior Executive Vice President and Chief Financial Officer

Lee R. Gibson -- President and Chief Executive Officer

Brady Gailey -- Keefe, Bruyette, & Woods, Inc. -- Analyst

Peter Ruiz -- Sandler O'Neill & Partners LP -- Analyst

Bill Curtis -- Hovde Group -- Analyst

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