Renasant Corp Q2 FY2022 Earnings Call

Good morning, afternoon, evening, and welcome to the Renasant Corporation 2022 Second Quarter Earnings Conference Call and Webcast. This event is being recorded. I would now like to turn the conference over to Kelly Hutcheson with Renasant Corporation. Please go ahead.

Good morning, and thank you for joining us for Renasant Corporation's 2022 Second Quarter Webcast and Conference Call. Participating in this call today are members of Renasant's Executive Management team. Before we begin, please note that many of our comments during this call will be forward-looking statements, which involve risk and uncertainty. There are many factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Such factors include, but are not limited to, interest rate fluctuation, regulatory changes, portfolio performance and other factors discussed in our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has been posted to our corporate site, www.renasant.com at the Press Releases link under the News and Market Data tab. We undertake no obligation and we specifically disclaim any obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. In addition, some of the financial measures that we may discuss this morning are non-GAAP financial measures. A reconciliation of the non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. And now I will turn the call over to our President and Chief Executive Officer, Mitch Waycaster.

Thank you, Kelly. Good morning, everyone. We appreciate you joining the call today. Before Kevin and Jim discuss the results for the second quarter, I will offer observations on the first half and the remainder of 2022. Starting with loan growth. The first half has brought solid increases throughout the bank. We anticipate additional growth but likely at a more moderate pace for the balance of the year. The focus on expense control, plus the benefit of higher rates has benefited profitability, and we anticipate further improvement in the second half of '22. Importantly, the balance sheet continues to reflect good liquidity, asset quality, and capital levels. We remain focused on core deposits as our primary funding source, and this has contributed to our first half success. I will now turn the call over to Kevin.

Thanks, Mitch. Our second quarter earnings were $39.7 million or $0.71 per diluted share compared to $33.5 million or $0.60 per diluted share in the first quarter. On a year-to-date basis, our diluted earnings per share were $1.30 compared to $1.75 in 2021. On the banking side, another quarter of strong loan production, coupled with the Fed rate increases drove an increase in interest income of over $13 million. We remain diligent in our deposit pricing, allowing that additional income to flow to the bottom line. Our capital markets, treasury solutions, and other specialty lending lines of business produced positive results for the quarter. Our mortgage division experienced another quarter of volatility as the industry abruptly returned to a more normal operating environment. Despite the headwinds affecting volumes and margins in the industry, our mortgage team remained profitable for the quarter. Our continued focus on expense discipline resulted in a slight increase in expenses with exclusions. We are subject to the same inflationary pressures on expenses, particularly in wages. Despite these pressures, we remain committed to continued expense discipline in future quarters. Although there may be an increase in the third quarter due to the full realization of our minimum wage increase, we still anticipate total non-interest expense for the full year of '22 to be less than 21%. With the revenue lift and expense discipline, we are seeing real operating leverage in our efficiency ratio. Our adjusted efficiency ratio, which reflects our run rate, excluding non-recurring items, declined to 62%, a decrease of approximately 5 percentage points on a linked-quarter basis. I will now turn the call over to Jim.

Thank you, Kevin. As we walk through the quarter's results, I will reference slides from the earnings deck. We continue to invest some of our excess liquidity into higher earning assets. Loan growth was strong again in the second quarter, with total loans increasing $290 million from Q1. Both production and advances on existing lines increased quarter-over-quarter, driving net loan growth in nearly all categories. We also invested excess cash in our securities portfolio, increasing the portfolio just over $200 million from the previous quarter. Rising interest rates had a negative impact on the value of our portfolio resulting in a fair market value adjustment of $76 million. All of our regulatory capital ratios are in excess of required minimums to be considered well capitalized and show the strength of our capital position. We recorded a credit provision of $2 million and net charge-offs of $2.3 million. The ACL as a percentage of total loans declined from 1.61% to 1.57%. We recorded a provision for unfunded commitments of $450,000, which is reflected in other non-interest expenses. Credit quality metrics are shown on Pages 14 through 16. Past dues, criticized and non-performing asset measures all remained relatively steady and net charge-offs were nominal. Net interest income increased $13.9 million quarter-over-quarter. Our core margin, which excludes purchase accounting accretion and income recognized in PPP loans and interest recoveries, was up 29 basis points from Q1. We mentioned last quarter that our balance sheet was well positioned to take advantage of the rising rate environment. We deployed some of our excess liquidity into higher earning assets, and we remain disciplined in our deposit pricing efforts, which, together with the Fed's rate increases, drove the meaningful expansion of the margin quarter-over-quarter. As expected, income from our mortgage division declined from Q1 from a combination of higher rates and lower volumes, but solid results in our wealth management and insurance divisions as well as growth in our SBA capital markets and treasury solution lines of business helped offset the impact for mortgage. Non-interest expenses with exclusions were up approximately $2.2 million for the quarter. Salaries and benefits increased $3.3 million, resulting from our annual merit increases going into effect in April as well as raising our minimum wage for non-exempt employees. Our discipline is evidenced in a decrease in all other non-interest expense line items. I will now turn the call back over to Mitch.

Thank you, Jim. I am proud of our employees and the contributions they make every day. We seek to provide exceptional customer service and go to market as 1 team and 1 bank. I look forward to the second half of the year. I will now turn the call over to the operator for Q&A.

Our first question comes from Will Jones with KBW.

I just wanted to start on deposit costs. It was really impressive to see you guys reduce funding costs quarter-over-quarter just in line with the rate backdrop. Just wanted to gauge how you guys are thinking about deposit betas as we move into the next quarter and just the back half of 2022? I know in the likelihood that we may get another rate hike this afternoon. Just curious if you have any levers still on the deposit side to keep the betas more contained through this cycle?

This is Jim Mabry. And I guess what I'd start is as it relates to deposits is a couple of things. We’ve sort of made deposits a real focus here. And as you know, we've taken noninterest-bearing deposits up about 10 percentage points over the last 3 or 4 years. And so we've really worked on the mix and attracting and building a good core funding base. And I think that was evident in the quarter. The other thing I'd say about our deposit base is very granular. On the consumer side, the average deposit account is less than $20,000. And so I think the mix as well as the granularity of our deposits is going to help us. And again, we saw that in Q2. I don't think that's repeatable in Q3. I think we went into this environment with probably a little longer duration than some in our deposit funding. And so we had some more room to come down, and that's why you saw it come down a touch in Q2. But I think as we look at Q3 and 4, I don't think we're going to repeat that trend, and I would expect those costs to go up.

Got it. That makes sense. So switching over to loan growth. I know you guys are very strong together 2 really nice quarters of double-digit growth. I know some of that is coming from portfolio in more of your residential book, just rates and yields get a little more attractive here. I hear you that you think growth may tick back down in the second half of the year. But how much more runway do you feel like you have to grow that mortgage portfolio?

Well, maybe a good place to start with that thought. And as I referenced in remarks, we could see that moderation. But I would begin here, just looking at our pipeline, we're starting this quarter with $297 million. That compares to $290 million the quarter before. So actually, we've seen a little increase in our pipeline. And of course, last quarter, that resulted in production of $877 million, which was above the prior quarter at $863 million on a core basis, if you adjust for Southeast Commercial that came in, in the first quarter. And just thinking about going forward and thinking about the current pipeline, our current pipeline is also reflective of the geographic distribution of where we saw that production in the prior quarter. And we see all of our regions in our various business lines contributing. And just back to your question, also the granularity, you mentioned real estate 1 to 4. If I take that production, I did this last quarter, and I think this speaks to the strength of our ability to continue to produce. About 27% of production this quarter was in the what I would call consumer non-real estate HELOCs, 1- to 4-type portfolio credits that historically we've offered. We think it's a core product, but that was about 27% of that production. Another 20% was in small business and business banking, loans under $2.5 million. And then another 27% in Commercial loans, 2.5 and greater that really are made up with C&I, owner-occupied commercial real estate type credits. And then the other 26% from our corporate banking activities and our specialty lending groups, larger C&I, commercial real estate, ABL, equipment finance, senior housing, SBA. So you can see we're hitting on a lot of different cylinders. And we've seen that consistently over time. Certainly, we've noted in the last 2 quarters, we've had moderation of payoffs, and we expect that to continue. So we feel good about our ability to continue to produce net growth in the coming quarter. It's hard to predict that moderation in the face of some of the economic headwinds. But certainly, I think our ability speaks to the markets that we do business in, the resiliency that we're seeing and to the talent in the company.

All right. Great. And just last for me, maybe more household. I noticed that the accretable yield ticked up a little bit quarter-over-quarter as well as some interest on problem loans. Was there anything one-time going on in there that we should just be thinking about? And how should we think about a normalized run rate for accretable yield moving forward?

Yes, what you mentioned, Will, was the result of one large payoff. Other than that, there was nothing I would highlight as non-recurring or unusual in interest income for the quarter.

Our next question comes from Michael Rose with Raymond James.

I got on the call a little bit late, but I just wanted to talk about the mortgage business. Not surprising that income down a little bit. I think last quarter, you talked about the efficiency ratio being in the high 80s to kind of low 90s, obviously, gain on sale margin dropped this quarter. Any color around the efficiency and then what the outlook is for the business as we move into the back half of the year, just given what we're seeing with purchase apps and declining volumes. Obviously, you have better markets than the rest of the country in a lot of places, but just wanted to get some color there.

Michael, it's Kevin. Yes. On the mortgage front, everything you mentioned regarding margins and volume was evident in Q2. To directly address the question about efficiency, the mortgage efficiency ratio was approximately 85% in Q2, remaining steady compared to Q1. Honestly, we believe it will stay around this level or slightly increase as we move into Q3. As we noted, we are still profitable and anticipate remaining so. Our mortgage team takes pride in their sustained profitability over the 19 to 20 years they have been with our company. They understand the fluctuations in the market, and while it's a challenging environment now, we expect to be profitable in Q3. This projection includes cost-cutting measures within mortgage. You've touched on the revenue side, but we've structured our mortgage operations to ensure a significant portion of their expenses are variable and aligned with revenue. This positioning gives us confidence in our ability to maintain profitability. However, as we approach Q3, we expect volumes and margins to remain tight, and we'll need to observe how Q3 unfolds to make a forecast for Q4 due to the ongoing volatility.

Great. Thanks for the color. Maybe just as a separate question. Can you just talk about some of the margin dynamics as we think about moving forward? Obviously, some growth in the balance sheet earning asset mix shift pretty positive, but cash levels are down a little bit. Can you just give us an update on your rate sensitivity from here?

This is Jim. I would say the outlook is positive. If we assume no further rate hikes, which is not likely, I think we're positioned for a meaningful expansion in the margin in Q3. It's related to the mix. Our deposit costs were favorable in Q2, and while I don’t expect it to be the same in Q3, I believe that due to the strength of our core funding, those costs will perform relatively well in Q3. Additionally, loan yields increased nicely in Q2, so I think all these factors indicate a significant improvement in the margin for Q3.

Our next question comes from Kevin Fitzsimmons with D.A. Davidson.

I wanted to discuss credit. The ACL ratio has slightly decreased to 1.57%, which is still a strong ratio compared to our peers. However, as you've mentioned, the outlook is quite uncertain. Regarding provisioning and its connection to loan growth, do you anticipate that this ratio will decrease slightly or remain stable until there is more clarity?

Kevin, this is Dave Meredith. I think what you said towards the latter part is kind of what we had forecasted over the past few quarters that will kind of pull that number steady. We'll see what potential impact may come out of economic changes. We haven't seen anything dependent to this point, let loan growth continue to use the existing provision for loan growth. And so I think your point is we'll kind of hold it flat and see if something changes in the economy.

Okay. Great. And then just following up on Michael's question on some of the net interest income dynamics. Is it fair to say average earning assets were fairly flat linked quarter? Is that pretty much what to expect going forward that it's a little bit of a flip flop? In recent years, we saw net interest income driven more by the balance sheet where the margin hit, and now it's kind of the opposite and because of deposits coming in and potential outflow there, and the use of cash, maybe that average earning asset balance stays flat, but your margin keeps going up, and in turn, still have the ability to drive NII higher?

Kevin, this is Jim. I think that's completely correct. It appears to be more influenced by rates than by volume. We don't anticipate a significant growth in the size of the balance sheet in the near term. So I agree with that assessment. The margin is expected to benefit more from shifts in rates rather than from an increase in the balance sheet size.

Jim, you mentioned that you are set for significant margin expansion in the third quarter. Can you tell us what your margin was in June, if you have that information?

Yes. The margin in June on a core basis was 3.12%, Kevin, and that was up from 3.03% in May. Each month in the second quarter showed nice improvement in the margin.

Okay. And one last one for me is, with some large mergers having occurred or are in process of occurring in your footprint generally? I know there's a real focus on efficiency, but you guys have also had a strategy in recent years of looking for new hires. Is that something that is active? Or is that something more kind of not very active given the focus on keeping costs stable?

Yes, Kevin, that's a great question. We consistently focus on identifying opportunities to enhance our already strong team. This past quarter, we added four relationship managers in Memphis, Atlanta, Mobile, and Huntsville, bringing our total to eleven so far this year. We continue to see opportunities and will remain proactive in this area.

Kevin, I'd like to add to the discussion about efficiency. I'm glad you raised this question because we are not merely cutting expenses to enhance efficiency. Instead, we are reallocating resources to maximize revenue. We are always open to bringing in talent and are leveraging market opportunities to do so. It's really about how we allocate our resources. As we consider new hires and opportunities, we focus on the returns they provide. If there's a strong rationale and it makes economic sense, we will definitely proceed with hiring. Additionally, accountability plays a significant role in our efficiency efforts. We have little tolerance for unproductivity within our current operations and staffing. This principle applies in both directions: we are open to hiring talent while also holding ourselves accountable, which means we expect a high level of productivity. This approach is what is fueling our improvement in efficiency and helping to stabilize expenses.

I would like to add to Kevin's comments. Looking at the $877 million in production we achieved this quarter, approximately 35% came from relationship managers who have joined the company over the last three years. While we are seeing good production from our current team, our focus on growing the company also includes managing our expenses, which we've been working on for several quarters. We are equally committed to driving revenue and expanding our markets, which is largely supported by our talent. Over the past three years, we've added more than 100 new hires, and it's important to hold everyone accountable for the production we are seeing from that group, specifically referring to relationship managers and their loan production.

Our next question comes from Dave Bishop with Hovde Group.

Staying on the topic of funding this year, you have reduced some of the excess cash and liquidity, with around $1 billion remaining. What is your comfort level regarding lowering that amount further to support loan growth?

Dave, this is Jim. I want to mention a couple of points. Yes, we would be comfortable reducing the $1 billion down to around $0.5 billion. I would estimate our lower limit to be between $450 million to $500 million. Additionally, we have $3 billion in securities, which represents a historically high percentage of our total assets, similar to many others. I believe there is potential to use that to support loan growth if we do not achieve the deposit growth we anticipated. Therefore, we see both of these as options to facilitate additional loan growth moving forward.

Got it. And then turning back to the loan growth discussion. Just curious if you have those numbers handy, maybe what the weighted average yield on new production was this quarter and just what you're seeing just in terms of the ability to get compensated for rising rates within the market.

Yes. So we've seen a nice improvement in terms of new and renewed rates. And if we look at core loan yields for the month in the quarter. Of course, they improved in every month. And in June, they were right around 4.07% core loan yield. And so the trends there are good and that contrasts mean we’re a good 30 or 40 basis points above where we were this time a quarter ago.

Our next question comes from Matt Olney with Stephens Inc.

This is actually Jordan on for Matt. I had a quick question on the loan growth. How much of that loan growth in 2Q was more a function of slower paydowns versus higher originations?

Yes. Payoffs increased slightly, remaining very close to the previous quarter. This past quarter, total paydowns reached $7.18, compared to $7.04 in the prior quarter. An important point to note is that the average related to bars selling the underlying asset, which negatively impacted net last year, has improved from around 56% last year to closer to 40% this year. Additionally, losses related to term and rate have decreased from approximately 24% in the first quarter to around 10%. This improvement is driven by consistent enhancements in production, with commitments continuing to rise. I previously outlined various geographic and loan types across the company, including consumer, small business, commercial, and commercial specialty. We are experiencing strong production resulting from excellent markets and talented individuals within the company. Our ability to produce effectively is a key factor in this success.

This concludes the question-and-answer session. I would like to turn the conference back over to Mitch Waycaster for closing remarks.

Well, thank you, and thank you to those who joined the call today. We appreciate the interest and look forward to speaking again soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.