Ladies and gentlemen, thank you for standing by, and welcome to the Southside Bancshares, Inc. Third Quarter 2021 Earnings conference call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during this time, you will need to press star one on your telephone keypad. Also, please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Miss Lindsey Bailes. Thank you. Please go ahead.
Thank you, Jess. Good morning, everyone, and welcome to Southside Bancshares third quarter 2021 earnings call. A transcript of today's call will be posted on southside.com under Investor Relations. During today's call and other disclosures and presentations, I will remind you that any forward-looking statements are subject to risk and uncertainties. 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, CFO. First, Lee will share his comments on the quarter, then Julie will give an overview of our financial results. I will now turn the call over to Lee.
Good morning, and welcome to Southside Bancshares Third Quarter Earnings Call for 2021. This morning, we reported outstanding quarterly results. I wanna thank the entire Southside team for their tremendous contributions and efforts, without which these results would not have been possible. Highlights for the quarter included earnings per share of $0.90, an ROA of 1.61%, annualized linked quarter loan growth, net of PPP of 7.9%, annualized linked quarter deposit growth of 13.5%, an increase in the net interest margin to 3.16%, and continued strong asset quality, with non-performing assets decreasing to 0.17% of total assets. The third quarter results also included a reversal of provision for credit losses of $5.1 million.
Linked quarter, our net interest margin increased 10 basis points, and our net interest spread increased 11 basis points, primarily due to a 10 basis point increase in the yield on earning assets. The average yield on loans increased 15 basis points, largely due to the increase in PPP loan accretion. The average yield on securities increased 5 basis points, and our cost of funds decreased 1 basis point. On September 30, 2021, we redeemed our 5.5% coupon, $100 million subordinated notes, which will further positively impact the net interest margin in the fourth quarter. During the quarter, we expensed $1.1 million in connection with this redemption. Annualized loan growth as of September 30, 2021 was 5.3%. Our loan pipeline in all of our markets is strong.
We anticipate this will continue well into 2022, given the strong outlook for the high growth markets we serve. Fourth quarter payoffs are anticipated to generate headwinds as the anticipation of potential tax law changes has accelerated sales of customer projects. We now believe loan growth for 2021 net of PPP loans will be closer to 5%. We are currently budgeting for and projecting 2022 loan growth net of PPP loans of 9%. During the third quarter, we continued to experience an increase in our average non-maturity deposits, which represent our lowest cost interest-bearing liabilities. Over the past 18 months, non-maturity deposits have increased significantly, which has allowed us to strategically transform our funding base by lowering our dependence on higher cost and shorter duration CDs and unswapped FHLB borrowings.
We had swapped FHLB borrowings at September 30, 2021 of $605 million. The economic conditions in our markets remain strong, bolstered by continued company relocations and existing company expansions, combined with population growth. The DFW market and Austin markets that we serve continue to be among the highest growth markets in the country. I look forward to answering your questions following Julie's remarks, and I will now turn the call over to Julie.
Thank you, Lee. Good morning, everyone, and welcome to our call today. We reported net income of $29.3 million, a linked quarter increase of $8 million or 37.5%, due primarily to the reversal of provision of $5.1 million and a net gain on sale of AFS securities of $1.4 million. Net income increased $2.2 million or 8.2% compared to the same period in 2020.
For the quarter ended September 30, 2021, our diluted earnings per share were $0.90, an increase of $0.08 or 9.8% compared to the same period in 2020, and an increase of $0.25 or 38.5% on a linked-quarter basis. Linked-quarter net of the decrease in PPP loans of $64.6 million, our loan portfolio increased $69.9 million to $3.65 billion. Our commercial real estate loans increased $174.2 million, partially offset by a decrease in construction loans of $106.1 million. The decrease in the construction loans was primarily the result of payoffs and completed projects converting to permanent financing. Commercial loans, excluding the PPP forgiveness, increased approximately $10.8 million during the third quarter.
We also experienced an increase in municipal loans of $9.9 million on a linked quarter basis. The average rate of new loans added during the third quarter was 3.6%. As of September 30, 2021, our PPP loans included in the commercial loan category totaled $67.5 million, down from $132.1 million at June 30, 2021. The average balance of our PPP loans for the three months ended September 30, 2021 was approximately $103.9 million. Our asset quality remains strong. Non-performing assets decreased by $2.8 million or 18.6%, down to 0.17% of total assets compared to 0.21% at June 30, 2021.
Linked quarter, our allowance for loan losses decreased $4.9 million or 11.4% to $38 million at September 30, 2021, due to recording a reversal of provision for credit losses on loans of $4.4 million in the third quarter of 2021. A decrease of $5.9 million compared to the second quarter provision. The decrease in the provision for the third quarter was primarily due to an improvement in the Moody's economic forecast at September 30, 2021. As of September 30, 2021, our allowance for loan losses as a percentage of total loans was 1.04% and 1.06% when excluding PPP loans.
Our allowance for off-balance sheet credit exposures at September 30th decreased to $3.1 million when compared to $3.8 million at June 30th, 2021, due to a reversal of provision of $683,000 compared to provision expense of $157,000 in the previous quarter. Combined with the reversal of provision for credit losses on loans, the reversal of provision for credit losses totaled $5.1 million for the three months ended September 30th, 2021. As of September 30th, our loans with oil and gas industry exposure decreased to $70.7 million or 1.9% of total loans, compared with $94.3 million at the prior quarter end, driven by pay downs on several oil and gas loans during the quarter. We currently have no remaining COVID-19 related deferrals.
Our securities portfolio decreased $15.3 million or 0.5% on a linked-quarter basis. We recognized $1.4 million in net security gains on the sale of AFS securities during the quarter, an increase from the net gains of $15,000 reported last quarter. As of September 30, 2021, we had a net unrealized gain in the securities portfolio of $106.7 million, and the duration of the portfolio increased to 5.8 years from 5.4 years at the end of the second quarter. Our mix of loans and securities at September 30, 2021 remain consistent on a linked-quarter basis at 56% loans and 44% securities.
During the quarter ended September 30, 2021, we repurchased the remaining authorized shares under our stock repurchase plan, a total of 420,204 shares purchased at an average price of $36.74. Our net interest margin increased 10 basis points on a linked quarter basis to 3.16%, and net interest spread increased by 11 basis points, a result of the increase in yield on interest earning assets and fees on PPP loans forgiven. Approximately 18 basis points of the net interest margin related to fees earned on the PPP loans. For the three months ended September 30, net interest income increased $2.6 million or 5.6% when compared to the linked quarter.
We recorded approximately $3.1 million in net fees related to the PPP loans included in interest income this quarter, compared to $1.7 million at June 30. As of September 30, 2021, we had net deferred fees of approximately $2.3 million remaining to be recognized as a yield adjustment over the terms of the loans. Additionally, we recorded $196,000 in purchase loan accretion this quarter, a decrease of $453,000 from the prior quarter. For the three months ended September 30, 2021, non-interest income, excluding net gains on the sale of AFS securities, increased $470,000 or 4.3% for the linked quarter, which was primarily driven by an increase in deposit services income and other non-interest income.
An increase in overdraft charges was the driver of the increase in deposit services income, and other non-interest income increased primarily due to an increase in mortgage servicing fee income. On September 30, we redeemed our 5.5% subordinated notes, resulting in a $1.1 million loss on redemption reported in non-interest expense. Excluding the loss on the redemption, non-interest expense remained consistent on a linked quarter basis. For the fourth quarter of 2021, we expect non-interest expense to be approximately $31 million. Our fully taxable equivalent efficiency ratio decreased to 47.92% compared to 50.31% in the previous quarter. The decrease in the fully taxable equivalent efficiency ratio was due to the increase in net interest income for the quarter.
Income tax expense increased $2.1 million or 72.4% compared to the three months ended June 30, 2021, driven by the increase in pre-tax income. Our effective tax rate increased to 14.5% for the third quarter, up from 11.9% last quarter, primarily due to a decrease in tax-exempt income as a percentage of pre-tax income. At this time, we are estimating an increase in our annualized effective tax rate to 13.2%. Thank you for joining us today. This concludes our comments, and we will open the line for questions.
At this time, I would like to remind everyone, in order to ask your questions, press Star, then the number one on your telephone keypad. Again, that's star one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Brady Gailey from KBW. Your line is open.
Yeah, it's Brady. Good morning, guys.
Morning, Brady.
Good morning.
I wanted to start with loan growth. I mean, 9% ex-PPP loan growth next year is a fairly healthy level. Maybe just a comment, you know, relative to this year, do you expect it to be more production that's driving that higher rate, or is it a lesser amount of payoffs? Just within your geographies, you know, where are you seeing the best growth?
I think it's, you know, it's gonna be a combination of both of those, but more additional production next year. Some of the people we hired this year, we only had for about, you know, 70% of the year that are producing well. Most of the production, the big dollar production is probably gonna come in the metropolitan areas, is what we're anticipating. You know, the DFW, the Austin, and the Houston markets. That's where we're seeing the largest dollar amount. Now, the largest number of loans are being made in East Texas markets, but in terms of the dollars, it's gonna be the metropolitan areas.
As far as the payoffs go, you know, a lot of people are, you know, concerned about tax changes this year, and so that's, you know, that generated some additional payoffs in the third quarter. You know, we're seeing that accelerate even more in the fourth quarter.
All right. Next on the buyback, you know, if I look at the first three quarters of the year, you've repurchased about 3% of the company. So a fairly healthy level. You know, you don't have anything authorized beyond that. Should we think about the buyback continuing from here, or does that pause?
I think at some point, you know, we'll discuss with the board an additional authorization to have available, if not this quarter, early next quarter. You know, I would anticipate we're gonna have additional authorization so that, you know, we have availability.
All right. Last for me, you guys have done a good job of holding expenses flat around this $31 million level. It sounds like it's gonna be the same, you know, to close out the year next quarter. As you look towards 2022, you know, what sort of expense creep should we expect?
You know, we haven't completed the budget for 2022. I know we're gonna have some additional technology spend. In all likelihood, you know, there'll be some increased compensation spend. You know, exactly what that's gonna amount to, I don't know from a percentage standpoint, Brady, but you know, I would anticipate somewhere in the neighborhood of, you know, maybe $1 million-$1.5 million a quarter. I'm looking at Julie to see-
Yeah. No, I'm thinking two things that came to my mind were compensation and technology.
Yeah.
Because we're looking at a few things right now. I think I mean I would like to see it around $1 million-$1.5 million at the most.
Well, we'll have a better idea of that, obviously with the January call, unfortunately. You know, based on what we're seeing now and what we're projecting, you know, that would be my initial stance on it.
Mm-hmm.
Okay, great. Thank you, guys.
All right.
Your next question comes from the line of Michael Young from Truist Securities. Your line is open.
Hey, thanks for taking the question. Just wanted to ask, you know, kind of a follow-up on the loan growth. Obviously, 9% for 2022 is very healthy, very good. Sounds like some larger loans may be kinda driving that. But just generally, you know, I think when we've been surprised at times, it's been related to payoffs or pay downs. Do you have, you know, better visibility into payoffs and pay downs into 2022 than you have in prior years or anything like that would just kinda help us with the confidence around that 9% number?
You know, our best visibility is for the fourth quarter, but we, you know, we know when construction projects are slated to be finished, and that's typically, you know, not too long after that. Some of those that begin to lease up, depending on, you know, how fast they lease up, that's when they become the most vulnerable for payoffs. You know, we know what's coming up, but we also have a good idea of, you know, what our pipeline, how strong it is right now. You know, we anticipate that's gonna continue on into 2022 because things are just, you know, continuing to explode in a lot of the markets that we're in.
You know, company relocations, companies expanding existing relationships that they have in the state, and then overall, just population growth. You know, they can't build the houses fast enough. Multifamily is needed in a lot of these areas. Warehouse space, there's just you know, all sorts of needs as we see the in-migration from the other states.
Thanks. That's helpful. Just on maybe the securities book, you know, with that strong loan growth outlook, you know, do you expect to kind of hold the size of the securities book, you know, relative to the loan book? Or do you expect to, you know, kind of continue to push some excess liquidity into that? Just any outlook there for kind of balance sheet size as we move through next year.
Our plan is not necessarily to expand the securities portfolio. The hope would be that the loan growth would be such that we'd be able to, you know, at a bare minimum, hold it where it is and maybe actually see it decrease a little bit. Some of that's gonna depend on continued deposit growth. If we continue to see deposits grow at the rate we've seen this year, then it's, you know, it's possible that the securities book would hold steady and might even be up just a little bit as we deploy some of that excess liquidity.
Okay, that's helpful. Maybe just lastly, just on asset sensitivity, could you just remind us, you know, how much of the loan book now is variable versus fixed? You know, any kind of early thoughts around, you know, impact of, you know, maybe a quarter point hike or more?
It is the loan portfolio is right at 50/50. It varies from 49/51 to 50/50, but it's stayed in that range all year. You know, that's essentially what we see moving forward. On our fixed rate loans, we typically don't fix them other than on the 1-4 family home loans. We typically don't fix them past 5 years. Even those, you know, probably have an average duration of 2.5-3 years, somewhere in that range. You know, with a quarter point up, I would anticipate, you know, we'll get to enjoy most, you know, almost all of that in the loan book.
Since we've been able to transform the liability side into a significant amount of non-maturity deposits, I would anticipate that, you know, we're not gonna see but, you know, maybe 10%-20% of that 25 basis points migrate up on the deposit side. So it'll be very small.
Okay, thanks. I appreciate it.
Your next question comes from the line of Brad Milsaps from Piper Sandler. Your line is open.
Hey, good morning, guys.
Good morning.
Good morning, Brad.
Lee, you guys have addressed most of my questions. I did wanna ask around loan yields. It looks like they are maybe only down, you know, 2-3 basis points, excluding, you know, accretion and the impact of PPP. I think earlier you were talking about, you know, new loans coming on, you know, kind of 3.15, if my memory serves. Now, sounds like it's closer to 3.60. Is that obviously driven by mix or are you just getting better pricing out there, more fees? Just kinda curious if you could help me kinda understand the kind of the key drivers there around kinda new yields on new originations.
In the first quarter, the average was, you know, in that lower 3 range. I think in the second quarter it was closer to, you know, 3.50. Then you hit it right on the nose. It's 3.60 for the new loans that went on the books in the third quarter. It's a combination of, you know, some better pricing and, you know, folks are concerned about rates moving up and, you know, we're just able to get a little better pricing.
Okay, that's great. You know, just as you think about, you know, your provisioning, reserving, you know, last quarter you took a provision. This quarter, you reversed that out and then some. Do you think you're kind of mostly through that at this point and, you know, you'd start provisioning again to support, you know, some of the loan growth you've got coming down the pike all else equal?
I think that's a correct statement. You know, we look at the CECL reserve, you know, obviously every quarter and kind of saw an upper and a lower band. We were right at the top of the upper band, where the reserve was this time. That band has narrowed dramatically and it's down to a fairly small number at this point in time. Absent a mix in the loan portfolio, I would anticipate that, you know, further loan growth is gonna come at the cost of some additional reserves, which is fine. I mean, that's what you ultimately want.
Sure. No, that's helpful, Lee. Final question. I know you guys typically, you know, pay out a special dividend in the fourth quarter where, you know, your payout ratio is typically, at least since I've come to you guys, you know, kind of been in the mid-fifties. You know, you guys are tracking to, you know, record earnings this year. I know a part of that's because of reserve release. Even then, if for you guys to go and get back to that mid-fifties payout, you know, would imply, you know, a special dividend, you know, a pretty large one. Just kind of curious how I know it's a board decision, but should we think about that type of payout or because it is coming from the reserve, maybe you scale back that a little bit?
Just kind of curious how to think about that based on your history.
You know, we haven't made any decisions, but to think about a payout in the mid-fifties is probably a little aggressive. But you know, that's something we're certainly gonna be taking up with the board here early next month. You know, I guess more to come on that. I'm sorry that doesn't provide you a lot of, but I don't see it being in the mid-fifties this year, simply because a lot of it has been that reversal of provision expense.
Yeah, no, you know, makes total sense. I really appreciate the color. Thanks, Lee.
Your next question comes from the line of Brett Rabatin from Hovde Group. Your line is open.
Hey, good morning, everyone.
Hey, Brett. How are you doing?
I'm great, thanks. I wanted to—I guess first I missed. I heard that there was $2.3 million remaining on the PPP fees, Julie, but I didn't catch what was the amount recognized in the third quarter, if you just had that handy.
Oh, yes. The fees recognized during the third quarter were $3.1 million, compared to $1.7 million second quarter.
Okay. You know, you talked about the margin and the potential for upside when rates go higher. You know, as you think about the remaining opportunities to improve the funding mix, you know, versus the loan yields, you know, and new originations in the securities book, does the margin creep from here a little bit lower unless you have a mix shift change in the earning asset base? Can you maybe give a little bit of stronger outlook on the margin and how you see that playing out until rates move higher?
Well, in the fourth quarter, I think the fact that, you know, we took $100 million at 5.5% off the funding side is gonna have a real positive impact in the fourth quarter. If they do start raising, you know, short-term rates, I think it'll be positive. The reason I say that is if you look at our average FHLB borrowings, approximately 90% of them are fixed with swaps at this point in time. Then, you know, we have reduced CD funding dramatically over the course of the last year and a half. You know, it's mostly in non-maturity deposits right now.
I would anticipate that, you know, if they do start raising the short-term interest rates, that that's gonna have a positive impact on our overall net interest margin. Even if they don't, I still think it's, you know, it's gonna improve in the fourth quarter and then, you know, if worst case would hold flat, you know, next year.
Okay. Appreciate the color there, Lee. Just thinking about if I heard it right, you're expecting 5% core growth for the year, ex PPP. The fourth quarter, you know, if I've got the numbers right here, means a little bit of stated atrophy relative to 3Q. You know, is that right? Just back on the 9% expectations for 2022, you know, is a lot of that construction in C&I and is that pipeline building? Just wanted to get maybe a little more color on, you know, the things that are growing in terms of the pipeline.
Right. You know, some of it is construction because there was a period of time in 2020 where we weren't putting on a lot of construction loans, you know, for about a 4- to 6-month period, simply 'cause, you know, people put their projects on hold until they figured out, you know, what was gonna happen with the pandemic. Then, of course, when you make a construction loan, the equity goes in upfront. You know, we're just now seeing in the last, you know, quarter or so, you know, funding up on a lot of those loans that were made in 2020. We're anticipating that, you know, the loans we've made in 2021 will start funding up in 2022.
That combined with, you know, there's a lot of wholesale funders that, you know, we're taking a look at on the CRE side, some on the commercial side. Municipal lending, we think, is gonna continue to have a nice increase. A number of the larger banks are not allowed or are not gonna be able to make municipal loans in the state of Texas, originate them, because of their position on guns related to what the state legislature did in their legislative session this time. There's just a number of factors that come in that we believe are gonna, you know, bode well for us in terms of loan growth next year.
Okay. I guess that was a two-part question, but there, the first part was just around the fourth quarter and the stated balances decline a little bit linked quarter.
I'm sorry, then what? Declines?
Oh, just with the 5% core guidance. Just wanna make sure I have it correct that the, you know, kind of the-
Yeah. I mean, basically we're right at 4% for the year. You know, if we didn't have any more loan growth, I think we were at 4% through three quarters. The 5.3% is annualized. We are anticipating some a little bit of loan growth in the fourth quarter, but not anything like what we experienced in the third quarter simply because of the headwinds with the payoffs.
Okay. Appreciate that. This maybe lastly, Lee, I'm curious, it seems like I've had some diverging conversations around M&A and the possibility of doing transactions here in the near term, and I think you'd been more optimistic at one point about potential deal making. What's your current view on M&A, and do you expect to be active, and how big of a priority is that for you at this point?
We expect to be active. You know, it goes back to banks are sold, they're not bought. You've got to have willing sellers. At this point, we're just not seeing a lot of willing sellers that you know, we would have interest in. Then some of them that we've talked to that may be you know, it's not something that is gonna be actionable here in the near future.
Okay. That's great, y'all. Appreciate it.
There are no more questions at this time. Turning the call back to Mr. Lee Gibson for closing remarks.
Thank you for joining us today. We appreciate the opportunity to answer your questions and your interest in Southside Bancshares. In closing, given the positive economic conditions in our markets, our strong pipeline, capital position, core earnings and asset quality, we look forward to reporting fourth quarter and annual results to you during our next earnings call in January. This concludes the call.