Home Bancshares Inc Q2 FY2022 Earnings Call

Greetings, ladies and gentlemen. Welcome to the Home BancShares Incorporated Second Quarter 2022 Earnings Call. The purpose of this call is to discuss the information and data provided in the quarterly earnings release issued this morning. The company presenters will begin with prepared remarks, then entertain questions. The company has asked me to remind everyone to refer to the cautionary note regarding forward-looking statements. You will find this note on Page 3 of their Form 10-K filed with the SEC in July 2022. At this time, all participants are in a listen-only mode and this conference is being recorded. It is now my pleasure to turn the call over to Donna Townsell, Director of Investor Relations. Donna, please proceed.

Thank you. Good afternoon and welcome to our second quarter conference call and our first quarterly conference call as a newly combined company. Today's discussion will follow a slightly different format. In an effort to get to Q&A more quickly, our prepared comments today will come from our Chairman, John Allison, Chris Poulton, President of CCFG and Stephen Tipton, Chief Operating Officer. The rest of our team is present and available for questions. Tracy French, President and CEO of Centennial Bank; Brian Davis, our Chief Financial Officer; Kevin Hester, our Chief Lending Officer and John Marshall, President of Shore Premier. It's been a hectic and exciting quarter here at Home BancShares as we have completed the merger of Happy State Bank, while also watching the volatility of the economy fluctuate at the same time. But as you can see from our press release this morning, those distractions didn't hinder our operating performance one bit. And to get more into the details of that, I will turn the call over to our Chairman, John Allison.

Thank you, Donna. Welcome everyone to the Home BancShares 2022 second quarter earnings release and conference call. I guess the only thing we know for certain is uncertainty. These times require a steady hand, a disciplined team of managers that provide strong leadership and are willing to go against the grain. I've always said there is no substitute for experience. For two years, we have been calling attention to the danger of inflation and now suddenly everyone's waking up talking about inflation. Did they just wake up? Where have they been? Home has been planning and taking action for the last year and a half. So I think we've called it right when we talk about inflation. We do not believe that the Fed is likely to back off of their desire to stop inflation and they should not because it is harming our seniors on fixed income. The reason I think they'll not back down is in the late seventies as inflation soared, there was a mistake made by backing off rate increases too soon and had to come back in the eighties and take rates to over 20% to correct the problem. We have to get rates in line with inflation to even begin to take control of this out of control monster. Last quarter, I said it was conceivable that fed funds could hit 6%, and I'm sticking with that call. Fed member Bullard is now calling for a 4% number. The only way to stop this monster is for the Fed to take decisive action. Actually, a 100 basis point shock would be a good thing now, and if they stopped the puppet show, I think that would be good for us. When you look at the tenure that's below the two year, why is that? How did that come about? It's got to be this — it's being manipulated. With consumer prices running from 8% to 20% and PPI running from 11%, it appears the Biden administration is still trying to raise taxes while Americans are already paying an inflation tax of between 8% and 20%. This administration does not have a clue and just doesn't get it. It still appears that the Biden administration has virtually no one with business experience in their entire cabinet. Has anyone ever heard of supply and demand? You can't make something out of nothing. It was said during the Clinton administration, it's the economy, stupid, but Ron White says, you can't fix stupid. I don't know if he's right or wrong. Our company has deployed some excess funds during this quarter as we planned, and we have had some loan growth. I think we ended up with a little over $200 million worth of loan growth primarily led by Texas and New York. Good job by all. The strong quarter is a result of planning and patience that your company has been exhibiting over the past because of our strong belief that inflation was raising its ugly head. The Fed has been very late to the table, which may result in higher rates and longer correction time. An interesting fact, for all you younger individuals out there, what do you think the average fed funds rate for the last 50 years is? I'm saying the average fed funds for the last 50 years, a lot of you have never seen a four or five. You think it was two or three? It was actually 5.44. That illustrates the fact that the world can exist at higher rates as we've done in the past. However, as our US national debt has climbed through the roof, we need lower rates to allow Congress to continue to spend recklessly. In addition, one of the differences today from earlier times is the world is now inundated with an additional $200 trillion in debt. Raising interest rates could affect lots of these smaller countries. Here's the problem: We're all addicted to the sugar-high feeling that we get from zero or low interest rates. But you know what? If you're going to dance, you have to pay the piper; obviously, that time is now. We can pay or we can kick the can down the road and continue this mismanagement. In addition to a $7 trillion Fed balance sheet created out of nowhere, by the way, I'm told that the Fed has not cut back on the purchase as of yet. So the puppet show continues week after week. Now, what happens when the Fed cuts back or stops buying US Treasuries and mortgage backs? Who will buy our bonds? You think maybe our good friends in Russia, or Biden's pals in China, or Trump's buddy, Kim Jong-un of North Korea? This is one of the biggest challenges of all this manipulation because we've been purchasing our own securities with fiat money created out of thin air. I'm very concerned about the ability to have a soft landing. I fear a crash could be on the horizon with this bold and reckless experiment. The key for banks is to be very calculated and cautious with their movements. It does not hurt to adopt a defensive mindset. Over the last 12 months, many have allowed their tangible common equity to fall into the lows. That's a number the investment community does not like, and they may be forced to raise high-priced capital. As you know, Happy may have had to do. Some banks have and others may be forced to do the same in the future; raise capital. Add to that how much flow mark they need for those trying to sell their companies that wrote long and low; any loan with a two, three, or four in front of it today is certainly elusive. The good news is your home company has a war chest of capital. We do not need to raise capital; we have plenty. We did not write long and low because we've been preparing for two years. I couldn't imagine trying to raise capital in this environment; it's very expensive. We used $25 million of our capital to invest in one of the top banks in the country, and we will be receiving 7.75% on this bond they had to sell to fix the tangible book problem. While almost everyone blindly plunged money into low-rate securities, Home was patient; paying off almost $400 million in debt and quietly building a war chest of cash and capital. Your company also refinanced our subordinated debt at much lower rates resulting in over $37 million in savings over the next five years. The conservative moves your company has made should pay dividends for our shareholders in the future because we did not jeopardize our future. We are already seeing the benefits of the Happy acquisition closed on April 1. Your home team is playing the long game, not the short game. We did not receive a very warm welcome. Some people called it a mini-mutiny in a couple of the markets. We hate to see good people go, but that may turn out to be a blessing in disguise, with select individuals leaving in a very unprofessional manner without any notice. The way it was executed could have harmed Happy's local shareholders who are now new home shareholders. I would hope that was not the intent since it would hurt their own customers and shareholders. In hindsight, it appeared that it was in the works for some time. Most employees that left went to some small Texas bank that I'd never heard of, nor do I know anything about their management or bond. The good news is that even with the temporary hardship it created, it also created many opportunities for those that stayed and many new hires that stepped up with enthusiasm and excitement. This may cost a little money over the next couple of years as we leverage the strength of Home's powerful balance sheet to compete in that market. It's a long haul road that does not turn; this should be a lot of fun. Everyone stay tuned. The impact on smaller competitors' balance sheets can be far more severe than the impact on ours. I consider this an unfortunate situation that is mostly behind us, except for the competition on loans. I want to personally thank our Texas shareholders on behalf of our entire team for traveling to meet all of you. Thank you for your time, kindness, and hospitality. I personally could not be more appreciative of the warm welcome you gave us. After all, we have a common goal and share partnership at Home and Happy. Proudly, we own this outstanding company. For the second quarter, we had deferred one-time merger expenses of $107,316,000. These are nonrecurring expenses that would not have happened without the Happy acquisition. I'm referencing numbers today that exclude the $107 million in expenses that allow everyone to see the earnings power of the combination on a go-forward basis. Let's go to the numbers. Net revenue was $243,339,000 for Q2. That is a beat over anyone's expectation and a corporate record. Net operating profit was $97 million, also a beat at a corporate record. We thought we might hit $100 million on a run rate on a quarterly basis in the second or third quarter of '23. So we're very pleased with the early performance of the $97 million. That equated to operating EPS of $0.47 a share, and that would have been a huge beat; according to rates they had us at $0.38, and our own analyst had us at $0.34. One sign is the strong margin. The first quarter of '22, we ended up with a margin of 3.21%, and at the end of this quarter, we were at 3.64%; that's a 43 basis points improvement. I've been watching the numbers come out from other banks, but I haven't seen anybody with that kind of improvement. We're watching that on a monthly basis, and we could see the number getting stronger just follow my numbers here: in March, it was 3.18; in April, 3.40; in May 3.65; and in June, 3.87. June had a little juice in it because it had all the quarterly accretion of the loan marks for April and May rolled into June, so that was inflated. PPNR or pretax pre-provision net revenue was 50% higher in the second quarter than it was in the first quarter. P5NR or pretax pre-provision net profit was 52.06%. Tangible common equity came out almost right at 9%, and we maintain our powerful loan loss reserves at 2.11% of loans or $294.3 million. That is one of the highest of all banks in the country, coupled with our top-tier asset quality. If there is a recession, which Wall Street is calling for, we may not have to add as many dollars to reserves as other banks do. Some have used reserves more like a piggy bank; we didn't do that. We just left them in place. We prefer a reserve of around 2.5%. Significant early improvement in our efficiency ratio as adjusted went from 47.33% in the first quarter to 46.02% in the second quarter. Think about that. Before the merger, Happy was over 62%, and Home was at 47%. More to come, but it will be challenging to achieve the targeted 40% ratio. We're still sitting on about $2.5 billion of cash deployed when we see opportunities. We're strategic in deploying that cash. We continue to repurchase stock when the price is favorable. During the quarter, we bought back over 1 million shares. Having the desire to meet our Texas shareholders, we held 4 shareholder rallies, one in Dumas, Texas, Amarillo, Lubbock, and Plainview, Texas. The meetings were well attended, and we estimate about 700 shareholders in total attendance. They were beneficial meetings that covered the entire story and the difference between owning stock in a private bank versus a public bank. Our discussions also emphasized the dangers in the volatile banking sector and reassured our shareholders of Home's strong balance sheet to get us through any hurdles. We found our Texas shareholders to be hardworking, God-fearing, patriotic Americans. We're looking forward to returning as soon as possible. However, we may consider another rally in Central Texas, possibly around the Dallas-Fort Worth area. On the marine book, John had a strong quarter. It was one of the best quarters ever. However, applications have decreased by about 25% to 30%. I don't know if that will pick up or not, but the dollar volume is increasing. The value of what we're financing is going up, but the applications are down. This time of the year, there are usually shows that could have an impact on sales, plus people tend to wait to make purchases for those events, combined with rising interest rates. In conclusion, it was a busy quarter, but it was one of Home's best, which is impressive for the first quarter together. I'm very pleased with this successful start and expect more positive outcomes in the future. Citicorp's earnings boosted nearly all bank stocks Friday. However, despite the prevailing trend within the banking sector, I am hopeful that we can distinguish ourselves because Home continues to outperform most competitors while remaining very defensive in these turbulent economic times. The good news is your company anticipated this scenario and made preparations to protect all our shareholders, our capital, and our shared future. We will continue to march forward and enhance the success that Home is known for throughout the entire U.S. as one of the best. Thank you for your support because it takes all of us pulling together to keep the company growing and the dividends coming to each of us. The more money we make, the more money we can pay in dividends. I look forward to seeing you all soon; it's an honor and privilege to serve as your Chairman. Donna, I'll let you have it back.

All right. Thank you. Thank you for those remarks and congratulations on such a great quarter. Now we will turn to Chris Poulton, and he will share an update on CCFG.

Thank you, Donna, and good afternoon to everyone. CCFG continues to see demand for our products. During the second quarter of this year, our portfolio grew by $274 million to just over $2.4 billion with about $450 million in new originations. This growth is part of a portfolio rotation that began in Q3 of last year in preparation for anticipated paydowns during the second half of 2022. Last quarter, I spoke about these expected payoffs and paydowns. For Q2, we received $190 million in payoff paydowns. However, we expect that number to increase significantly in the coming 3 to 4 months, especially as prepandemic projects are completed, sold, or refinanced. For context, we've already received approximately $200 million of payoffs in July alone. I expect an equal amount or more in the coming months. This level of paydowns is a feature of our portfolio as it allows us to continuously rebalance our product mix for changing market conditions. Over the last 6 to 9 months, we've slowly reduced our level of active construction loans while increasing our originations in multi-asset loans and facilities. Of the $450 million in new commitments in the second quarter, almost 90% were in multi-asset loans and facilities, and 65% were with repeat customers. Historically, periods of market volatility provide opportunities to support our existing roster of clients as well as add new institutional asset acquirers to our client mix. One of the strengths of the CCFG platform is our willingness, in fact, our desire to realize repayments, which allows us to position our portfolio for what lies ahead, especially during times of market disruption. Thank you, and I appreciate the opportunity to share our results this quarter. Donna, back to you.

Thank you, Chris. And now for more operating results for the quarter is Stephen Tipton.

Thanks, Donna. It's a pleasure to report on our company today. First, I would like to recognize our bankers on the ground in Texas for their tremendous effort over the past several months. The Happy closing and conversion has been a monumental task for all of our teammates, and thanks to you all. As Johnny mentioned, it's certainly been a busy three months at Home, but our patience and persistence are beginning to pay off. The net interest margin improved nicely to 3.64% for Q2. The addition of the Happy balance sheet, variable rate adjustments across the loan portfolio, and higher earning cash balances all contributed to the increase, and we would expect to see additional improvements as rates continue to rise. We are keeping a close watch on deposit balances and customer activity in this dynamic rate environment in our new markets in Texas. We took the opportunity in Q2 to make improvements to our funding mix, specifically a subset of broker deposits, along with several fully indexed or 100% beta municipal relationships. We will continue to refine the deposit base and navigate this rapidly rising interest rate environment. After peaking at a little over $20 billion early in April, total deposits ended the second quarter at $19.6 billion. As the mix is refined, we believe the result is a more granular core deposit base highlighted by over $6 billion in noninterest-bearing deposits or 31% of the total base. Switching to loans. Production was strong at $1.6 billion for the quarter, with $1.1 billion coming from the community banking markets in Texas, Arkansas, Alabama, and Florida. Kevin can provide additional insight on what he is seeing in the pipeline during Q&A, but the activity in our communities in the past few months looks really good. Switching to capital and a few key ratios. We had total risk-based capital of 16.6%, common equity Tier 1 capital of 12.8%, and a TCE ratio of 9.01% as of June 30, all of which are well in excess of our internal targets. Johnny mentioned the strength of Home’s balance sheet in his remarks. Given the capital ratios we just mentioned, top-tier reserve coverage on loans, and the flexibility of having well over $2 billion in cash to invest or to put into loans, we are extremely well-positioned to weather any storms or opportunities that come our way. Donna, with that, I'll turn it back over to you.

Thank you, Stephen. Johnny, before we go to Q&A, do you have any additional comments or questions?

No, this is Tracy. Do you have anything you want to add?

Before we go to Q&A, do you have anything you would like to add? I think I covered most of it. Again, it has been an extraordinary quarter for Happy Bank and Centennial Bank. You couldn't have been prouder of the efforts. As Johnny mentioned, being able to meet the West Texas shareholders was uplifting and a great opportunity to meet new friends. All of us here at the company work for the shareholders. We look forward to the next quarter results.

Thank you. It was a great trip with about 6 or 7 of us that were there. It was a heartfelt experience. We began with no expectations, and it was wonderful to meet the shareholders and tell the home story. I hope they're on the phone today, and they can listen to the report. So, Donna, I think we can go to the Q&A.

Okay. Thank you very much. So operator, we'll turn it back to you.

Before we go, I'm just going to summarize. I thought it was one of the best quarters in the company's history. You got a margin up 43 basis points. You've got revenue of $243 million. You've got $95 million operating profits with $0.47 EPS, good solid loan growth, peer-leading asset quality, strong liquidity. We're doing lots of work on our debt, increasing profitability and activating our buyback plan. It has been one of the best quarters in the company's history. So, we are very proud of our performance during this time and hopefully, we won’t have these one-time expenses next quarter.

Our first question comes from Brett Rabatin with Hovde Group. Brett, your line is now open.

I wanted to first talk about the loan pipeline from here. Johnny, you indicated you still think that interest rates fit funds should be at 6%, and the market isn’t reflecting that. Given your thoughts on rates, would you want to continue to be conservative and not open the lending spigot, particularly with fixed-rate lending? I'm curious how you're going to treat the current environment until it becomes more aligned with your expectations from an interest rate perspective?

I'll comment a little bit, and then let Kevin talk about that. Kevin, do you want to go?

Yes. From our side, we're going to continue to do what we always do, which is be conservative and make good credits. I think we're going to see an opportunity, possibly if things do get volatile, that we'll have an opportunity to continue to do what we do, and you may see some loan growth. You may not. It will just be — as Johnny always says, we'll take what's given to us, and we'll make that work. Rates will be a part of that. We're not going to do anything outside of our norm. The pipeline looks solid, and Texas had good growth last quarter when they just came on board with us. So I think that looks good, too. Chris, I think we're probably not going to show the same numbers we showed last quarter. So we'll probably contract a little bit, and then we'll go from there. We're just going to keep doing what we do.

Interestingly, I saw more loans with 6% interest rates at the loan committee this week than I've seen in a while; probably about 60% of loans have a 6 in front of them. Anything that we ask for just indicates the market is recognizing that. We expect to still have a robust pipeline. We don't write just to write; we're careful. We're prudent. In other markets, we probably won't pursue loan growth as aggressively. So, we'll see what happens. We remain cautious, and regardless of the economic outlook, we are glad that we've prepared to protect our shareholders because it could get rough. I recall when all the Texas banks failed in the late '80s. Everyone should be cautious.

That's great color. I wanted to ask about the expense savings of $53 million related to the Happy transaction. Can you discuss the pace of those savings and what we should expect from an expense run rate moving forward?

I don’t have an exact number for the month, but when we were running at 47% in the first quarter, Happy was running over 62%, and we combined through this quarter around 46%. That is a pretty amazing turnaround concerning expense reductions. Some of that is due to personnel who were likely overpaid exiting, which helped us. Stephen and Brian...

Brett, I think we modeled 75% of that number to occur over the course of this year. Some of the departures helped from a personnel expense standpoint, and then we're currently in negotiations on contracts. On insurance, I think we're set to pick up about $600,000 in improvements there. So, I believe we'll continue to generate those savings over the course of this year and will also look into facilities and other areas.

We're realizing that on the insurance, we were paying around $1.4 million, and Happy was at $800,000. Combined, we will pay $1.4 million, and that’s about $600,000 in savings, we’ll take that. We’re continually clipping along and seeing benefits as we proceed.

Yes, certainly really strong results this quarter. One last quick question. You mentioned marine sales were down 25%, or applications were down 25%. It's interesting that used RV prices are actually up 5% year-over-year in June. John, are you seeing anything indicating that the economy is actually slowing and there are pressure points out there, or are you not seeing anything yet?

On the residential side, we are seeing an overall slowdown. The subdivisions and homes are decreasing in activity—it’s likely due to rising mortgage rates; approximately 5.5% now on 30-year mortgages. I think that will impact purchases; there's no doubt about it. Kevin, you have any insight?

No, I would just add that we operate in some favorable states for housing. So we may experience less of a slowdown than others. We are watching closely what our borrowers are doing and monitoring our ground situation.

Indeed, operating in Florida and Texas, two of the best states for business, is a significant advantage. It provides reassurance to our shareholders and their families. With both operations working together, it’s mutually beneficial to have them pulling in tandem.

Our next question comes from Brady Gailey with KBW. Brady, your line is now open.

Johnny, you were active in the quarter, putting some cash to work in the bond portfolio. You're still sitting on a pile of cash. Could you share your thoughts on how that progresses from here? Will you continue to shift that cash into bonds slowly, or are you waiting to see?

Well, we're sitting on about $2.5 billion now after paying off some deposits. We’ll probably start putting some cash to work, but I think we should wait for the next increase, which is likely to be 75 to 100 basis points, probably around 75. Then we'll start deploying more funds. We’ve been careful choosing our spots. Some of these companies have raised capital, and we know them well; we've been very selective and managing the time for getting the best yields. If I predict 6%, we're beginning to see that in our own securities.

You mentioned earlier that the core provision has been close to zero for some time. As we possibly head into a recession, do you foresee a need to start adding provisions? Or will your reserves put aside suffice?

We won't have to add as much as others, that's for sure. We’ve maintained strong reserves. Many banks have used their reserves as a temporary convenience; they pull it in and allocate it into income temporarily. We've taken a disciplined approach, leaving the reserves intact to ensure safety for our shareholders. If we do see a one-time need, we might take the hit, but I can’t see it being substantial.

Yes, I agree with John. We didn’t draw down our reserves during COVID, so we are currently higher than most, and if we need to allocate some back, it shouldn't be on the same scale as some other banks.

Finally, regarding M&A, it’s an interesting time. Happy is on the books, and you have substantial capital. However, considering the economic weakness, do you still intend to pursue M&A? Given that bank stocks are currently cheap, how do you evaluate participating in M&A?

We purchased Happy's book on April 1 for $128 million. I'm shocked at anyone attempting an M&A transaction today. Not only do they face a marked bond book, but also a marked loan book. If someone's rolling loans at 2%, 3%, or even 3.5%, the impact will be significant. I don't know how someone perceives the value of their loan book under current conditions. It poses significant risk; many banks are currently for sale, yet that came with severe risks. Price levels are certainly changing. We just need to remain cautious.

If the focus is on avoidance of tangible book dilution, then the dynamic is much different. Marking down the loan book will be painful for anyone attempting an acquisition.

Yes, that's my point. I initially thought about $128 million for Happy, and then I consider the loan books and think, “Wow, that’s a big cost in such a downturn.” It was major for Happy; they did a good job. However, it's complicated to enter transactions today due to market conditions and the necessity of marking securities.

Hi, just to follow up, most of my queries have been addressed, but can you help clarify expenses? What’s your anticipated run rate for Q2?

While I don't have an exact number, we have some personnel reductions coming off payroll post-conversion. August will be telling regarding our operational cost. I’d estimate we’ll hopefully be at about $100 million this quarter.

Yes, to summarize on expenses, we are seeing reductions through attrition and streamlining our costs. We’re optimistic about achieving a better run rate moving into the next quarter.

So, guys, given your positions and good standing, you've talked about higher reserves, liquidity, and being patient. What are your plans for the buyback at this point? You've been active this quarter, and I think you've had success in buying back shares.

I had anticipated the stock being up today; I don't know what’s behind the downturn.

As long as the stock price remains favorable, we’ll continue to buy back shares. We purchased 1 million shares, and the liquidity allows us to do this. We’ll likely continue investment in key partnerships. The key is to maintain patience as a means to grow our portfolio despite market fluctuations.

I think we always approach with a measured perspective; patience has served us well.

I'm seeing themes in larger ticket loans but there appears to be apprehension on the side of large banking institutions due to volatility in the market. Therefore, we're adjusting our funding base to provide better support for reliable customer requests.

Can you provide an update on direct customer feedback surrounding deposits as some banks have made adjustments?

We're seeing the same trends. After the first rate increase in March, we were able to be neutral. But we've had to pass a little more along in May and June, which has caught customers' attention. A 2% rate definitely has our customers actively discussing options. We model deposit beta at around 40% blending everything, and we're being cautious and intentional.

This is certainly a reflection on what we've seen across the entire banking sector; banks are reacting to maintain deposits. We’re prepared to face any spikes as interest rates shift, but it’s about nurturing long-term relationships.

Could you help clarify what the net interest margin is and how that bodes for growth amidst fluctuating conditions?

The margin hit 3.64% with new rates restructuring positively impacting loan performance. I project continuous improvement as we navigate through this evolving financial landscape.

In summary, moving forward, we’ve had significant progress in multiple areas such as margin, reserves, and expenses. I'm optimistic about how we are positioned.

Our final question comes from Jon Arfstrom with RBC. Jon, your line is now open.

Could you clarify the expenses you anticipate going forward and how some of these will affect run rates?

While not definitive, we are moving past a significant conversion period influencing costs. We see a positive trajectory in expenses moving into future quarters, and I don’t anticipate any shocking changes moving forward.

In conclusion, we’re proud of the accomplishments we’ve made but aware of the challenges that remain. I'm confident that with our strategies and strong management, we will overcome these hurdles. Thank you all for your support.

This concludes the Home Bancshares Inc. Second Quarter 2022 Earnings Call. Thank you for your participation. You may now disconnect your lines.