Independent Bank Group, Inc

Good morning, everyone. I am Paul Langdale, Executive Vice President of Corporate Development and Strategy for Independent Bank Group, and I would like to welcome you to the Independent Bank Group first quarter 2022 earnings call. We appreciate you joining us. The related earnings press release and the slide presentation can be accessed on our website at ibtx.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 five of the text in the release or page two of the slide presentation for our safe harbor statement. All comments made during today's call are subject to that statement. Please note that if we give guidance about future results, that guidance is a statement of 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 am joined this morning by David Brooks, our Chairman and CEO, Dan Brooks, our Vice Chairman, and Michelle Hickox, Executive Vice President and CFO. At the end of their remarks, David will open the call to questions. With that, I will turn it over to David.

Thanks, Paul. Good morning, everyone, and thank you for joining the call today. For the first quarter, we were pleased to announce adjusted earnings of $1.22 per diluted share, as well as strong organic loan growth of 13.1% annualized for the quarter, excluding mortgage warehouse and PPP. This continued growth is driven by demand from our relationship borrowers across Texas and Colorado, as our markets continue to experience strong economic and demographic growth. During the quarter, We also optimized our balance sheet by strategically reducing non-core funding in preparation for additional rate hikes by the Fed. This resulted in a reduction of interest expense by $3.6 million, or 27% versus the linked quarter, and resulted in a lower overall cost of interfering deposits. This strategy evolved together with our ongoing retail initiative that has focused on fortifying and enhancing our core deposit franchise. With that overview, I'll now turn the call over to Michelle for more detail on the operating results for the quarter.

Thank you, David. Good morning, everyone. Note that slide 6 shows selected financial data for the quarter. First quarter adjusted net income totaled $52.1 million, or $1.22 per diluted share, a decrease of $2.9 million, or $0.06 per diluted share over the linked quarter. Net interest income was $131.1 million in the first quarter which was down from $132.7 million versus the linked quarter. PPP fee income was down from $4 million to $1.2 million and acquired loan accretion was down from $5.7 million to $3.6 million from Q4 of 21 to Q1 of 22. These decreases were offset by a $3.6 million decline in interest expense, which was due to a reduction in rates on deposit accounts in the fourth quarter. Non-cash earning assets grew during the quarter, primarily driven by the 13.1% annualized loan growth, but also through opportunistic investments in our securities portfolio. As noted on slide 21, we designated $188 million of longer duration municipal bonds as held to maturity during the quarter. The NIM excluding accretion was 3.13%, up 26 basis points from the linked quarter. This increase was driven by the reduction of higher cost funding as well as higher security fields and loan growth in addition to a reduction and shift in cash balances. Total non-interest income was $12.9 million for the first quarter, a decrease of $2.2 million versus the linked quarter. This was primarily due to decreases in mortgage banking revenue from the interest rate headwinds broadly impacting mortgage volumes. Non-interest expense totaled 82.5 million for the first quarter. The increase of 2.5 million versus the linked quarter was mostly driven by an increase of 3.3 million in salaries and benefits. The change includes a $1.2 million increase in payroll taxes from the linked quarter which are seasonally higher in the first quarter and also includes taxes paid related to annual stock vestings. In addition, 401K expense is higher by $633,000 in Q1 due to matching on annual bonuses. The increases in salaries and benefit expense was partially offset by a $1.2 million decrease in other non-interest expenses. Slide 19 shows our deposit mix and costs. Deposits total $14.9 billion at quarter end, a reduction of $704 million versus the linked quarter. This was primarily driven by our efforts to reduce non-core funding in advance of Fed rate hikes. These efforts included the strategic exiting of our bankruptcy trustee specialty treasury vertical, as well as reducing brokered money. As a result of this and other efforts, interest-bearing deposit costs decreased an additional 10 basis points during the quarter to 22 basis points. The chart on slide 20 illustrates the change by vertical and shows the stability of our core deposit customer accounts since year end. Capital ratios are presented on slide 22. In the first quarter, the company's consolidated capital ratios remained strong with a common equity tier one capital ratio of 11.09% and total capital ratio of 13.72%. Tangible common equity increased to 8.62%. That concludes my comments, so I will turn it over to Dan to discuss the loan portfolio.

Thanks, Michelle. Overall loans held for investment, excluding mortgage warehouse purchase loans, were $12 billion at quarter end, compared to $11.7 billion in the linked quarter. Excluding the impact of PPP loans, core loans held for investment increased by $372.1 million over the linked quarter. which represents a 13.1% annualized rate of loan growth. Loan growth continues to be driven by broad-based relationship lending to our customers across Texas and Colorado. Average mortgage warehouse purchase loans decreased to $549.6 million for the quarter. This decrease was primarily driven by upward pressure on mortgage rates, resulting in decreased demands, lower volumes, and shorter hold times across the mortgage industry. Credit quality metrics remain healthy. Total non-performing assets increased slightly to $71.1 million or 0.40% of total assets at quarter end, which was driven primarily by one commercial real estate loan totaling $15.3 million being added to non-accrual during the quarter. Net charge-offs totaled one basis point annualized during the quarter. During the quarter, we sold a note at a discount of $1.4 million that had been previously reserved in our ACL. We reduced the ACL with a $1.4 million credit provision taken during the quarter. At March 31, 2022, the allowance for credit losses for loans is $146.3 million, or 1.22% of loans held for investment excluding mortgage warehouse loans. 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. Thanks, Dan. Looking ahead, we are now confident in our ability to grow our core loan portfolio at the 8% to 10% level for the remainder of 2022. We are also very encouraged by the success of our balance sheet optimization initiative, ahead of additional tightening by the Fed. We believe that we are well-positioned to benefit from a rising rate environment and we continue to deliberately book new business with the forward curve in mind. Our top priority remains to create long-term shareholder value by growing our franchise across our four great markets and to deliver consistent high performance to our shareholders, customers, and communities. We will continue to strategically invest in people and technology to position our company for the future, and we remain optimistic about the growth opportunities ahead. I'm grateful to all our bankers for their tireless dedication to earning new business and expanding existing relationships each day. And I'm excited to build on this momentum we have established in the first quarter as we continue to grow the platform across Texas and Colorado. Thank you for taking the time to join us today. Now we'll open the line to questions.

Operator. Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for your questions.

Our first question has come from the line of Brad Millsap with Piper Sandler. Please proceed with your questions.

Hey, good morning.

Good morning, Brett.

Thanks for taking my questions. Michelle, maybe I kind of wanted to start with, you know, your plans for how you plan to manage the balance sheet going forward. Do you think most of the, you know, runoff on the deposit side is complete? And I think last quarter, You talked about maybe growing the bond portfolio by another half a billion dollars with some of your excess cash in 2022. You've got a better loan growth guide now, less cash. Just kind of curious how to think about, you know, managing, you know, some of the liquidity that pertains to the overall balance sheet.

Yeah, you know, I said the whole time, Brad, that, you know, that was our plan for the bond portfolio. It would certainly depend on our loan growth as it came in and liquidity and We did have some, I would call specialty treasury deposits that went out right before the end of the quarter. And then I think we had said we were going to exit our bankruptcy trustee vertical, which was about 200 million. And so really all of that outflow was related to those types of funds. Our core deposits were stabled actually up a bit for the quarter. We haven't raised our deposit rates at all at this point, and really hopefully we can lag those for a bit, and we will manage deposit runoff that way. If we start to see significant outflows, that means we may have to raise rates. The bond portfolio, I would say at this point half a billion is probably still a good bogey for the rest of the year, but that could change if we continue to get loan growth where it is.

Great, thank you.

And can you remind us, you know, sort of with your interest rate sensitivity, kind of what you guys assume in terms of, you know, maybe loan and deposit betas as you kind of think about, you know, as the Fed does move, kind of what we could expect, you know, in terms of, you know, your NIM continuing to move higher?

You know, I think betas on loans and deposits, I mean, may be lower than what people expect, but I think what our model shows for the rest of the year, and I think we're assuming an additional 125 basis points in rate hikes in our model, could add 25 to 30 basis points to our NIM through the rest of the year.

Okay, great. I'll hop back into you. Thank you. Okay, thanks, Brett.

Thank you. Our next question has come from the line of Michael Young with Truist Securities. Please proceed with your questions.

Hey, good morning, everyone. I wanted to start on the loan growth outlook of eight to 10%, a little better there. So could you just walk us through kind of the improvement? Is it, you know, increased pipelines that you're seeing in demand or less payoffs and paydowns? Any other clarity there would be appreciated. And also as a follow-up on that, just loan yields, are you seeing any increased pricing in the market at this point as rates move higher?

Good morning, Michael. Yes, we feel good about, obviously, the loan growth we've seen the last couple of quarters. Really driven by, I think, the biggest factor is just the strength of the markets. All four of our markets are doing extremely well. Our customers and new customers are investing and purchasing assets and doing things that cause them to want to borrow money. So that's the number one factor. We also had a slowdown. We saw a slowdown in the first quarter of paydowns, which we had hoped for and kind of signaled in the first quarter callback in January that we expected that over the course of the year as rates go up. But we have, in fact, seen that. We think that's a trend that we'll continue to see and should give us some tailwind as we go through the year. Thirdly, but certainly not least important, we've continued to add a lot of talent across our four markets, both in commercial CNI as well as on the community banking and commercial banking real estate side. So we've got really not only the largest team, but really the strongest and deepest team of lenders that we've had uh, in the history of the company we think right now. And so we feel good about that. And we think that portends again, Brad, uh, I'm sorry, uh, Michael for, for, uh, a continuation of strong loan growth hints, you know, where we've been guiding seven, eight, we believe now we can continue to deliver eight to 10 ish kind of growth for the balance of the year. Um, the pipelines are, are really strong, uh, We're off to a good start here in the second quarter. It's very early, obviously, but all the signs, everything we can see right now appears positive. The other good news, Michelle alluded to it just a moment ago, we expressed some concern in the first quarter. We felt confident we'd be able to hold our deposit betas down a little below historic averages here, at least for the first couple raises. But we also expressed concern that the competition with all the liquidity and the competition for high-quality loans might keep loan yields suppressed for a while. In fact, we have not seen that. We've actually seen better yields and the ability to increase our pricing, both obviously the floating rates floating up with the indexes, but to us, as you know, we still do a lot of real estate lending. That's been a core of ours for a long time. three- to five-year fixed rates. We've seen the ability here late in the first quarter and early in the second quarter to push those rates through. We're seeing rates, for instance, on the loans that we've booked here in April so far, the rates are coming on right at or a little above the yield of our current portfolio. So we're not seeing any pulled down at this point on our, uh, you know, on the yields on our overall portfolio. So that's a change from really, we've been struggling with that for two years, uh, since, you know, the beginning of pandemic and the rate cuts. Um, so we're seeing positive trends on that. So as Michelle said, we think the continued increase in rates will, uh, will help our, our net margin. We think that will be a product of, as Michelle said, you know, improving loan yields and then being able to, um, you know, at least lag here early on the deposit basis.

Okay, great. Thank you for all that color, David. And, you know, the only other question I have is just on kind of mortgage warehouse, obviously a little bit weaker with the rising interest rates, but in terms of the yield you're actually getting on that portfolio, you know, is there at some point, would you look to, you know, maybe let that continue to shrink so that you could fund, you know, higher yielding, either loan growth or securities or, you know, Do you think those yields will kind of rise enough that it would still be attractive as we move forward into a higher rate environment?

Yeah, we certainly saw more headwind. That has been our biggest challenge, right, in the first quarter was the decline in the mortgage warehouse and our retail mortgage business, which hurt our fee income materially. And so that is going to continue to be our biggest headwind. I say that from a high-level standpoint, Michael. Then in the details, as you ask, we're seeing a real trade right between pricing and volumes and super competitive. We have seen maybe, knock on wood here, some of the worst behavior of some of the participants in the market seems to be slowing a little bit. That said, we will continue to balance that up and we're not going to, we try not to provide services and products and everything on a non-profit basis. That's not our usual theme. So that said, we kind of expect the mortgage warehouse to level out here around $500 million. That's the way we're thinking about it going forward, but we'll see how that goes and And that will also, and I think you alluded to it, Michael, just now, if we continue to see stronger than what we think is the normal type of loan demand and pipelines, then we could choose to just continue to let that roll down a little bit and replace it with the loans and fees from our normal commercial business. So we'll just manage it, but I think for us, The way we're thinking about it internally is we're planning for the rest of the year. It's around $500 million in pricing kind of level to where it is today.

Okay, great. Thanks, David. I appreciate it.

Thanks, Mike. Thank you. Our next question has come from the line of Brett Ravitin with HubD Group. Please proceed with your questions.

Hey, good morning, David and Michelle.

Brett.

Good morning, Brett.

Good morning.

Wanting to first ask about expenses, you know, and obviously there's some noise with mortgage and the first quarter obviously has some higher expenses than usual. Michelle was just curious, you know, one, what are you seeing from inflationary pressures? And, you know, maybe if you could give us some. some thoughts around what the year looked like. And, you know, David, you said this looks like the best lending team you've ever had. You know, I didn't know if you wanted to continue to try and grow that. And so that might, you know, play into expenses this year. You know, we're just hoping for some color on how you see the expense level trending throughout the year.

Yeah. You know, first quarter expenses are always a bit higher, I think, than a lot of people expect, you know, because we have stock vestings that we have payroll taxes, payroll taxes reset. This year we paid, we did matching on our bonuses. So there were some things in there in the first quarter that won't be in, continue in the run rate. I still feel good about, you know, the guidance of a little over 5% increase from year over year expenses from 21, I think, which would put us at about 330 million of expense for the year. The run rate could be down a bit in the second quarter, but I anticipate the expenses are going to be in that $82 to $83 million range for the rest of the year each quarter.

Okay. That's great, Collar. And then credit obviously continues to be really good, and you only had one basis point of net charge-offs, but you did have that one $15 million commercial real estate credit, and I was just curious if there was any trends in classified assets and maybe what that one commercial real estate property was related to or what type of property it was.

Hey, Brett. This is Dan. Good morning. As you noted, there was just one credit that was downgraded to non-accrual. It was already on our adversely classified list. That's an office property. I would say not anything unusual about it, and we expect it will be managed in the normal course. I think probably the bigger message is, as expected, we continue to see a reduction in criticized and classified loans in the quarter, and in fact, adversely graded credits are half of what they were a year ago, so those trends continue to be very good.

Okay, great. Appreciate that, Dan. And then just lastly for me, maybe David, you know, you've been a little less ebullient about prospects for M&A maybe the past three, six months. And it seems like everyone's taking a bit of a pause trying to figure out what their own bank might make in the next year or two. And if we might have a slowdown in the economy, I'm assuming that you would tell us that You think M&A is more on the back burner from here, and given the pipeline, you're focused on organic growth. Can you give us any thoughts on how you view M&A and what you might think that could mean for your franchise in the next year or so?

Well, from the highest level, we still view that as a core competency of our company. We've demonstrated over the last 32, 33 years. That said, it ebbs and flows with the economy and how people feel about their franchises and companies. And as you just alluded to, Brett, bankers in Texas and Colorado continue to feel very good about their companies and performance of their companies. So My focus continues to be just to build quality relationships with high-quality companies and the major markets in Texas. We'll see. I think this quarter, the only thing changed really from how I felt about last quarter is just the volatility in the stock prices. In January, everyone was saying financials were going to be the number one performing asset class in 2022, and we went from that to a pretty significant decline in the bank stock index and then just a lot of volatility in all the stocks. We'll see how it plays out, but I don't think any of those things help how banks are thinking about their strategic plan. In the face of volatility, people like the whole band they've got is my experience over the years So, you know, I still believe the M&A, we're going to see M&A, you know, in the next 12, 18 months, but just timing of it, I really think depends on so many things that we don't control, you know, how the Fed interest rate increase cycle here goes, how it affects the economy, how the war in Ukraine goes and how people feel about that and the chance of it spreading or becoming accelerated in some ways. So there's so many things we don't control, but And I think that then points back, Brad, as you said, to control what we control, which is grow our company, continue to add terrific talent both on the administrative side and on the production side. continue to invest and embed it in those expense numbers Michelle talked about. We're investing in infrastructure and people and teams and building out our risk management across the company at a level that will allow us to grow and do the things we want to do in the future.

Okay. That's great, Keller. I appreciate that.

Thanks, Brett.

Thank you. Our next questions come from the line of Brady Gailey with KBW. Please proceed with your questions.

Hey, thanks. Good morning, guys. Good morning, Brady. So maybe on the flip side of M&A, it doesn't look like y'all did any buybacks in the quarter. I know you repurchased about 1% of the company in the back half of last year, but how are you thinking about the buyback, especially given the pullback in bank stocks?

Yes, I mean, We continue to believe that when there's disruption and volatility in the markets, those are chances for us to be opportunistic. We have seen those kinds of opportunities here early in the second quarter, but we'll see what kinds of volumes and things coming out of earnings season here. I think the market seems to be kind of on hold here for a minute waiting to see how everything goes next week or two. So we'll see how it comes out the other side, Brady. But yes, we will be aggressive when the stocks are, we believe, mispriced.

And then I know the dip in deposit balances was kind of strategic runoff of broker deposits. Is there any more of that left going forward or are you kind of happy with your deposit mix at this point?

You know, we still have a bit of that. I think most of our broker is gone, and obviously we use that as a liquidity source when needed. But I think the majority of that runoff has happened at this point. But, you know, those are still available to us at a point in time when we need to bring them back. Okay.

All right, great. Thanks, guys.

Thanks, Brady. Thank you. Our next question has come from the line of Michael Rose with Raymond James. Please proceed with your questions.

Hey, good morning, everyone. Thanks for taking my questions. Obviously, asset quality has been one of the hallmarks of the company, excluding one seemingly idiosyncratic addition this quarter. Just more broadly speaking, anything that might give a little caution to the outlook and Obviously, the reserve to loans has come down, but just given the growth and maybe some broader macro concerns on the horizon, should we expect further reserve releases to be somewhat limited from here, or is the outlook just so good in your markets that we could expect that reserve level to come down a little bit from here?

Thanks.

Michael, this is Dan. I'll take that. I think as we really look at the portfolio we have, as you know, low non-performing assets and I would say rather minimal charge-offs are consistent with our credit culture and really our history in managing our loan portfolio. So we expect that to continue to be the case. That certainly was the case through the pandemic. As we look ahead at potential headwinds in the economy, certainly continue to expect our portfolio to perform in a similar fashion. In addition to that, certainly the opportunities we have on the loan growth side that we've already spoken to this morning, I think would indicate that we'll not be in a position where we would expect to release any additional provision. We certainly would expect that we would continue to grow the book and have the adequate reserves already in place to manage that. And based on what we know today, we certainly wouldn't expect to make any additional provision in 2022 based on that. But hopefully that gives you a little bit of color.

Yeah, it's very helpful. Maybe just one follow up on capital as well. You guys have increased the dividend four quarters in a row here. It seems like capital is going to build. Obviously, earnings are strong. Internal capital generation is solid. Should we think about further dividend increases? Looks like you guys have been trending around a 30% or so payout ratio. Is that what we should expect moving forward?

Good morning, Michael. I think that's a good way to think about it, around 30% of our earnings, although Again, as we talked about over the last couple quarters, if we don't see M&A prospects, immediate prospects, then we'll continue to look at dividend increases, and certainly the board could decide to pay out at a higher level in the future if that looks like a good way to return the capital to our shareholders and also pending the stock rebate. the stock repurchase plan and how active we are with that could also impact how we think about, you know, dividend increases, but our, our lean, if that's helpful would be toward, uh, dividend increases as we go forward. And, and that's something else based upon the fact that we expect our earnings to go up. So.

Yep, exactly. Perfect. Uh, maybe just one final one for me. Um, obviously the tax rate, um, down this quarter looks like to be a permanent change is kind of 19.5% kind of what we should be using going forward. Thanks.

Yeah, really that a little over 20% is probably a better run rate. We had a permanent difference related to a contribution of some property. So I would use a little over 20% in your modeling.

Perfect. Thanks, Michelle. Thanks for taking my question. Hey, thanks, Michael.

Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next questions come from the line of Matt Aldy with Stevens. Please proceed with your questions.

Hey, thanks. Good morning, everybody.

Hey, good morning, Matt.

I think Michelle mentioned the bank has not yet changed any deposit pricing recently. Did I hear that correctly, Michelle? And any more color and Are you seeing any movements from competition that are trying to get ahead of some of the Fed tightening? Thanks.

You know, we really haven't seen a whole lot of competition. You know, we will get one-off calls from some of our relationship managers where maybe they have another bank or a lot of times it's a credit union that's offering a higher rate or a promotional product. But we haven't really heard a lot of noise from our field at this point.

And so we have not increased our rates at this point. Matt.

Okay. Thank you for that. And then I guess on the other side, on the loan side, just remind me of the dollar amount of loans that will reprice immediately with higher rates from the Fed that we saw in March and probably here again in a few weeks.

So we have about a billion and a half of loans that are tied directly to the index, Matt. That's what repriced with the March rate increase. To date, we have a little over $3 billion that have increased from that rate increase that were on a different, either they reset at the end of the month or on a 30-day basis or something like that. And so I think that would be consistent with future rate increases.

Ultimately, over the course of, what, a year or so, we would expect about half of our portfolio to reprice.

That's right. About half of the portfolio has some sort of variable rate. It's just that the time frame on which they reprice is extended a bit more.

Most of that is within the first 90 days, Matt, and then the rest kind of just quarter by quarter as annual rates adjust.

Okay. Got it. Thank you for that. And then I guess earlier, I think, Michelle, you mentioned potentially growing that securities portfolio during the course of the year. And I guess we've seen more attractive yields in recent weeks. Have you started to take advantage of this yet or still being patient? And then within the target type of security you're looking at, any more color on the yields that you're seeing in recent weeks? Thanks.

Yeah, I mean, we have been reinvesting our cash flow, which right now is about $60 million a quarter. It's come back a bit as rates have increased right. We've been buying mortgage backs, and the yields on those have been about $330. We've invested in more munis. That yield's been about $420. And then treasuries, just to manage out the portfolio, on days that rates go up, we've gotten at $250. So we have been able to increase the investment rate of the portfolio significantly over this past month.

Okay, thanks for that. And just to clarify, Michelle, those are just reinvestments of cash flows from what's coming off. It doesn't sound like you've increased the size of the book in recent weeks. Am I getting that right?

Well, we are still growing the portfolio, but like I mentioned earlier, it will really depend on loan growth, which has been good, a bit better than expected. So I think growing the portfolio to $2.5 billion by the end of the year is still a good target at this point, but that's a long time away, so we'll certainly manage it as our liquidity and loan growth comes in.

Okay. And I guess under that $2.5 billion scenario that you mentioned, the security side, what would that imply the excess liquidity position would look like at the end of the year?

You know, that depends on... what happens with our deposit flow, but I would expect by the end of the year, we'll be back in sort of our, where we'd be comfortable with liquidity by the end of the year in that 12 to 15% range.

Got it. Okay. Thank you very much.

Thanks, Matthew.

Thank you. There are no further questions at this time. I would now like to turn the call back over to David Brooks for any closing comments.

I really appreciate everyone joining this morning. We continue to feel good about our position here as we move forward in this year with the uncertainties ahead. I appreciate everyone's interest in the call. Hope you have a great day.