Earnings Call Transcript - HOMB Q2 2023

Operator, Operator

Greetings, ladies and gentlemen. Welcome to the Home BancShares, Inc. Second Quarter 2023 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 their cautionary note regarding forward-looking statements. You will find this note on Page 3 of their Form 10-K filed with the SEC in February 2023. And this conference is being recorded. It is now my pleasure to turn the call over to Donna Townsell, Director of Investor Relations.

Donna Townsell, Director of Investor Relations

Thank you. Good afternoon, and welcome to our second quarter conference call. With me for today's discussion is our Chairman, John Allison; Tracy French, President and CEO of Centennial Bank; Stephen Tipton, Chief Operating Officer; Kevin Hester, Chief Lending Officer; Brian Davis, our Chief Financial Officer; Chris Poulton, President of CCFG; and John Marshall, President of Shore Premier Finance. While Home BancShares continues to stand tall in this shaky banking environment with strong second-quarter results, our first speaker, Chairman, John Allison, will illustrate those details for us with some prepared remarks.

John Allison, Chairman

Thank you, Donna, and welcome, everyone, for attending the second quarter of 2023 earnings release and conference call. I hope you found it interesting and informative. Some people set themselves up for an easy target, and sometimes it’s hard to pass that. Here we are in July '23 and just wrapped up a very interesting and unusual quarter, to say the least. We have seen the worst financial crisis since the great recession from 2005 to 2010 and the pandemic of 1917 like we have never experienced, while inflation, not seen since the late '70s and early '80s, results from both past and present administration spending money without any restraint. The administration has tried to control inflation with this uncontrolled spending. I call that swimming upstream with handcuffs. What is working? The suicide rate has jumped, homelessness has exploded, and we are seeing the highest number of bankruptcies in 12 years. We're starting to replace the U.S. dollar with a digital one, which is concerning; bank failures—we’ve experienced several this year and could see many more; interest rates are at the highest level; crimes are rampant in cities; and the war in Ukraine continues. The economy is slowing; the deficit is exploding; and the administration is trying to convince us the economy is strong while 31% of Americans have tapped a loan from their retirement fund due to record levels of credit card debt hurting American families. Thousands are crossing the border; inflation continues to persist, although it is showing signs of improvement. The last I checked, we are still busy buying nonstop from our Chinese counterpart. China appears to be a threat to the U.S. because we look weak. They try to exert their influence around the world. I've also noted Hunter Biden has finally agreed to take his place before the U.S. attorney under certain conditions. However, aside from that, things are pretty good. The second quarter has been stressful with several bank barriers in the previous quarter and possibly more to come. This is a risky time in my banking career. As I stated last quarter, liquidity becomes important quickly during a crisis. Seeing firsthand what liquidity issues can cause has been nerve-wracking, but I remain proud to be at one of the few banks with a balance sheet strong enough to manage uninsured deposits while keeping Home's balance sheets intact. Though paying out insured deposits has cost us some income, the security and strength of Home as one of America’s strongest financial institutions outweighs short-term earning concerns. We can service those payouts and even retain strong profitability, remaining among the top 25-30% of profitability for the best publicly-traded banks in the U.S. Despite inflation, the second quarter performed well overall. The only weakness noted was an interest expense exceeding interest income by about $6.9 million from last quarter. Interest income hit a record, but so did interest expense, which has been disappointing to me, and we are addressing it. We have about $760 million to reprice between now and the end of the year at just above 5%. We could possibly see a 300 basis point increase in yields, adding around $5.7 million to quarterly interest income, which isn't sufficient but is close. We are also seeing a similar dollar amount of scheduled payoffs, and we hope to retain some of those customers at a higher rate while continuing to originate new business as long as we feel safe and secure. Our philosophy remains cautious, and now is not the time to take risks. Our goal was to achieve about $400 million for the year, and we are on track with $208 million in the first half. I believe our investors and shareholders will be pleased with those figures, especially considering we’re on track for our best year amidst a banking crisis characterized by unprofessional treatment and potentially illegal behavior experienced in West Texas. My wife often says to protect the chuckwagon, and that’s precisely what we are doing. This is a time for caution, slow movements, and not taking on others' problems through refinancing bad loans. We are seeing many banks struggle with problem loans, and while our New York office is witnessing a surge of them, no one has yet taken the initiative. These banks are running ads with 5.5% and 6% rates, having already torpedoed their balance sheets due to prior mistakes. I expect the cost of deposits will continue to rise for them. Unfortunately, their margins are getting squeezed, and if forced to sell securities, they risk a run on the bank similar to what happened at Silicon Valley Bank. I have spent 23 years developing this company and the thought of it disappearing in an instant is unnerving. Many banks allowed their balance sheets to exceed 105% loan-to-deposit ratios, with weak capital levels. History tells us that a repeat of past mistakes could be imminent. Strength and safety have been our priorities for the past 23 years, and that will never change as long as I’m in charge along with this management team. Let's review our results: $105.3 million in earnings for the quarter—$0.52 per share, which slightly exceeded expectations as the analysts anticipated $0.51. Revenue was $257.5 million, exactly as projected, with an efficiency ratio of 44%. Our net interest margin remains strong but dropped 9 basis points during the quarter. We are continuing efforts to maintain it. Asset quality is solid, our reserves are strong at 2.01%, and nonperforming loans and assets both improved for the quarter, with loans improving from 0.51% to 0.43% and nonperforming assets from 0.33% to 0.28%. We sold $30 million in loans we've discussed for a couple of years, successfully refinanced with multiple buyers, showcasing our conservative underwriting practices. Asset quality remains good. The only item to mention is that we received information recently regarding an office building with a value between $25 million and $30 million, which we are monitoring but do not anticipate a loss. The tenant has invested over $10 million in improvements, and we are keeping an eye on it. Lastly, we have nearly $300 million in loan loss reserves, which provides peace of mind in these uncertain times. The return on tangible common equity is a nice 19.39%, with capital ratios at top-tier levels: CET1 at 13.63%, leverage at 11.92%, and total risk-based capital at 17.28%. Tangible common equity in relation to tangible assets is at 10.65%, with a tangible book value of $10.87 and book value of $18.04. This quarter, we repurchased 560,849 shares for approximately $11.8 million, leading to a total year-to-date buyback of 1.15 million shares for $25.3 million. The average loan yield increased from 6.64% in the first quarter to 6.84%. Interest-bearing deposits rose from 1.90% to 2.27%. I anticipate the second half of the year to be more challenging than the first. The good news is that Home is well positioned to navigate whatever comes our way. We did not stabilize our position through luck; we’ve managed our operations with maximum conservatism. During the last 18 years, we have faced one surprise after another time and again. I see how our Home BancShares employees have worked tirelessly, often from dawn till dusk, even sleeping in the office at times. I find that truly remarkable. I feel blessed to lead such a dedicated team. I want to thank the investment community for their tremendous support. Navigating the banking space hasn’t been the best asset class over the last 15-20 years, but many of us remain committed. Home is my largest asset, as well as that of my executive committee members and numerous regional presidents. There is a strong commitment to our company's success; I'd argue no management team in the U.S. aligns more closely with their shareholders than Home, and we will protect this company with all we have. An attack on Home is an attack on all our families' futures, considering the value we have committed to for nearly a quarter century. I hope you are all proud of these performance results. Not many banks trade at twice tangible book or more. As we’ve seen multiples decrease over the years, we make no apologies for our multiple; we’re proud of it. I often hear, “I would love to own your stock, but...” to which my response is that we are fortunate to have the best institutional investors in the banking sphere, along with strong insider ownership. Our ownership is approximately 7%, with my family stake around $200 million. We are here to stay, dedicated to our shareholders, and we will continue to make you proud as we remain part of the elite top-performing banks in the country. You have my personal commitment. Thank you for listening, Donna. I'll turn it back over to you.

Donna Townsell, Director of Investor Relations

Thank you for a very insightful report as always. Next, we have Stephen Tipton here to provide us with some more operating details.

Stephen Tipton, Chief Operating Officer

Thanks, Donna. I'll start with liquidity and funding topics. We mentioned last quarter that the shift of deposit balances to investment firms, money market mutual funds, and a highly competitive interest rate environment in the bank space continued through the second quarter of 2023. Total deposits declined by $449 million this quarter, with most of that occurring in late April as tax payments cleared. Across our geographic footprint, the Arkansas regions remained stable, while Texas and Florida attributed the majority of the decline. Though noninterest-bearing balances dipped slightly less than $350 million, they account for a strong 27% of total deposit balances. As Johnny indicated, our uninsured balances relative to our borrowing capacity improved slightly from Q1 to 29% of total deposits when accounting for collateralized deposits, typically municipalities, local school districts, and higher education relationships. Alternative funding sources look strong, with broker deposits comprising only 2.2% of overall liabilities. Our internal limits would allow for an increase of over $1.4 billion if asset-side opportunities arise. Our top 10 depositors account for less than 6% of total deposits, with only one customer being uninsured and uncollateralized. Additionally, our deposit base boasts nearly 500,000 deposit accounts, with over 70% of those accounts being open and active for a minimum of 3 years and over 25% for a decade or more. Presently, the mix stands at roughly two-thirds commercial and one-third retail, with approximately 80% of the accounts being retail. The focus on loan committees and discussions amongst our regional presidents is centered around deposit gathering, core customer growth, and retention. On the asset side, loan origination volume has increased slightly from Q2, with $1.34 billion in commitments, notably 80% of which came from the community bank regions, with over $400 million each from Texas and Florida. Yields on those originations continue to improve, averaging an 8.64% coupon in Q2. Finally, as Johnny mentioned, our net interest margin compressed by 9 basis points in Q2 to 4.28%, impacted by lower event income contributing approximately 3 basis points to the decline, with the remainder attributed to deposit rate increases outpacing the rise in earning asset yields. Interest-bearing deposits averaged 2.27% in Q2, up 37 basis points from Q1, and exited the quarter at 2.39%. Meanwhile, the core loan yield, excluding accretion and event income, averaged 6.72%, rising by 23 basis points from Q1 and exiting at 6.79%. With that, Johnny, I’ll hand it back to you.

John Allison, Chairman

Yes, we've all been watching this bank crisis live from the front lines and understand the impacts of interest rates on our banks. I remember the late '70s and '80s when a similar process occurred, and while an orgy of excuses can be manufactured, the financial position of any company is either good or bad based on past executive decisions. In retrospect, management and the Board must ultimately be responsible for these outcomes. We may say we were blindsided, but we need to prepare for such occurrences. One significant difference between the current banking crisis and the SNL crisis is the speed of the downturn: this time, it is light speed due to modern technology. SNL faced a slow demise, while now billions can exit banks almost instantly. This can create rapid shifts like what we saw at SVB. Early on, I was uncertain about whether we could meet payout demands for insured deposits. It became clear that if any bank could cover those demands, Home should be able to. Brian Davis and Stephen Tipton reassured me, and the relief was palpable. The decision not to invest excess funds into securities was a prudent, albeit difficult, choice that had a significant bearing on thousands of stakeholders. Reflecting on our choices during last year's rate increase, the decisions we made paid off as we dodged many bullets. Yet, we could have easily found ourselves in the same predicament as other banks that strayed from sound strategy. Hence, I emphasize that not all regional banks are created equal. We strive to differentiate ourselves from the rest. The decision to hold $3 billion in excess funds as Fed loans proved fortuitous. Even so, we did mistakenly reinvest cash flow from our securities, blurring our focus during that high-pressure period. In hindsight, this mistake may have cost us significantly in additional liquidity and earnings. Nevertheless, that liquidity comes at a price, and I'd rather be mostly right than completely wrong. We take total responsibility as management, ensuring all decisions align with the company's overarching interests. The bank's success hinges on coordinated decision-making across all management sectors. A major crisis may not be completely avoidable, but I am confident that we’ve constructed one of the safest financial institutions in America. We’re proud of our performance. The second quarter yielded $105.3 million in earnings, equating to $0.52 per share, and performs as anticipated at approximately $257.5 million in revenue. The efficiency ratio stands at an admirable 44%, albeit with a slight dip in our net interest margin, which we are actively working to improve. Our asset quality showcases reserves maintaining a strong 2.01%, with nonperforming loans reduced from 0.51% to 0.43% and nonperforming assets dropping from 0.33% to 0.28%. Additionally, we have conscientiously divested $30 million in loans. Asset quality remains robust, with new challenges emerging on one office building closely monitored. Overall, we are comfortably positioned to protect the wealth of our employees, partners, and stakeholders. Our return on tangible equity is an impressive 19.39%, and we maintain strong capital ratios demonstrating our resilience. We have executed buybacks totaling $25.3 million year-to-date as of this quarter, and our emerging loan yields have positioned us positively with regards to future income. Despite the looming pressure anticipated in the latter half of this year, Home remains adept to handle any challenges that arise. Historical experience has bred caution and prudence in our operations. Home BancShares has consistently secured its place at the forefront of U.S. banking—our recognition as a top-tier institution is commendable and speaks volumes about our management's efforts. I appreciate the ongoing support from our investment community. In closing, let’s remain committed and diligent because setbacks do not deter us. We have the resources to navigate whatever challenges emerge as we continue to grow our operations. Thank you, and I’ll hand it back to Donna.

Donna Townsell, Director of Investor Relations

Thank you very much for those comments. I think now we are ready to go to Q&A.

Operator, Operator

The first question comes from Jon Arfstrom with RBC.

Jon Arfstrom, Analyst

Do you hear me all right? Okay, good. Question for you, maybe Tracy or Kevin, what do the loan pipelines look like? I'm curious if you're seeing quality opportunities and if you had some decent community bank growth? Just talk a little bit about the drivers there.

Kevin Hester, Chief Lending Officer

Jon, this is Kevin. So I'll let Chris talk about CCFG when that comes time. But in the community bank footprint, we're still seeing good opportunities. It's hard to make some of the deals work. I mean, you got to get—you're looking at 45%, 50%, 55% equity in a lot of these deals to make them work. There are people willing in some cases to do that. So we're still seeing good opportunities. We actually had growth at the community bank level last quarter, so good pipelines and good opportunities. As Johnny always says, we'll take what the market gives us. If you see growth, it's because the market is there for us, and we'll continue to do what we always do. Chris?

Christopher Poulton, President of CCFG

For CCFG, it's—we’re seeing opportunities there, but you work in the market you're in, like Kevin said. If you look at the CMBS market, for instance, I think it's down 70% this year for the first half. There haven't been many transactions getting completed. However, I believe there are ideas circulating, but not all of them may come to fruition. It requires patience for both us and sponsors while working through current conditions. The pace for the first half was somewhat slow, which isn’t concerning. We haven't forgotten how to grow.

Jon Arfstrom, Analyst

Okay. And Chris, what are the pain points in your business? I’m just curious how your competitors are behaving. Is it just that the volume has dried up? I’m worried about the central business district office and major geographies; I'm sure you can see that in your deal flow. Where are the pain points and how are your competitors reacting?

Christopher Poulton, President of CCFG

The pain points for our borrowers—that’s where the issues lie, honestly. A lot of transactions aren’t built for an 11% coupon rate, right? It’s tough to set the numbers to get a decent return for sponsors for those transactions. So, in some cases, they slow down or pull back to see if conditions will improve. At some point, transactions will occur because they need to develop or acquire properties. We’ve not seen aggressive competition regarding rates or leverage yet, but nonbank players came in on a recent deal we liked and ended up taking the whole transaction. Nonbank lenders are still active, but not in ways that are overly aggressive. So, while things are slow, they will eventually pick back up. Builders will build and sponsors will sponsor.

Stephen Tipton, Chief Operating Officer

Jon, this is Stephen. I think we’re going to continue to see deposit costs rise. We’ve maintained a measured approach for our bankers to engage customers directly rather than relying on advertisements. Johnny highlighted opportunities around loan repricing renewals, which is the primary goal. While slight decreases might continue, we are discussing basis points rather than larger drops, as we've seen from other banks.

Matt Olney, Analyst

On the credit side, I really appreciated the update on the memory care centers as you've focused on that. It's great to see that move. I have a question regarding the office loan you're monitoring; could you provide additional details—what market is it in, when does it mature, and any context behind the LTV?

John Allison, Chairman

I’ll let Kevin take that. It’s in the West location, concerning the LTV. Kevin, do you want to respond?

Kevin Hester, Chief Lending Officer

Yes. We are currently having it reappraised, but it should fall within the 55% to 60% LTV range. We are monitoring that closely. Johnny wanted to get ahead of this and inform you of its status. I think it's prudent to assess our position proactively to prevent negative surprises.

John Allison, Chairman

We do actively manage these matters and apologize for the limited information right now. We look forward to identifying outcomes, and when we have details, we'll update you accordingly.

Matt Olney, Analyst

Thank you for the context. Switching gears, I want to inquire about capital levels. Capital levels are building, and it appears the pace of buybacks has slowed from last year. I anticipate the CET1 ratio could be close to 14% by year-end. What are your thoughts on capital deployment, and how do you weigh your options at this stage of the cycle?

John Allison, Chairman

Matt, it's not the right time to engage in heavy M&A when the market is unpredictable. However, we are exploring the opportunity to consider selling some securities to redeploy funds strategically. We’re conscious of maintaining a balance between loans and deposits, as that remains paramount. Thus, we don’t want excessive deposits causing liquidity expenses. As we evaluate this further, we expect some fluctuations in our deposit base due to various external factors.

Brett Rabatin, Analyst

I'd like to focus on your sentiments regarding the second half being more challenging than the first half of the year. Could you elaborate on those challenges? Is it to do with margins or nonrecurring fee income?

John Allison, Chairman

To me, it’s the competitive pressure in this environment. Competitors are running rates as high as 6% or more, and their offers are unsustainable. It brings me back to past bank crises where costs eclipsed loan balances. I'm aware of how risky this situation can be if liquidity issues arise. Therefore, we need caution in our strategy moving forward. If clients spend their money without remaining liquidity, it is an urgent situation.

Brett Rabatin, Analyst

That's informative, thanks. I want to circle back to the loan pipeline commentary. I'm curious about the impact of prolonged caution in the market—particularly, is that affecting equity positions or increases?

Kevin Hester, Chief Lending Officer

In our community bank footprint, local banks are still making moves around smaller deals, while others are out of the game—most notably in the larger spheres where clients may seek 50% equity or more, which is quite high. We are seeing growth in the community bank segment, while assessing higher equity regarding larger clients. Perfectly fine if that interest remains focused.

John Allison, Chairman

I want to reiterate it’s not the time to stretch in our lending practices. It's essential to stay cautious, informed, and aligned with our customers without engaging in risky behaviors for short-term gains. Our focus is on building solid relationships based on our history and potential future opportunities in a responsible manner.

Stephen Tipton, Chief Operating Officer

Looking ahead, we have room for loan growth, and we have opportunities to evaluate various investments while positioning ourselves wisely. Our internal projections suggest a solid framework and a proactive strategy lending towards balance in our loans and deposits.

John Allison, Chairman

We do not feel rushed to engage in loans that could compromise our integrity—we've taken a firm strategy throughout our journey. We believe our positioning can allow us to weather any challenges while staying fit and prudent.

Stephen Scouten, Analyst

Johnny, you gauge the environment really well. It surprises me to hear a more negative outlook than in previous quarters, but perhaps competition is impacting sentiment. Could you articulate where concerns are stemming from?

John Allison, Chairman

My concerns largely revolve around banks with ratios exceeding 110% loan to deposit. Those banks lack sound liquidity management. If they encounter even minor issues, the impacts could become magnified, leading to serious consequences—essentially an inbred problem in the industry today. We are prepared and aim to build a fortress-like leadership posture during this time.

Stephen Scouten, Analyst

As we talk about the longer-term M&A environment, how do you anticipate it unfolding? Do you believe more opportunities might emerge?

John Allison, Chairman

Based on my experience, I believe we will start seeing boards act more decisively as they recognize their institutions' vulnerability; many may explore M&A to pivot. However, my worry rests equally on the buyers—specifically those of us who would need to integrate weaker banks, and where those banks’ prior decisions have created poor conditions making it very risky. It would need quite a balanced structure and assurances before pursuing such avenues.

Michael Rose, Analyst

I have to frame this transcript because of the interesting dialogue I've heard today. I just had a couple of questions regarding M&A; considering some rhetoric on the Hill, how do you foresee that affecting your strategy? Do you expect consolidation?

John Allison, Chairman

I believe it is crucial to evaluate these situations critically. Like many groups, boards of directors will need to understand where their institutions are and will ultimately need to align on M&A strategies that make sense. This dynamic creates uncertainty, and many banks may falter. Security will remain at the forefront of our decision-making, ensuring we assess risks appropriately before engaging in prospective mergers or acquisitions.

Kevin Hester, Chief Lending Officer

In addition to what Johnny said, while we observe some normalization in lodging and hospitality, we are remaining observant of trends affecting the sector. Current economic conditions shape our strategy, and we’re continually reevaluating transactions based on solid historical performance rather than temporary peaks.

John Allison, Chairman

I appreciate your insights and highlight the caution with which we engage in lending within the marine and RV sectors. While our larger sea vessels remain stable, the RV market might be adjusting given its previous inflationary context during COVID. Our underwriting focuses on secure investments to mitigate the risk presented by sector shifts.

Michael Rose, Analyst

Briefly looking at other income categories, I noticed an uptick of about $4 million in this quarter. Has anything changed that we should be aware of?

John Allison, Chairman

Our recent equity investments performed well, contributing heavily to this uptick. Approximately $3.8 million in income was recorded in Q1, while we saw an impressive $7.5 million in Q2—indicative of our strategic involvement with SBIC investments, ultimately yielding strong returns. Looking ahead, a run rate of around $3 million to $5 million seems reasonable.

Operator, Operator

The next question comes from the line of Brady Gailey from Stifel.

Brady Gailey, Analyst

Most of my questions have been addressed; however, regarding margins that have now plateaued around the 4.3% rate after enjoying expansion, can you share your outlook moving forward, especially considering your skepticism?

Stephen Tipton, Chief Operating Officer

Brady, this is Stephen. For the quarter, we posted 4.28%, with June achieving 4.29%. However, it included 4 to 5 basis points of event income. I told John earlier that a slight decline in margin is likely moving forward, but we can manage this while leveraging effective repricing and opportunities on the loan side. We may see adjustments, but we expect to do better than many other institutions in the latter half.

John Allison, Chairman

I remain optimistic that we will preserve a robust margin. We are actively monitoring the $750 million in repricing opportunities and allocating resources to maintain positive margins throughout.

Brian Martin, Analyst

To follow up on Brady's question, Stephen, would you expect the margin to begin troughing towards the fourth quarter or first quarter, given the loan repricing time frame? Is that a fair perspective right now?

Stephen Tipton, Chief Operating Officer

The loan repricing carries out through the second half, with amounts consistent at around $100 million to $150 million monthly due. I maintain that downward margins may taper off, but how our balance sheet morphs will also be pivotal, depending on the interest rate landscape and competition as well.

John Allison, Chairman

Creativity in our loan approach is essential; we have sufficient capacity to accommodate shifts. Engaging dynamically in both loans and deposits affords us the advantageous flexibility to navigate future conditions and resilience in financial matters.

Operator, Operator

There are no additional questions at this time. I would like to pass the conference back to Mr. Allison for closing remarks.

John Allison, Chairman

Thank you for your time and interest today. We'll talk again in 90 days. With luck, there will be brighter skies over the horizon. It’s paramount to remain calculated in our approach while protecting our assets. Thank you, everybody. Goodbye.

Operator, Operator

That concludes today’s call. Thank you for your participation. You may now disconnect your lines.