South Plains Financial's Q2 Earnings: Navigating Margin Gains Amid Credit Crosscurrents

South Plains Financial (NASDAQ:SPFI) delivered a robust Q2 2025 earnings report, showcasing a 4.07% net interest margin (NIM) and a loan portfolio growing at a 3.0% annualized rate. However, these positives are tempered by rising credit costs and elevated classified loans, creating a tension between profit expansion and risk management. This analysis evaluates whether SPFI's operational strengths—particularly its Texas-centric relationship-based banking model—outweigh emerging credit concerns, ultimately supporting a Hold rating with a critical caveat: stabilization of credit quality is essential for sustained success.

The NIM Story: Strength Amid Shifting Rates

The bank's NIM expanded to 4.07% in Q2, up from 3.81% in Q1, driven by a 32-basis-point rise in loan yields to 6.99% and a 5-basis-point decline in deposit costs to 2.14%. Even excluding a $1.7 million one-time interest recovery, the margin reached 3.90%, reflecting organic strength. A key factor is the loan portfolio's 42% allocation to immediately repriceable variable-rate loans, which have helped SPFI capitalize on rising rates without excessive duration risk.

This margin expansion aligns with the bank's focus on relationship-based lending, where long-term borrower ties allow SPFI to retain pricing power. Texas markets, particularly Dallas and Houston, are central to this strategy, as evidenced by the recruitment of seasoned commercial lenders to bolster CRE and C&I lending.

Loan Portfolio Diversification: A Mixed Picture

While SPFI's loan book remains well-diversified across 1-4 family residential (19%), non-owner-occupied CRE (19%), and C&I (14%), headwinds from multi-family loan payoffs (totaling $52.6 million) highlight execution risks in certain segments. The bank's geographic focus in Texas—where CRE accounts for 38.3% of total loans—requires close monitoring.

The non-owner-occupied CRE portfolio, though with a conservative 58% loan-to-value ratio and minimal delinquency (0.04% of loans 90+ days past due or nonaccrual), faces broader macro risks. A downgrade of a $32 million multi-family loan pushed classified loans up by $24.3 million, underscoring vulnerabilities in CRE-heavy regions.

Deposit Cost Management: A Quiet Success

SPFI's deposit strategy has been a bright spot. Noninterest-bearing deposits rose to 26.7% of total deposits, reducing funding costs even as total deposits dipped slightly to $3.74 billion. The decline in public fund deposits (down $73.7 million) was offset by growth in retail and commercial accounts, indicating strong client retention.

This stability in funding costs supports further NIM resilience, though deposit competition remains fierce in Texas's dynamic markets.

The Credit Crosscurrent: Risks Looming

Despite the positives, SPFI's credit metrics warrant caution. The provision for credit losses surged to $2.5 million in Q2—over five times Q1's $420,000—due to specific reserves, net charge-offs, and credit downgrades. While the NOO CRE portfolio's low delinquency rate is reassuring, the $24.3 million rise in classified loans (driven by multi-family CRE) suggests heightened risk in this segment.

The bank's credit culture and conservative underwriting—evident in its 0.16% nonperforming assets ratio as of Q1—provide a buffer. Yet, further deterioration in Texas CRE markets could strain these metrics, especially if energy or office sectors weaken.

Strategic Advantages: Relationship Banking and Capital Strength

SPFI's relationship-focused model in Texas markets is a key differentiator. Its penetration in Dallas and Houston, where it has deepened commercial lending teams, positions it to capture organic growth. Meanwhile, a tangible book value of $26.70 per share and $1.95 billion in liquidity underscore its resilience.

The bank's improved efficiency ratio (61.1% in Q2 vs. 66.9% in Q1) reflects cost discipline, and its 17.93% total risk-based capital ratio ensures ample headroom for growth. These factors justify a Hold rating—provided credit quality stabilizes.

Investment Takeaway

South Plains Financial's Q2 results highlight two conflicting narratives: a margin-driven earnings story and a credit risk cautionary tale. While its NIM and deposit management are commendable, the spike in classified loans and provisions signals that SPFI's Texas exposure carries risks.

Hold Recommendation:
- Upside Catalyst: Stabilization or reduction of classified loans, coupled with further NIM expansion.
- Downside Risk: Deterioration in Texas CRE markets or a sustained rise in provisions.
- Monitor: Track SPFI's CRE portfolio performance and compare its credit metrics to peers like Texas Regional Bank (TRB) and First Horizon (FHN).

Investors should remain cautious but not dismissive. SPFI's operational excellence and geographic focus justify patience—provided credit metrics improve.

Final Note: The "Hold" rating assumes no further credit downgrades. Investors should pair this position with a close eye on Texas real estate trends and SPFI's Q3 credit disclosures.