Hancock Whitney Corp Q2 FY2023 Earnings Call

Good day, ladies and gentlemen, and welcome to Hancock Whitney Corporation's Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to introduce your host for today’s conference, Kathryn Mistich, Investor Relations Manager. Please go ahead.

Thank you, and good afternoon. During today's call, we may make forward-looking statements. We would like to remind everyone to carefully review the safe harbor language that was published with the earnings release and presentation and in the company's most recent 10-K and 10-Q, including the risks and uncertainties identified therein. You should keep in mind that any forward-looking statements made by Hancock Whitney speak only as of the date on which they were made. As everyone understands, the current economic environment is rapidly evolving and changing. Hancock Whitney's ability to accurately project results or predict the effects of future plans or strategies or predict market or economic developments is inherently limited. We believe that the expectations reflected or implied by any forward-looking statements are based on reasonable assumptions, but are not guarantees of performance or results and our actual results and performance could differ materially from those set forth in our forward-looking statements. Hancock Whitney undertakes no obligation to update or revise any forward-looking statements, and you are cautioned not to place undue reliance on such forward-looking statements. Some of the remarks contain non-GAAP financial measures. You can find reconciliations to the most comparable GAAP measures in our earnings release and financial tables. The presentation slides included in our 8-K are also posted with the conference call webcast link on the Investor Relations website. We will reference some of these slides in today's call. Participating in today's call are John Hairston, President and CEO; Mike Achary, CFO; and Chris Ziluca, Chief Credit Officer. I will now turn the call over to John Hairston.

Thank you, Kathryn, and good afternoon to everyone. The second quarter of 2023 exhibited the continued benefits and challenges of the current operating environment. Our balance sheet remains solid with loan growth funded by both client deposit growth and cash flow from the securities portfolio. The precautionary liquidity added in March was eliminated in May as planned. So by June 30, we were back to normal levels of liquidity. As expected, loan growth moderated somewhat this quarter. Total loans were up $384 million, primarily driven by project draws in multifamily real estate, small to medium-ticket business lending, and mortgage. As a note, about 60% of the volume we show as mortgage growth on Slide 8 is in reality, a reclassification to mortgage from construction as residential projects are completed. Our indirect auto portfolio continues to amortize but has now reached generally immaterial levels. As of mid-year, demand continues to soften in new construction, middle market, and corporate banking as disciplined pricing, more conservative terms, inflationary pressure, and debt costs sideline clients waiting for a more advantageous borrowing moment. Interestingly, demand in small and medium business ticket items is more resilient as economic activity in that space remains brisk. The net effect is a slowing of net loan growth but becoming more granular with better yields and in more self-funding sectors. So we would say at this point, the efforts of the Federal Reserve Bank to slow economic activity down a bit seem to be taking hold and thankfully, without creating any significant recessionary pressures. Looking forward, we expect further moderation in our loan growth will be driven by selective appetite in CRE, a focus on full relationship banking, and disciplined loan pricing and terms. Within investor CRE, growth in the second quarter was 90% multifamily and 10% industrial, which we expect to continue in the short run. We maintained our guidance for the year with loan growth expected to finish the year in low to mid-single digits. We continue to maintain a seasoned, stable, and diversified deposit base. As shown on Slide 6 of the investor deck, consumer and wealth deposits make up 49% of the deposit base, while the remainder is comprised of 11% public funds, 35% commercial and small business, and only 5% brokered CDs. Uninsured deposits are 34%. The ICS product, which is available to clients as a way to ensure deposits above FDIC limits, has stabilized after an initial and brief surge following the March bank failures. We remain pleased with the quality of our book of deposits. However, growth remains a challenge in today's environment. While we reported deposit growth of $430 million this quarter, it is important to note that growth was influenced by a couple of factors. During the quarter, we issued broker deposits of $590 million to support lending activities. Later in the quarter, we received approximately $250 million in temporary trust deposits. These deposits were invested by our clients shortly after quarter-end. DDA remix continued this quarter given the current banking environment drives promotional CD pricing. Clients are highly rate-sensitive and we don't expect that will go away anytime soon, especially if we see another rate hike this month. Where CDs reprice in the second half of '23 is a meaningful part of the NIM story going forward, which Mike will address further in his comments. Our guidance for deposit growth in 2023 remains unchanged. However, given the continued pressure on gathering DDAs, ongoing mix shift, and increasing betas, we have updated our guidance for PPNR for the year and now expect PPNR to decline 1% to 3% from 2022. Earnings and a lower level of tangible assets contributed to improving capital levels. TCE was up 34 basis points to 7.5% and Tier 1 at 11.83% improved 23 basis points. We have been and continue to be cognizant of the current macroeconomic environment that is impacting our industry. We've maintained a robust ACL, we have solid capital, and multiple sources of liquidity, which will help us manage through any continuing volatility. We remain confident in our ability to remain strong and stable as we have for 124 years. With that, I'll turn to Mike for further comments.

Thanks, John. Good afternoon, everyone. Second quarter's net income totaled $118 million, or $1.35 per share. Those levels were down $8.7 million and $0.10 per share, respectively. PPNR was $158 million for the quarter and was also down $9.2 million. The challenges we face as an industry from rates and deposits, both mix and betas have led to higher than expected NIM compression in turn driving linked quarter decreases in net interest income and earnings. Our cost of deposits increased again in the second quarter to 1.4% from 0.91% last quarter. For the month of June, our cost of deposits was 1.57%. That drove our total deposit beta for the quarter to 104% or 28% cycle to date, or 25% excluding the recently issued brokered CDs. We expect that our total deposit beta for the cycle to now approach 35%, assuming the Fed raises rates to 5.5% in July and holds through year-end. The reality of higher rates for longer and the growing dependence on CDs as a non-interest bearing deposit remix destination is driving this reality. Reminder that our total deposit beta in the atlas upgrade cycle was 29%. As was the case in the first quarter, our deposits in the second quarter continue to remix between non-interest bearing deposits and primarily time deposits. Our mix of non-interest bearing deposits to total deposits moved from 43% at March 31 and to 40% at June 30. Given the pressure on deposit costs and assumed continued remix of non-interest bearing deposits, we do see additional NIM compression in the second half of 2023, although likely at a slower pace than what we experienced in the first half of the year. Again, assuming Fed funds topped out at 5.5%, we could see NIM compression of about 5 basis points to 8 basis points in each of the next few quarters. Included in our assumptions is the expectation that our non-interest bearing deposit mix could fall to just below pre-pandemic levels by the end of the year, or about 35%. Slides 14 and 15 in the deck provide additional details related to our NIM and interest rate sensitivity. Turning to credit, criticized levels were relatively stable and have been for several quarters. We did have an uptick in non-accrual loans as those levels have begun to normalize. Net charge-offs were down $3.4 million from last quarter and came in at 6 basis points of average loans. During the quarter, we built reserves by $4.2 million, which resulted in a solid ACL of 1.45% to loans at June 30. Fee income improved this quarter driven by increases in service charges on commercial accounts and specialty income. Expenses were up slightly linked quarter driven by higher insurance and regulatory costs, but also higher technology-related costs. Otherwise, expenses were well controlled. We have continued to reinvest back into the company through additional revenue-generating staff, technology improvements, and automation, all leading to increases in personnel and technology-related expense. We intend to continue these reinvestments to support adding additional value in the future, but of course, are paying attention to the impact of inflation on expenses during the challenging top line revenue environment. We are pleased to see stability in other expense categories and as noted previously, we will have to manage through items outside of our control such as retirement costs, benefits, insurance cost as well as normal FDIC assessment increases. All of this leads to a few updates to guidance called out on Slide 20, reflecting both second quarter activity as well as changes in the operating environment. John mentioned the change to the PPNR guidance; we have also updated guidance on fees, expenses, and the efficiency ratio. One important note, the PPNR and expense guidance does not include any impact from the expected FDIC special assessment related to the March 2023 bank failures. I will now turn the call back to John.

Thanks, Mike. And moderator, if we could, let's open the call for questions.

Thank you. We'll now take questions, starting with Michael Rose from Raymond James.

Good afternoon, everyone. Thank you for taking my questions. Mike, I appreciate your comments about the NIB mix settling slightly lower than previously discussed. Can you provide us with an idea of the level of confidence or the possible range here? It seems the 35% is somewhat of a baseline, what are the factors that could influence that? We're trying to determine if we are nearing a bottom in terms of mix shift and beta expectations. Thank you.

Yeah, Michael. Obviously, this is Mike, I'd be glad to. And the 35% mix that we kind of called out is really what we're looking at to come in at really towards the end of this calendar year. So obviously, this quarter, we came in at 40%. We could see that trajectory kind of moving to around 37% or so, by the end of the third quarter and then down to maybe 35% by the end of the fourth quarter. And obviously, it's this environment related to higher rates for longer that's driving that. But then also, if you look at our average account balances, they're still about 20% to 25% higher now compared to where they were pre-pandemic. So I think to get full confidence on where that NIB mix actually ends up, we really need rates to start to come down and we need that average account balance also to come down some. So the 35% is what we're looking at by the end of this year. And into '24, I mean, obviously, we're not here to give guidance for 2024. But certainly, if we don't have lower rates and we don't have average account balance down, we could end up lower than 35% as we move into '24. But for now, our focus is pretty high confidence that I think it will be around that 35% level by the end of this year.

Thanks for the color, Mike. Maybe just as a follow-up, just switching to expenses. I think they were a little bit higher than what I was looking for, and you raised the guidance a little bit. Can you just talk about some of the expense reduction efforts? I understand you're investing in the franchise technology investments, things like that. But just given the pressure on spread revenue, what kind of actions could we expect to see you guys take to get that efficiency ratio down back closer to your CSOs? I know it's 10 quarters out from here, but just trying to get a better sense of what actions you could take? Thanks.

Yeah. I mean, obviously, we did a lot of hard work throughout our company to get our efficiency ratio down to the levels that we reported the last couple of quarters. So there's necessarily no joy in being above or slightly above 55% like we are right now. But going forward, in terms of continuing to control expenses. I mean that's something that I think everyone knows is pretty well institutionalized at our company and it's something that we focus on and I think do a good job of. The things that are kind of driving the change in expense guidance compared to last quarter really have to do with visibility that we have in the second half of the year to certain expense categories. We called out higher pension, higher regulatory costs, and then higher insurance costs related to the P&C insurance on our facilities. So we really do look at those as kind of one-off items. And I think if you look at the change guidance, so the 7.5% to 8.5%, if you back out all retirement costs and all regulatory costs, kind of that core expense run rate is more in the neighborhood of 5% to 6%. But getting to your question directly, again, we'll continue to focus on expense reduction and expense control. We've talked in the past around standing up a very professional and very effective strategic procurement process. That process is becoming mature and we certainly expect to harvest expense savings through the full implementation of that program. You mentioned reinvesting back in the company. That's something we feel strongly about continuing to do. I mentioned that in the prepared comments. And John, I don't know if you wanted to add a little bit of color or your thoughts around. Go ahead.

I'll be glad to. You've addressed many of the questions already, so I won't take up too much time. This is John, and we've made significant investments in technology over the years. In the past two to three years, about 75% of that technology expenditure went towards improving frontline effectiveness by implementing Salesforce across the revenue-generating areas of the company, enhancing our marketing, lead generation, and follow-up processes. We've seen positive outcomes from this work, particularly in the growth of both deposits and loans in small and mid-sized business lending, which reflects that benefit. However, as we roll out this technology, we've encountered a high turnover rate in our industry, especially at the hourly levels, which has affected the productivity improvements I hoped to see from our automation efforts. I'd like to see those improvements realized. Our focus for the next couple of quarters will be on this work and the strategic procurement initiatives that Mike mentioned, as well as considering the time it takes for our newly hired revenue-generating staff to reach full profitability in this environment. Mike chose his words well; there's no satisfaction in having a turnover rate above 55%. About half of that was due to factors beyond our control, but we believe that what rises will eventually fall, and we anticipate a decrease in assessments and insurance costs related to both property and FDIC. I also hope to see increased efficiency in our back-office operations through automation in the coming quarters. We have some work to do to maintain our current reinvestment pace, and I appreciate the question.

Thanks for taking my questions. Appreciate the color.

You bet, Michael. Thank you.

The next question comes from Casey Haire, Jefferies.

Yeah. Thanks. Good afternoon, guys. I guess a question on capital, you guys are approaching 12% on CET1. I think I know the answer, but I just want to just curious if your appetite for buybacks.

Yeah, Casey. This is Mike. So appreciate the question on capital. And yeah, you're right. I mean really for the next couple of quarters, buybacks is not something that's a big priority for us. So I don't know that we'll be participating in that, at least for the next couple of quarters. In this environment, our stance really is more around preserving and growing capital. And we're pleased to see those capital levels move up. So we will continue that approach.

Okay. What about possibly adjusting the bond portfolio now that the situation is much calmer compared to March and April? Is there any interest in using some of the excess capital for that?

Yeah, I think there is, and that’s a great question. And so that’s something that we’ve looked at through this environment and continue to look at not here today to announce that we’re executing on anything per se. But I think it’s a fair expectation to have that we would certainly look very seriously at doing something like that in the second half of this year.

Okay. Great. Thanks very much.

You bet.

Next up is Catherine Mealor, KBW.

Thanks. A question on the margin. It feels like from your margin guidance, we're going to be ending the year somewhere around $315 million to $320 million, I think depending on where the deposit remix shifts out. And as you think about next year, we're just trying to get this year done, but as we think about next year, we're exiting the year around that kind of margin level. How do you think about higher for longer? And what type of, I don't know, kind of tailwinds you may have on the loan portfolio or maybe what some defenses you may have if we stay kind of at that 550 Fed funds through next year? Thanks.

Certainly, Catherine. To begin addressing your question, we previously discussed the potential restructuring of our bond portfolio, which could serve as a good starting point for 2024. Depending on the rate environment and the changes in our deposit mix, this will significantly influence our net interest margin for next year. It seems that deposit costs may be stabilizing, which is part of our outlook and expectations for the latter half of this year. If this trend continues into next year, we may have the chance to reprice some CDs at lower rates. Additionally, if the operating environment improves, we could see opportunities for loan growth next year. While it may be too early to provide specific guidance for 2024, these are key considerations we have in mind. John, do you have anything to add?

Yes, Catherine. This is John. It's not easy to predict, but conceptually, I see how a prolonged higher interest rate environment could impact our business. We anticipate around two to three quarters of growth from our real estate activities. Our construction and development pipeline is strong, supported by a skilled team known for delivering high quality and solid spreads over time, although we're seeing some constraints in that pipeline. The growth highlighted in our construction and development section on Slide 8 is largely fueled by draws from current projects. As these projects conclude, a portion of that portfolio will transition into real estate, while a significant amount will be sold in permanent finance markets. The same goes for mortgages; once residential construction projects finish, they'll be reclassified within our mortgage portfolio and start to amortize. Currently, around 90% of our mortgage applications are aimed at the secondary market. Given all these factors, along with our disciplined pricing and cautious credit approach in the middle market, corporate sector, and certain syndications, we should start to see some liquidity return next year from this part of the portfolio. The plan is to invest this into more granular, higher spread areas that are less volatile and more favorable for margins. We are also seeing about $2 of liquidity support in our small business lending sectors. I hesitate to discuss 2024 extensively right now, but there's potential for some self-generated liquidity relief next year. If policymakers ease the pace of money withdrawal from the system as they have in the past year, and with more competitive bank rates compared to treasuries, we could see a decrease in the significant funds exiting the banking system for federal instruments. If everything aligns, and if the Fed halts rate increases, as we all hope will happen later this year, we could have a clearer outlook for 2024 regarding stability in both portfolio and margins. It's still early for concrete forecasts for 2024, but those are my thoughts.

That's very helpful, very helpful. And then, John, you hinted that there was some CD repricing to be aware of over the back half of the year. Can you just remind us of what that looks like?

Catherine, this is Mike. Back half of '23? Yes. Yeah. So we have about $1.2 billion of CDs maturing in the third quarter. Those are coming off at about $386 million. And then in the fourth quarter, we have about $900 million of CDs maturing and those are coming off at right at about 4%. We also have about $500 million of the brokered CDs that we added back in March that will be coming off in the month of December. Those are coming off at 5.45%. So those are the CD maturities we have in the second half.

I previously referred to the NIM story, and we were somewhat optimistic about not facing another rate increase. However, recent comments from the Fed suggest that a rate hike in July is likely. We are uncertain if there will be additional increases after that. We were hoping for more flexibility to lower our rates, but the guidance assumes we won't have that opportunity. Thus, we are adjusting our expectations to account for the possibility of further rate hikes and ongoing tightening. This means the competition for CD rates may not ease until after the year ends, which poses challenges for us in terms of reducing rates from the levels Mike discussed. The change in guidance reflects this outlook, rather than any underlying issues; it's simply that competition seems likely to remain tough over the next six months.

Got it. That makes sense. Yeah. That makes perfect sense. And then maybe one last one. Just there was one commercial NPL that increased this quarter. If you could just give us a little bit of color on that.

Chris, do you want to take that one?

Yeah, sure. Hi, Catherine. It's Chris Ziluca. Yeah, it was a credit that we've been tracking for a while and it kind of migrated from criticized to NPL, which is why you don't see the criticized going up at all, really. And frankly, it's just a customer in the retail space, it's a C store operator that probably just over-expanded a little bit. So they're kind of going through a little bit of a restructuring of staff, so therefore, we needed to move it into the NPL category.

Great. Thank you.

You bet. Thank you, Catherine.

Your next question comes from Brett Rabatin, Hovde Group.

Hey. Good afternoon. Thanks for the questions. I wanted to first start on fee income and just the guidance, the change there linked quarter, if that was a function of less annuity fee growth than maybe you were expecting or if there were dynamics in the back half of the year that resulted in that change?

Yeah. Great question. This is John. Great question, and you're pretty right on top of it. The guidance change is really sort of like in the deposit conversation we just had with the prior question. When we look at the effect of higher rates for longer, there are two areas of the fee income buckets that should see less activity. So it's not our lack of appreciation for the sector. It's just the reality that we will likely sell less annuities in the back half of the year than we saw in the front. We had a terrific year up until now. But when we look at less traffic with the pie of opportunity shrinking a bit in both annuities and in non-amortized loan fees. If we're doing less lumpy loans, then you get fewer fees that you bring to the bottom line in that same quarter. And so with a little bit more anemic outlook for that traffic for the back half of the year, we resized the guidance down a bit to accommodate it. So nothing going particularly wrong, no threat just trying to be thoughtful and ensure that we're being as transparent as we can about the chatter we're getting back when we look at competitive assessment and the outlook for opportunities. So if the opportunities were the same as they had been, we wouldn't have changed the guidance. So it really is just an issue of the pie getting smaller.

Okay. That's helpful. I just wanted to clarify your perspective on the competitive landscape. Last quarter, it seemed like banks were starting to stabilize during the earnings season in April after the tumultuous March. However, it feels like there was an increase in competitiveness noted in May and June. I'm curious if you believe this trend of increasing promotional activity continues in your markets, or if it has maybe lessened since the busy period of late May.

Is your question specific to deposit pricing, Brett, just to make sure we hear you right?

Yes. Just the deposit pricing and what you're seeing in your markets in terms of your competitors' pricing.

Yeah. This is Mike. I think you hit the nail on the head there. And certainly, over the course of the second half of the second quarter, we saw that ratcheting up of primarily deposit pricing competition. A couple of folks have kind of stepped out there. So that's more or less, I think it's kind of calmed down a bit. We certainly don't see that getting any worse as we move into the first couple of weeks of July.

Okay. Great. And then maybe one last quick one. One of the pushbacks I get on Hancock is just the markets might not perform as well in a recession. So I was just curious what you were seeing economically in some of the coastal markets, how norms was behaving. I know that gas was probably the best one ever in May. So I know there's been some solid tourism.

I hope you had the chance to visit. This season was really good. In our markets, we can separate them into high growth areas like the larger metropolitan statistical areas in Texas and Florida, which has seen a significant population increase during the pandemic recovery. Those areas are one group, while the core regions experience slower but steady growth. During the last recession, we were pleased with how those markets performed. We faced challenges with energy, but it wasn't due to economic conditions in our markets; rather, we had an excessive concentration at an inopportune time. Overall, the market performed well in sales, and once we incorporated it into the book, the AQ metrics were quite impressive. We’re confident in the positive sentiment. Conversations with our larger clients from four or five months ago showed more caution; they were mindful of the risks associated with potentially rapid and prolonged rate increases by the Fed that could result in a hard landing. However, we are no longer hearing that level of concern from our clients. While they may be tightening to manage capital, preserve liquidity, and maximize returns, it doesn't stem from fear of an economic downturn. Rather, it reflects a cautious approach to a slower economic recovery that may limit their revenue opportunities. We believe we're well-positioned in this region if a recession were to occur. I hope that doesn’t happen, but we are optimistic. This summer, tourism has been exceptionally strong across our footprint. New Orleans, which struggled during the pandemic due to the shutdown of the convention center and family tourism, has fully rebounded. Restaurants are busy, and there are plenty of reservations. The convention center is thriving, and festivals are back in full swing. The only aspect that hasn’t returned to pre-pandemic levels is the number of attendees per convention or trade show, which is still about 15% to 20% lower. I think this isn't a result of any issues with New Orleans itself but rather a trend we're observing nationwide. Overall, I hope this conveys the strong confidence we have in our markets. We're feeling quite good about the situation.

That’s great. That’s very helpful. Thanks for the color.

You bet. Thank you.

Kevin Fitzsimmons from D. A. Davidson is up next.

Hey. Good afternoon, guys.

Hi, Kevin.

Just one thing I wanted to ask about the margin. I know it's been very clear that there's ongoing margin compression ahead maybe at a less of the pace than what we've seen in the second quarter. But I was a little actually encouraged to see the margin for the month of June was equal to the full quarter margin, if I saw that right, as opposed to it being lower, like I think we're used to seeing indicating going lower coming out of the quarter. And I was just curious, were there any unusual items driving that? Or is that a source of encouragement?

Yeah, Kevin. This is Mike. That's correct. Our NIM for the month of June came in at $330 million, which as you pointed out was equal to what we are reporting for the quarter. So yeah, that is encouraging, and I think that speaks probably as much as anything else to the fact that we do see deposit costs kind of leveling out a bit. Certainly, I think there's more of that to come in the second half of the year. In fact, if we look at the increases in our cost of deposits for the second half of the year compared to the first half of the year, much less. So in the first half of the year, we had about 90 basis points or so of increased deposit costs. We think that will be roughly about half of that in the second half of the year. And again, those are broad numbers but, yeah, you're correct. I do think and believe that the NIM compression will lessen as we go through the rest of the year. And really, the primary driver and probably the biggest wild card will be the continued level of NIB remix if that lets up a bit for whatever reason as we go through the second half of the year. And obviously, I think that bodes well for us coming in at maybe the lower end of the NIM compression range that I gave in the prepared comments.

Mike, I assume you're keeping track of the deposit remix on a quarterly, monthly, and weekly basis. However, it can be challenging to draw conclusions if it appears to be stabilizing, as it tends to fluctuate significantly. For instance, if there's a Fed rate hike, it could lead to a substantial shift, and then the question becomes whether there will be additional hikes. At some point, even with more hikes, could we reach a stage where the outflow from those accounts declines simply because the remaining balances are from individuals who haven't withdrawn their funds?

That's a good observation. We monitor this closely, often on a daily basis. There was a moment during the quarter when we thought there might be a chance for some improvement in the remix. However, the percentages show that in the first quarter, the remix was around 3.5%, and in the second quarter, it remained close to that, possibly slightly lower. Additionally, we keep a close eye on the average balance per account, which is still somewhat higher now compared to the second quarter. For us to move past this situation, we anticipate that either lower rates or a combination of lower rates and a decrease in the average deposit balance to pre-pandemic levels will help signal the end of the remix.

I'm sorry I stepped in. Kevin, this is John. I can't recall which quarter it was; it may have been about a year ago when we noted that using the pre-pandemic average balance and the spending rate of what people want, as well as what they need, it suggested that we might reach the pre-pandemic average balance around June 2024. That still appears to be the case. At that time, we did not expect a 5.25% overnight money rate to materialize at the rapid pace it has. Therefore, one might think we would be approaching the average balance sooner than June, given the changes in consumer spending habits. Consumers are currently favoring more trips over buying larger homes, altering the sources and uses of cash in 2023 compared to 2022. This should indicate that we could be closer to average balances by year-end. However, predicting these behavioral trends and factoring them into our forecasts is challenging. We've taken the behavior we're observing now and tried our best to project what the balance would look like at the end of the year. We don't take any satisfaction in guiding towards negative outcomes, but the current environment and our competitors, who are nearly fully loaned, require liquidity and are pricing their services accordingly, which is increasing some of our costs more than we would prefer. Therefore, our expectation for normalization may be further out, possibly extending past year-end and into 2024, rather than happening in the latter part of this year as we had hoped a quarter ago.

That's great, John. And one last one for me. You mentioned earlier how the level of borrowings has come down. That was an abundance of caution post the bank failures and now you've kind of taken that off. Should we assume that level of borrowings at second quarter end remains fairly stable or could there be more moves in that line item?

Yeah, Kevin. This is Mike again. I think we're more or less back to managing the balance sheet in a normal fashion. So the level of liquidity we kept on the balance sheet at June 30 may be a bit higher than what we would normally do, but not much more than a couple of $100 million or so. So maybe that comes down a little bit more, but I don't know that that's a significant number.

Okay. Great. Thanks very much.

You bet. Thanks for the questions.

We'll go next to Brandon King, Truist Securities.

Hey. Good afternoon.

Good afternoon.

Yeah. So I wanted to know what your expectation was for the pace of increases in loan yields on the balance sheet, so as a 270 basis point benefit in the quarter. And new loan yields are coming on at 7.4%. So I wanted to know to what extent could you potentially offset some of this deposit pricing pressure over the next couple of quarters?

Yeah, Brandon. This is Mike. I mean that's absolutely part of what we're thinking about for the second half of the year. Certainly, our earning asset yields will move up as the Fed raises rates. We have a very focused effort also on improving our loan yields both on new-to-bank business as well as renewals. So that's something that's a big, big focus on what we're trying to accomplish. And I think as part of our assumptions as we think about maybe less NIM compression in the second half of the year versus the first half of the year. Related to the bond portfolio aside from a potential restructuring, no change in how we think about reinvesting back in the bond portfolio right now will continue at least for the next couple of quarters and maybe beyond with putting those cash flows and maturities, help fund loan growth and other needs on the balance sheet. So I think that's how we think about this. John, anything you want to add on the loan side?

No, but I would like to respond to your question, Mike. It's a very insightful point. While I don't want to focus too much on 2024, approximately half of our portfolio is fixed, and much of that will continue to renew into 2024. As the variable rate business stabilizes with the Fed's 25 basis point hikes, we should see our fixed rate portfolio grow. In our region, banks have established a certain level of non-interest bearing accounts in relation to revolving lines, particularly for commercial customers. If those balances decrease because customers are willing to pay fees instead of having them waived, we might witness the index for prime on revolvers start to increase slightly. This would occur as banks adjust to the new balance. When that happens, we could see improvements in spreads against prime. If prime stabilizes, fixed rate money is also likely to be repriced higher as we head into next year. If deposits stabilize towards the year's end and the intense competition from T-bills eases, it suggests that the net interest margin outlook for 2024 and 2025 may be significantly more positive compared to the compression we experienced in 2023. However, I prefer not to present any specific numbers at this stage, as we need to get a bit closer to the year to discuss that, but this outlines our perspective.

Got it. Understood. And then I noticed C&I line utilization ticked a bit lower in the quarter. So I just wanted to get some more context behind that. And if you're still seeing some new customers kind of delever themselves in this sort of economic environment and what they're anticipating?

Sure, I'll address that. This is John again. I truly enjoy this business and discussing it, so I hope I don't take up too much time. There are three different classes of loans outside of the revolver. We are a genuine consumer bank, and our home equity line business is robust and revolving. Utilizations have been declining ever since Prime dropped to about 100 basis points below its current level. The volume of new applications has also decreased as people are hesitant to borrow against their homes for now. Additionally, utilizations have fallen as clients are reducing some excess balances and paying down debt because they aren't comfortable with the cost associated with the revolver. Another factor contributing to the decreased utilization is the normal drop in commercial utilization. As rates increased, our clients had significant liquidity and chose to use some of it to pay down lines instead of borrowing, opting to incur fees on their analysis accounts. So, two out of the three sectors are seeing a decline in line utilization. In contrast, on the construction side, as projects progress, they start at zero and increase to around 85% or 90% as they near completion. After that, they may move out of the bank to farming or into real estate for a period until they lease up and sell. If new project volumes are slowing down at the start, that can lead to a natural increase in utilization as projects near completion. So looking at all three of those factors, the downward pressure from consumer revolvers and commercial lines of credit is balancing out the increase we see in construction utilization. This trend will likely continue for a couple of quarters until things normalize. Is that what you were asking about?

Yeah. That makes sense. Yes, that makes sense. Okay. Thank you so much for taking my questions.

You bet. Thank you.

Your next question is Stephen Scouten, Piper Sandler.

Hey. Good afternoon. I appreciate the time here. I wanted to follow up just going back to that CD conversation. I know you said there might not be as much room to reprice those lower as you thought at one point in time. Can you give us a feel for where you saw new CDs come on out on a percentage basis this quarter?

Yeah, Stephen. This is Mike. What I can share with you that probably as equally as useful is kind of where our current rates are. So that gives you a little bit of insight into where we think those maturities may land. So the highest rate we have right now is a 5.25% at eight months. We also have a 5% in three months. But then we also have a little bit longer maturities, nine and 11 months at 4.5% and 4%, respectively. So I think where those maturities land in terms of people re-upping their CDs will depend a little bit on their outlook for rates. So people want to lock in a little bit lower rate for a bit longer than some of the damage to our NIM related to the CD maturities won't be as bad. If folks ought to stay short and higher and obviously, that's a little pain that we have to endure.

Yeah. That makes sense. And then I have a question kind of around your asset sensitivity modeling and this is just something I've been curious about this industry-wide really, but you still screen asset sensitive. I think it was up 1.9% and up 100 basis points. But obviously, in the near term, the balance sheet isn't really reacting that way. So I'm wondering, what is it about the modeling that isn't encapsulated in real time? Is it just the pace of the deposit moves? And would we actually see this play out if we do get stability in rates and get that back book repricing that John was speaking to a minute ago?

Yes, the short answer to your second question is yes. We believe this introduces some level of stability. Regarding your first question, we mentioned that we are modestly asset sensitive, with 59% of our loan book being variable. The wildcard this cycle, which has deviated from prior cycles and impacts how an asset sensitive bank behaves in a rising rate environment, is related to the changes in our non-interest bearing mix on the balance sheet, similar to most other banks. It's no secret that about a year ago, our non-interest bearing mix was nearly 50%. We maintained that level around 49% to 50% for three consecutive quarters, but we have now decreased to 40% over the last couple of quarters, and potentially down to 35% by the end of this year. This change introduces variables that may distort the typical model.

Got it. That makes a lot of sense. Yeah. That makes a lot of sense. I appreciate that. And then just last thing for me. I know you said earlier kind of expense management is an institutional mindset at this point. But I'm wondering, obviously, given the difficult revenue environment, is that something that you take an even deeper and closer look at maybe a more the potential for a more fulsome expense plan or anything along those lines? Do you see that in future quarters by any chance?

Yeah, I think so. But again, keep in mind, our commentary narrative around continuing to reinvest back in the company. So as a reminder, back in the days of the pandemic back in 2020, we were really one of the first banks that really made a concerted effort to use the pandemic as a period to get a lot more efficient. And that resulted in a pretty significant decrease in our expense run rate and a pretty nice increase, obviously, in our efficiency. In fact, our efficiency ratio actually went slightly below 50%, just a couple of quarters ago. So that's something that we know how to do, and that's what I mean when we say that expense management is really kind of institutionalized at our company. But again, in this environment, we also see the opportunity to reinvest. And so that's important to us as well. So the notion of being able to cut expenses or save expenses so that we can be efficient and also have room to reinvest back in the company. Those things are very important to us. John, anything you want to add?

Not to belabor the question further, Stephen, there. We gave that target of 55% out there. And while it's in the CSOs, we're really not pleased to see it go above 55% at all, even though we haven't gotten to the CSO period. But I mean the drivers for that are largely deposit pricing, the progression on them. And FDIC insurance expenses are just a lot more expensive than '23 than they were in '22; we didn't expect that a year ago, but here we are. So all those things are real. They're true and they don't matter. We still need to get back to below 55%. So I think our reality is not to make it overly dramatic, but we kind of go off a defcon level, so to speak, when we get above 55%. And so there will be curtailments and discretionary expenses that will be implemented as we move along. And if the benefit of continuing in our reinvestment pace outlines some of the pain of doing some of the more board across the board expense curtailments, then we're not bashful about making that call. Our goal though is, we don't think about everything in quarters; we think of it in years, and it's very important that our company is in super and very strong shape to execute and play very offensive when the economy turns, and we start seeing a better opportunity to grow. And so I don't want to curtail investments to the degree that we will wish we had a year or two down the road. So we're still adding bankers. We're still adding technology, but the pace with which we're doing it is going to need and require some belt-tightening elsewhere. So not really talking about those techniques and all that now, but it's all the things that you would imagine based on our history of being pretty good at managing expenses.

Yeah. That’s extremely helpful. Thank you all for the time and color.

You bet. Thanks for the questions.

We'll go next to Christopher Marinac, Janney Montgomery Scott.

Thanks for hosting the call today. A quick question for Chris on the criticized assets. I see that they were stable, obviously, this quarter, but just curious kind of what's out there that would cause that trend either go down in a good way or perhaps see some inflection with the deterioration in future periods?

Yeah. Good question, Christopher. We're not really seeing any specific sector related confluence of events. Obviously, we're operating at a historically low level on the criticized loan levels. So there's probably a little chance of substantial improvement from where we are. But our goal, obviously, is to maintain as high asset quality as we can. I think some of the sectors that are always going to have pressure are the ones that have had to absorb the wage increases and some of the higher operating costs associated with some of the inflation that is starting to cool off but obviously has not come down. So they're having to kind of manage through that as well as companies that are maybe having some continued staffing challenges just because of the relatively low unemployment rate. So I think those are the sectors that we keep an eye on. We're not necessarily seeing any significant or any sort of connected issues in any one sector, but we pay particular attention to those that are getting squeezed from a margin perspective and also the higher interest rates if they have fixed-rate debt, they're going to have to obviously absorb when they renew the higher interest rate for that debt at renewal. So we're looking at that closely as well.

Are those drivers for potential changes to the reserve beyond where you're positioned now?

I mean not really. I mean it could be, but generally speaking, we are factoring that into the decisions that we take. We think that the reserve is adequate for the risk that we have in the portfolio. So our objective is to kind of match the reserve to any sort of direction of risk in the portfolio, either as it increases or decreases. So I would say, generally speaking, no.

Great. My follow-up is for Mike Achary, just has to do with kind of your longer-term experience on the length of your deposit relationships. I'm just thinking out a couple of quarters if we get some stability on pricing kind of trying to reassess how to value the franchise and the sort of funding advantage that you've always had?

Yeah. So Chris, I assume you’re talking about our NIB mix and the long-term stability related to that. And so, yes, if so, look, that’s been a hallmark of our companies and continues to be. And while that NIB mix has certainly come down. It’s where it is now from a peak of nearly 49%. We think and believe that when the cycle is done, where our mix ends up, we’ll still be in an enviable position. And certainly, we would think it would be top quartile. So that’s something that we’re very focused on. And we think and believe, again, that will continue to be a hallmark of our company and our balance sheet.

Great. Thanks for taking all the questions today.

Sure. You bet.

Next up is Matt Olney, Stephens.

Okay. Thanks. Just want to follow up on that loan growth discussion and that one-time closed product that drove the 2Q growth. I appreciate this was kind of a reclassification as far as the driver. But I'm curious about the product itself. Are these loans all originated by the bank? And then when they move from construction into the mortgage classification, do any of the terms of the loan change?

Not many at all. They're pretty much fixed, but the volume of that, just to make sure I explained it clearly, about 60% of that number was the reclass but the pipeline is zero and has been zero for some time. So what we see in that category is largely the back quarter of the back quarter of the egg going through the snake, so to speak. And so I think we're probably two quarters away from that beginning to fall pretty dramatically, and then the portfolio itself against the shrink as we go into '24. Did I answer your question?

Yeah. That's helpful. And then just one more follow-up here for Mike on the discussion of those time deposits for pricing in the back half of the year. I heard those current offering rates that are out there that you disclosed. I'm curious if the current guidance assumes those are the roll-on rates kind of in line with those promotional rates that you've mentioned or does it assume some other type of roll-on rate for those time deposits?

Matt, it absolutely assumes some combination of those current rates, along with a re-up number that we have in mind, so around 80% or so. So we think roughly 80% of our CDs will reprice into some configuration of the current rates that I gave on those CDs.

Okay. Great. That’s all from me. Thanks, guys.

Yeah. Thank you very much for the questions.

And everyone, at this time, there are no further questions. I'll hand things back to management for additional or closing remarks.

Sure. Thanks, Lisa, to you for moderating today. Everyone, have a wonderful day and a wonderful weekend, and we'll see you on the road.

Once again, everyone, that does conclude today's conference. Thank you all for your participation. You may now disconnect.