Independent Bank Group Seeing Improved Deposit Costs And Okay Loan Growth In A Challenging Period
IBTX's third quarter results were driven in large part by provisioning, but revenue was better than expected and lower deposit costs helped the net interest margin.
Criticized and non-performing loan ratios are moving up, but the reserves look adequate and IBTX has a strong history of quality underwriting.
Organic growth (as measured by deposit share in major MSAs) has not been so great, but I do expect management to return to M&A soon.
IBTX shares look modestly undervalued as is, and accretive deals can boost the long-term upside.
In a challenging environment, a bank with a respectable core deposit franchise and a good underwriting track record is not a bad call, and Independent Bank Group (IBTX) has rebounded sharply since calling off its merger of equals with Texas Capital Bancshares (TCBI) back in May – outperforming regional banking peers by more than 30%. While there are nits to pick with respect to Independent’s standalone performance since its last acquisition (Guaranty in 2018), I nevertheless believe this is a good lender with meaningful growth prospects in Texas and Colorado.
M&A has long been core to the IBTX growth story, and I see no reason to expect that to change. With deal activity picking up, including the recent PNC (PNC) acquisition of BBVA’s (BBVA) U.S. operations, I would expect IBTX to be back on the hunt. As the shares are relatively fairly valued on an “as is” basis, and I do have some concerns about execution where organic growth is concerned, I do believe accretive deals are important to driving further rerating here.
Pretty Respectable Results On Balance
While lower provisioning was the main driver for IBTX’s bottom line performance relative to expectations in the third quarter, as it was for most banks, there are still some solid takeaways from the quarter, including improving deposit costs.
Revenue rose 3% yoy and 2% qoq on a reported basis, or more than 8% yoy and 4% qoq on an adjusted basis, beating top-line expectations by around 6%. Net interest income rose 5% yoy and 3% qoq (2% on an adjusted basis), with minimal net interest margin erosion (up 1bp reported, down 2bp core) as the bank benefited from lower deposit pricing and surprisingly good (at least to me) loan yields.
Fee income was a line item where reported versus adjusted numbers are substantially different. Reported income declined 8% yoy and 1% qoq, while adjusted income rose 34% yoy and 21% qoq; I believe the adjusted numbers are a better reflection of the core results.
Operating expenses, too, showed some variance. Reported opex declined almost 5% yoy and 12% qoq, while adjusted expenses (which strip out merger-related costs, COVID-19 related costs, and so on) rose 12% yoy and 11% qoq. Adjusted pre-provision profits were up 6% yoy and basically flat sequentially – not great, but not awful. PPOP as a percentage of loans was 2.6%, marking Independent as a pretty profitable bank, particularly given a relatively small base of typically lucrative fee-based businesses.
Tangible book value per share rose 15% yoy and more than 3% sequentially, while the CET 1 ratio came in at 10.7% - not bad for a smaller growth-oriented bank.
Excess Liquidity Isn’t So Bad For IBTX
Most banks have lamented the surge in deposits they’ve seen in recent quarters, as it has saddled with surplus capital that they cannot profitably deploy, leading to greater than expected pressure on spreads. Not so for IBTX. This bank went into the pandemic downturn with a relatively high loan/deposit ratio (97%) and managing deposits costs had been more of a challenge in 2018 and 2019, contributing to a string of disappointing results relative to expectations.
Coming out of the third quarter, though, the loan/deposit ratio is a much more manageable 93%, and strong growth in non-interest-bearing deposits (up 5% qoq versus less than 1% growth in interest-bearing deposits and 2% growth in loans) has not only improved the deposit mix, but reduced deposit costs from about 1.1% last year (and 0.57% last quarter) to 0.47%.
A key question is whether Independent can hang on to those deposits when the economy eventually recovers and depositors once again look to chase yields (and deploy capital in their businesses). I’m concerned about this, particularly given the high level of competition in Texas for deposits.
A Better Than Average Loan Book
Independent is a smaller bank (well, small-ish; $17B in assets and $2.6B in market cap isn’t that small), and like many smaller banks it is heavily leveraged to a particular type of lending – CRE lending in this case. Management has been trying to diversify the loan book in recent years, and CRE loans are now less than 50% of the total mix, but still about 325% of risk-based capital.
While investors are understandably concerned about CRE lenders now, I think IBTX is in good shape despite exposure to office (25% of the CRE book), retail (25%), and lodging (6%). Almost half of the lodging portfolio is on deferral (making up more than a third of total deferrals), but the loan-to-value ratios offer some security (53%) and these are generally franchised locations.
Every cycle is different, but Independent has typically posted meaningfully lower bad debt expense than its national and Texas-based peers. Whether this cycle will continue that trend remains to be seen (we haven’t seen a downturn that impacted consumer-exposed businesses like this), but average loan balances are small and the reserves look adequate.
Organic Growth Is A Fair Area To Question
One concern that I think is fair with regard to Independent is the bank’s ability to grow organically. Management has spoken of its frustration with regard to loan growth (challenges due to the cycle/economy in particular), but it’s the organic deposit growth that gets my attention.
Absent deals, Independent hasn’t really added that much deposit share in Dallas or Austin (a couple tenths of a percentage point each), and likewise hasn’t added share in Houston. I understand that the market for deposits in Texas is intensely competitive, but I think it is fair to flag this as a risk – growth through M&A is a time-tested and valid way for banks to grow, but the long-term winners (like PNC) are able to layer organic growth on top of those deals.
The Outlook
With a population and economy that is likely to grow faster than the U.S., Texas remains an attractive market. I continue to like Independent’s underwriting approach, emphasizing relatively small loans (the average CRE loan is $1.2M) and looking to diversify and grow the C&I lending operations, particularly in areas like equipment finance. Independent has also been very careful with energy lending (less than 2% of loans) and has avoided leveraged lending and national lending (SNCs, or syndicated loans). Organic deposit growth remains a concern, but not a deal-breaker for me.
On its own, I believe the bank can generate double-digit core adjusted earnings growth and an ROE in the low double-digits (around 12%). Independent is not very asset-sensitive and loan growth is likely to remain the principal driver.
The Bottom Line
As is, I think IBTX shares are a little undervalued, with a fair value in the low $60’s. “As is” is arguably not a really good way to think of these shares, though, as management is all but certain to look for additional deals (most likely in Texas, but perhaps selectively in Colorado). Provided management continues to make the right calls on deals, and particularly if organic deposit share growth can accelerate, these shares are at least worth a closer look.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
