Good morning. Welcome to the Origin Bancorp second quarter 2018 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Chris Reigelman. Please go ahead.
Good morning. Thank you for being with us. Before we begin, I'd like to remind you that this presentation may include information about our management view of our future expectations, plans, and prospects that constitute forward-looking statements. Actual results may differ materially from historical results and those indicated by these forward-looking statements due to risks and uncertainties. For a discussion of these risks and uncertainties, please refer to the forward-looking statements section of our earnings release and the risk factors included in our prospectus filed with the SEC on May 9th, 2018, pursuant to Section 424 of the Securities Act and our most recent quarterly reports on Form 10-Q, as well as other documents we periodically file with the SEC. The company undertakes no obligation to publicly revise any forward-looking statement.
If you're logged into our webcast, please also refer to our slide presentation, which includes our safe harbor statement beginning on slide two. For those joining by phone, please note the safe harbor statement and the presentation are available on our website at www.origin.bank. All comments made during today's call are subject to that safe harbor statement. Finally, in this presentation, we will discuss certain non-GAAP financial metrics. Please note that the reconciliations of these non-GAAP financial metrics to their closest comparable GAAP metrics are contained in our current report filed yesterday with the SEC on Form 8-K. Any references to non-GAAP financial measures are intended to provide meaningful insights. These non-GAAP disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
I'm joined this morning by Origin Bancorp's Chairman, President, and CEO, Drake Mills, our Chief Financial Officer, Stephen Brolly, and Lance Hall, President of Origin Bank. After the presentation, we'll be happy to address any questions you may have. At this time, I'd like to turn the call over to Drake.
Thank you, Chris, and good morning. We appreciate you joining us for today's call. This is a special day for us as it marks our first earnings call as a public company. We are extremely grateful to our team and our partners who have worked so hard to help Origin get to this point. We have a proud history, and we look forward to continuing our commitment to excellence and are excited about what the future holds for Origin and our partners. As we begin, I will briefly discuss highlights for the quarter and go through the first part of the slide presentation, then Steve Brolly will cover financial results. Lance Hall will talk about loans and deposits, as well as credit quality, and I will end with closing remarks and open it up for questions. Origin Bancorp had a strong second quarter.
We reported net income of $12.7 million, or $0.53 diluted earnings per share. Our net interest income was at its highest level ever for our company, increasing by $2.4 million, or 7% over the linked quarter. We saw continued improvement in our net interest margins at 3.74% on a tax-equivalent basis, six basis points higher than the first quarter of 2018. I am proud of our teams throughout our markets who remain focused on relationship development while driving yield in the portfolio. The yield earned on total loans held for investment during the second quarter was 4.89%, up 16 basis points from the linked quarter. Total loans held for investment increased to $126.1 million, or 3.9% over the first quarter of 2018.
We were successful with the continued lift-out of a seasoned and well-respected team in Houston market with the addition of eight lenders. We are optimistic about additional opportunities as we move into the second half of 2018. Deposits grew by $91.4 million, or 2.6% over the linked quarter, with noninterest-bearing deposits continuing a positive growth trend, increasing to 25.9% of total deposits in the second quarter. Our team has been laser-focused on strengthening relationships with our customers, as evidenced by the increase in our noninterest-bearing deposits. We are mindful of the competitive rate environment associated with deposits. We have seen a slight increase in our deposit betas. However, we continue to be pleased with our positive net betas when factoring in loan betas, as yields increase in most loan categories and outpace the increase in rates paid on interest-bearing liabilities.
Now I will turn it over to Steve to provide additional details around financial results for the quarter.
Thanks, Steve. I will begin on slide five, selected financial data for the quarter. As you heard, Drake discussed highlights pertaining to net interest income, net income, and diluted earnings per share. I would also like to point out that our loan loss provision for the second quarter was $311,000, which was in line with our expectations and indicative of the ongoing health and growth of our loan portfolio. Looking at key ratios, our return on average assets for the current quarter was 1.17% compared to 1.30% for the linked quarter. Return on average equity for the current quarter was 9.94% compared to 11.82% for the linked quarter. Turning to slide six, our net interest margin continues to improve as interest rates increase. We ended the quarter with a tax-equivalent net interest margin of 3.74%, up from 3.68% for the linked quarter.
Our yield on total loans held for investments was 4.89% during the quarter, compared to 4.73% for the linked quarter. Our loan portfolio remains mostly variable, with a limited number of loans remaining at or below floor. As you can see on slide seven, these factors should position us to benefit from the anticipated additional increases in interest rates.
Non-interest income for the second quarter was $10.6 million, an increase of 8.3% from the linked quarter. The amount of non-interest income continues to be north of 20% of our total net revenue, as you can see in the bottom of slide eight. Non-interest expense for the quarter was $32 million, an increase of 7.2% compared to the previous quarter. This change is primarily driven by increases in salary and benefits, which was impacted by the addition of our lift-out teams in Houston and Shreveport, Louisiana. Our efficiency ratio of 66.99% for the second quarter showed a slight improvement from the linked quarter of 67.06%. We're pleased with this improvement, particularly given the expenses associated with the new teams we hired in the second quarter. Lance will now give us an overview of our loans and deposit results and credit quality.
Thanks, Steve. As I start on slide 10, I'm very proud of the fact that we continue to drive noninterest-bearing deposits. As Drake discussed earlier, this has been and continues to be a strategic focus for our bankers in the markets. We pride ourselves on being able to build long-lasting relationships, and these numbers are indicative of that behavior. Average deposits for the quarter increased by $103.1 million, or 2.9% over the linked quarter. The most significant portion of this increase was in average noninterest-bearing deposits, which grew $78 million, or 9% over the linked quarter. This is one of the key drivers in increasing our mix of noninterest-bearing deposits to total deposits. Our cost of total deposits increased to 75 basis points during the quarter, up from 68 basis points during the linked quarter.
As we look at our loan activity in the second quarter of the year, average loans held for investment increased from the linked quarter by $97.5 million, or 3.1%, to $3.28 billion. This is attributed to an increase in all significant categories of loans. We continue to believe there will be increased opportunity with loan growth through our new relationships across our legacy as well as our lift-out teams. When looking at credit quality, we continue to see improvement with five consecutive quarters of a decrease in net charge-offs, and a second quarter net annualized charge-off rate to average loans held for investment of one basis point. I'll turn it back over to Drake.
Thanks, Lance. We believe Origin Bancorp is operating from a position of strength and set up for continued success in 2018. As you can see on slide 13, our capital levels are healthy and position us well for ongoing growth opportunities. Looking forward, we remain focused on our strategic plan and fixated on driving a winning culture and providing value to our stakeholders. We celebrate a major milestone for our company this quarter. I'm extremely proud of our team and the successful execution of our initial public offering. We issued over 3 million shares with net proceeds before expenses totaling $96.3 million, a portion of which was used to redeem all of the outstanding shares of SBLF. This simplifies our capital structure and lowers our overall cost of equity.
During the quarter, all of the 901,644 shares of outstanding Series D preferred stock were converted into common stock on a one-for-one basis. As a result, no shares of Series D preferred stock remain outstanding. We firmly believe we have opportunity in all of our markets to drive growth through relationship development and increase value based on the long-term proven track record of our company.
Thank you, sir. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Matt Olney with Stephens. Please go ahead.
Hey, great. Thanks. Good morning, guys.
Good morning, Matt.
Good morning, Matt.
I want to start on the deposit side. It's great to see the growth of the non-interest-bearing deposits. Any more details behind this? What was the driver? What markets? I guess the big question is, how much more opportunity do you have to continue to grow the non-interest-bearing deposits?
Yeah, Matt, I'll let Lance answer the question. Lance?
Hey. Good morning, Matt. Thanks. We're incredibly proud of that. As we had talked when we went out on the roadshow, that continues to be a huge emphasis for us as the way we have built our incentive plans. Driving NIB for us is equal to loan growth in our incentive plans for our bankers. That combined with some of the teams that we've been able to hire, the emphasis in Houston, the bankers in Dallas that have really been focused on calling on specific industries that we felt could drive NIB growth for us, as well as really kind of getting refocused back on our C&I business. NIBs are a function of operating companies, the calling efforts in those operating companies. We've grown about 14% year to date in NIBs.
That continues to be something that we're going to continue to drive for the rest of the year.
Matt, I'd also like to add very quickly that we have a tremendous treasury management team, resources that we continue to focus on, and they have been instrumental in developing relationships on the NIB side.
Okay. Very good. On the credit side, from what I could tell, it was more of a mixed bag in 2Q. Looks like classified loans were down, but NPAs ticked up a little bit. Any more color as far as the credit migration that you can see, and what are your expectations for credit in the back half of the year?
Yeah, we'll continue to see improvement there. We have the pickup in NPAs. We're just an aggressive stance on some credits that we're looking at now. In these, as we talked about on the road, there are three credits, I think, with absolutely no chance of loss. It's just going through managing those credits as our economy continues to improve in North Louisiana. Primarily, those credits are in North Louisiana. We continue to see our credit trends, not only NPAs, non-accruals continue to go down. Our classified assets to total capital is now 17.55, down from 19.99. We feel very good, not only about charge-offs, but about past dues. Our past dues for the end of Q2 were at a record low for our company at 43 basis points. We are seeing very good trends on credit quality.
We will get aggressive with credits as we always do. We don't cover anything up. We're not here to make sure. I think that the key going forward in Q3 and four is to look at the past dues. That'll give us a very good, clear picture of what it looks like, plus our classifieds continue to move down.
Okay. Thanks, Drake. Last question for me is just about the Houston market. I know Houston's a big focus for you guys, and Lance mentioned this a few minutes ago, seeing some nice deposit growth out of Houston. Just taking a step back in general, how much progress did you see in the Houston market in 2Q, and how much more opportunity is there for Origin?
Well, actually, it's pretty interesting, Matt Olney, because if I break down, one of the points I made during the IPO is that I would be looking at and measuring our performance pre- and post-lift out, especially this Houston lift out. If you look at net interest income, pre-lift out, $37,170,000. Post lift out, $37,176,000. No impact in Q2 from the lift out. From an income standpoint, $13,229,000 pre-lift out, $12,702,000 post. We saw the impact, $527,000 in the second quarter. We felt that return on average assets, 117 versus 122 without the lift out efficiency ratio was 66.99%, with the lift out, 65.65% pre. What shows where we are, 1,558 on loan growth, with lift out, 1,518. No impact on loan growth, pretty decent impact on deposit growth, which we expect to see deposits first.
Houston grew deposits $59 million in Q2. The first couple of weeks of the month in the third quarter, starting to see some pretty decent loan growth coming out of the Houston team. We expect very good, strong impact in Q3 and four from our Houston group. That number is now at 11. We think we're going to sign a 12th person on that team and really get us in a good position to see significant impact on loan growth.
That's great, guys. Thanks for your help.
Thank you, Matt Olney.
Our next question comes from Wally Wallace with Raymond James. Please go ahead.
Thank you. Good morning, guys.
Hello, William.
Maybe continuing the conversation on loan growth, Drake, could we talk a little bit about where that growth was concentrated or where it was kind of broken out across your geographies?
Really some good news here. I'm going to let Lance go through those numbers because the loan growth might surprise you where it's coming from at this point without the impact of Houston yet. Go ahead, Lance.
Yeah. Hey, good morning, Wally. Thanks a lot. We've actually had real strong growth here in our Louisiana market. Year to date, $66 million of our loan growth has come here in Louisiana, $34 million of that was in Q2. We've actually dropped back in Mississippi about $30 million. We had a couple of big commercial real estate payoffs. Pipeline looks really good there, though. We fully expect that to ramp back up in the third quarter. Dallas-Fort Worth has been a star for us from the loan growth perspective, $102 million year to date in loan growth in the Dallas-Fort Worth market. $29 of that was in Q2. Again, Houston, $10 million in loan growth. We really are starting to see those fundings kick in, both from our organic team as well as the new lift out team that's coming.
Obviously we had a seasonal lift in the second quarter in mortgage warehouse that helped drive the loan growth.
What you're saying about Houston and general commentary, it sounds like the pipeline is building, absent some sort of acceleration in pay downs, it sounds like loan growth could even accelerate from what we saw in the second quarter in the back half of the year. Is that a fair characterization?
It's fair. I don't know that I want to state that at this point because we have struggled, Wally, to really get a good handle on paydowns. For instance, we had a company that sold in our East Texas market that created almost $53 million in deposits that we weren't expecting. We'll continue to try to get a handle on that. We think loan growth will be where it is today, if not stronger. The Houston pipeline, I'll tell you, the quality, what we're doing, the approvals we're getting through the pipeline, the first couple of weeks in July and going into this last week felt really good with Houston credits.
Okay. Were the paydowns in the second quarter less than they were in the first quarter? If so, was it a pretty significant difference?
They were. It's funny you asked that because I almost said, let's just take the paydowns through the first six months and annualize them because it was very similar to the first quarter, but still somewhat higher than expected. Again, I think we're replacing it with high-quality relationships, and these relationships aren't going away in these paydowns.
Okay. Turning the conversation then to margin, you were up six basis points sequentially in the second quarter. With the June hike, how much expansion might we anticipate in the third quarter?
Okay. Steve?
About the same as this quarter. Loans are going to be between the 15 and 20 basis points, but when you look at total assets, it'll probably be closer to the 12 basis points. Deposits, we are trying to keep the betas where we are right now, which is in the low to mid 40%. If the rates go up, I'd say about the same, maybe a little bit higher, one or two basis points higher for the next quarter.
Well, Wally, I think an interesting add to that also is we talked about pricing discipline. We have $1.1 billion of loans that we'll renew and reprice in the third and fourth quarter, which gives us a really great opportunity to offset deposit betas. It's a strategy that we are deploying here and getting very serious about pricing disciplines through the third and fourth quarter.
Okay. Thank you. Maybe one last question. On the expense line, you mentioned in the release and in the prepared remarks about the impact from the new hires. Had you continued to hire through the second quarter, should we anticipate that that base should continue to grow in the second half?
Well, we do have an opportunity in Dallas that we're working on, Dallas-Fort Worth, that would be significant for us, not to the level necessarily of Houston, but I would say 50% of that potentially, if we're successful. We will continue this strategy, as long as we feel comfortable that we're going to get the production ramp-up from those investments. At this point, that's the only thing that's on the burner. We also have some slight work going on in Mississippi with some single lift-outs. We have to get loan growth rolling in Mississippi, and it's going to be through continuing to build bankers. We're also getting aggressive as we can with potential M&A activity in Mississippi.
Wally, also, there was only one person in that group that was hired in the first quarter. Towards the end of the quarter, the vast majority of the people were hired in the beginning to the mid of the second quarter. If you look at the second quarter, you would add just a little bit to catch up for a full quarter of work. Then if we had any other lift-outs. Without any lift-outs, I would say a little bit higher, very little bit to break even on the second and third quarter.
Okay. Thank you, guys. I'll step out and let somebody else ask a question.
Our next question comes from Brad Milsaps with Sandler O'Neill. Please go ahead.
Hey, good morning.
Hello, Brad.
Good morning, Brad.
Just wanted to follow up on Wally's NIM question. I know, I think during the IPO, you guys kind of talked about maybe 10 or more basis points of margin expansion with each Fed rate hike. I was curious, you still got six this quarter, which is great, but kind of how that might have changed. It looks like too, you got a fair amount of liquidity with the IPO proceeds, and just want to get a sense of how you're thinking about working that down and putting that to use over the next quarter or so.
We did have a lot of liquidity. We paid down the FHLB. We also paid down some Fed stock at the end of the quarter. If you saw the average by month, our liquidity is a lot lower at the end of the second quarter. We believe the third quarter, we won't have as much liquidity. Also with typical mortgage, we'll have a lot more on mortgage production and also the warehouse. The third quarter is usually when our loans deposit ratio is a lot higher. We will be less liquid, which means we'll have less money in the lower yielding instruments. If you look back at last year, I would say it's about the same level as last year. We were a little high in the first and second quarter. The second quarter was because of the IPO, but we put that to use.
We waited about a month to put that to use.
Great. That's helpful. Then just switching gears to fees. If you exclude the positive valuation adjustment this quarter, maybe fees are a little less than I thought. Steve, just kind of curious, are there levers you think you have that you can push that maybe closer to back up to where they were in the first quarter, or what are your thoughts around that?
If you're talking about other income, the fees of $2.9 million compared to the $1.8 million, that was on other total non-interest income. Most of those items, we'll have a little bit to pull. That's income on bank-owned life insurance. That's going to be relatively flat. Credit card exchange will be relatively flat. There's a couple items in here that we do not really control. They are investments in CRA, LP investment income. One quarter, maybe $800,000 because of the investment may have sold, and we got a capital gain. This month it was almost flat, this quarter rather. We typically get about $250,000-$300,000 a quarter, but it could go as much as $800,000, $900,000, and as low as zero. Other items that are in there, valuation income. We also have swap fee income.
Swap fee income is going to be whenever we get into a swap. Out of the last five quarters, two quarters we had swap fee income, and three we didn't.
Bigger picture, this is probably a decent runway, notwithstanding some of the things that you talked about, swap fees, et cetera.
That would be the large variable. We also have mortgage banking in the total. Mortgage banking in the third quarter is generally a little bit higher than the second quarter. That is seasonal, we do believe that will be a little bit higher than the second quarter.
Okay, great. Thank you.
Hey, Brad, real quickly, this is Drake. Not to get off of that because we were seeing that $10 million-$10.5 million number. It came in at 8.7. That was really driven, in large part, by mortgage banking. That came in about 1.1 below our expectation. What drove a tremendous amount of that was the impairment on runoffs. We've been a little bit concerned about as we shift to a total retail platform, we continue to see production slowly coming up. The lack of production is certainly causing some impairment. Also the payoffs have been surprising to us to the point to where we did a tremendous amount of work this quarter, not only chasing payoffs, but understanding what's driving those payoffs because they're historically much higher than they should be, especially with an increase in rate environment.
Thankfully for us, it wasn't a service issue. It wasn't a number of things that you could think it was. It was amazing that there are people selling houses, people moving. It was nuts how much impairment we took on for those payoffs. We expect, based on historical in the third quarter, to see a reduction in that impairment, which should help us get because the point is we're trying to restructure and rebuild mortgage to a retail platform where we expect to be at a break-even run rate at the end of the year, something I've talked about on the road. If you take that 1.1, obviously, that's offsetting the gains that we're seeing because of the lack of provision and increased credit quality.
We do believe we're going to recover that and get back on track by the end of the fourth quarter.
Great. That's helpful. Thank you.
Our next question comes from Brady Gailey with KBW. Please go ahead.
Hey, good morning, guys.
Hello, Brady.
Hello, Brady.
Brady.
Just to follow up on what we were just talking about on mortgage. You did $2.3 million of mortgage fees in 2Q. I think I heard you right that there's kind of a, not one time, but the impairments were $1.1 million. Should we expect that mortgage line to go up a little bit in 3Q, and then, by the end of the year, be up closer to a kind of a three and a half million mark, which would be what it would've been this quarter without those impairments?
That's our expectation at this point. We've made some pretty strong moves. We feel that there's some significant opportunity for efficiency moves in the third quarter. As we downsize the operation and go to true retail, we think there's some significant reductions in expenses that we're going to see. This is all going to be around our ability to understand and control these payoffs that are triggering this impairment. Again, we have to go back to historical third quarter, what it looks like during that period in 2017 and fourth quarter, which looks much better. It is our expectation, as I told investors on the road, we're going to fix this by the fourth quarter, or we're going to make some hard decisions.
The retail mortgage business is extremely important to me because of the relationships on the deposit side we're able to build out of it and also the services that we're able to provide in our markets. We're focusing on our footprint, those things, and we do think that by the fourth quarter, we'll be back to those numbers and at a break-even run rate going into 2019.
All right. Drake, I know it's only been, what, two or three months since the IPO has closed. You now have a publicly traded currency. The stock's done pretty well post-IPO. Are you starting to have some M&A conversations now that your company's in a position to actually execute on something? I know you mentioned the State of Mississippi, but just give us some color on where you're at on the M&A front now.
It's been rewarding because of the phone calls, the contacts. We actually are in discussions to some level or another with four different opportunities at this point. It's picking up. One of the points I made is that we're not going to just jump out and do something very quickly. We're going to do something that makes a tremendous amount of sense more on the funding side, which could be a huge add for us in Mississippi if we could reduce our overall funding costs there with a good acquisition. At this point, they're in all three markets, I mean, states we're in, and we're focused a little more on Mississippi. There is an opportunity in Louisiana. We'll continue to push. We think it's a great opportunity for us to maybe have something on the front burner by the end of the year going into 2019, hopefully.
Great. Thanks for the color, guys.
Again, if you have a question, please press star, then one. Showing no further questions, this concludes our question and answer session. This also concludes our conference for today. Ladies and gentlemen, thank you for attending today's presentation. You may now disconnect.