Renasant Corp Q3 FY2022 Earnings Call

Good morning, and welcome to the Renasant Corporation 2022 Third Quarter Earnings Conference Call. All participants will be in listen-only mode. Please note that this event is being recorded. I would now like to turn the conference over to Kelly Hutcheson, Chief Accounting Officer of Renasant Corporation. Please go ahead.

Good morning and thank you for joining us for Renasant Corporation's 2022 Third 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 release's 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 third quarter, I will comment on the results and the outlook for the balance of the year. The first nine months have seen higher levels of loan growth and improved profitability. While loan production activity has slowed, so have payoffs. This has resulted in a continuation of solid loan growth through the quarter. The benefits of loan growth, margin expansion and expense control all contributed to the stronger financial results. Renasant's balance sheet remains sound with a solid base of core deposits, continued good asset quality and strong capital levels. I will now turn the call over to Kevin.

Thanks, Mitch. Our third-quarter earnings were $46.6 million or $0.83 per diluted share compared to $39.7 million or $0.71 per diluted share for the second quarter of 2022. On a year-to-date basis, our diluted earnings per share were $2.13 compared to $2.47 in 2021. On the banking side, another quarter of strong loan growth, coupled with the Fed rate increases drove an increase in interest income of over $19 million on a linked-quarter basis. Interest expense was up quarter-over-quarter but the increase was isolated to certain public fund deposits and our trust-preferred securities which pay a variable rate of interest. We are not immune to the competitive pressures on deposit pricing but our strong funding base positions us to manage our deposit costs as we expect funding pressures to escalate in future quarters. Our capital markets, treasury solutions and insurance lines of businesses produced positive results for the quarter. We are still experiencing volatility in our mortgage division as production levels have quickly returned to more normal levels, and we have prudently managed our expenses in this division. Nonetheless, while overall headcount is down for the year, we are still investing in strong production talent and expect our mortgage team to continue to be an important part of our business model. Non-interest expense increased modestly quarter-over-quarter in light of the broader inflationary pressures on expenses; operational efficiency remains a focus. With the revenue lift from margin expansion, coupled with our expense discipline, our adjusted efficiency ratio, which excludes non-recurring income and expense items, improved nearly four percentage points from the second quarter and was 58.8%, which is below our stated goal of achieving an efficiency ratio below 60%. We still anticipate total non-interest expense for the full year 2022 to be less than 2021, despite these inflationary pressures. 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 excess liquidity into higher earning assets, which benefited net income and profitability metrics. Loan growth was strong again in the third quarter, with total loans increasing over $500 million from the second quarter. As Mitch mentioned, production was down quarter-over-quarter, but still strong. This, coupled with a slowdown in payoffs resulted in net loan growth in nearly all categories. We slowed down purchases in our investment portfolio and reinvested cash flows into loans. The continued increase in interest rates had a negative impact on the value of our portfolio, resulting in a fair market value adjustment of $85.3 million. Although we experienced an overall decline in deposits, we grew non-interest-bearing deposits by $86 million, and those deposits now represent 36% of our total deposits. Core deposits and overall liquidity position remains strong. Our loan-to-deposit ratio of 79% provides us flexibility. All regulatory capital ratios are in excess of required minimums to be considered well-capitalized and underpin the strength of our capital position. During the quarter, we transferred $883 million in securities to the held-to-maturity category as we have no intent to sell these securities. A benefit of this transfer helped preserve book value and our tangible common equity ratio declined only eight basis points from the second quarter. We recorded a credit provision of $9.8 million and net charge-offs of $1.6 million. The ACL as a percentage of total loans was flat quarter-over-quarter at 1.57%. Our model did not produce a need for additional provision for unfunded commitments. Credit quality metrics are shown on pages 14 through 16, past dues, criticized and nonperforming asset measures all remained relatively steady and net charge-offs were nominal. Net interest income increased $12.8 million quarter-over-quarter. Our core margin, which excludes purchase accounting accretion, income recognized on PPP loans, and interest recoveries was 3.5%, up 50 basis points from Q2. The change in our mix of earning assets positioned us to take advantage of the Fed's rate increases. Furthermore, we remain disciplined in our deposit pricing efforts, experiencing only a nominal increase to our cost of deposits, which helped drive the meaningful expansion of margin quarter-over-quarter. We expect to experience competitive pressures around deposit pricing and believe funding costs will increase in the coming quarters. We sold a portion of our mortgage servicing rights portfolio for a $3 million gain. The carrying value at the time of the sale was $15.4 million and represented $1.7 billion in unpaid principal amount. Excluding the gain on sale, our mortgage banking division was still profitable. Further, solid results in our wealth management and insurance divisions as well as growth in our Capital Markets and Treasury Solutions lines of business helped to drive the increase in non-interest income from the second quarter. Non-interest expense excluding gains were up approximately $5.1 million for the quarter. We realized a full quarter's impact from the increase in minimum wage adjustments, and we invested in additional revenue production talent. We believe that additional operating efficiency gains are possible in the near-term, although expenses may increase modestly in the fourth quarter given inflationary pressures. I will now turn the call back over to Mitch.

Thank you, Jim. We look forward to the balance of the year and are positioned for a successful fourth quarter. Our team remains focused on providing exceptional customer service and growing relationships as one team going to market as one bank. Before we begin Q&A this morning, I would like to take a moment to convey on behalf of the Renasant family that we are deeply saddened by the passing of Lisa Ferris, Vice President of Loomis Sayles. Lisa was a valued professional, a friend to many on this call, an outstanding mother and spouse. We will miss her greatly. Our thoughts and prayers are with her family. I will now turn the call over to the operator for Q&A.

We will now begin the question-and-answer session. The first question comes from Kevin Fitzsimmons of D.A. Davidson. Please go ahead.

Hey good morning everyone. Hope you are all well.

Good morning Kevin.

I appreciate the insights regarding the expected increase in funding costs, which aligns with our recent discussions. However, the margin expansion this quarter was much stronger than I anticipated. Given that funding costs are likely to rise and the deposit beta might be accelerating, could you provide your perspective on the margin outlook moving forward? I assume we won't see this level of expansion in the coming quarters, but any details you can share about expected trends in the next few quarters, including where margins, yields, and the cost of deposits stood in September, would be very helpful. Thank you.

Good morning Kevin, this is Jim. I wanted to share a few points that might assist you in understanding margin and its future direction. Firstly, I agree with your thoughts on Q4 and beyond. We experienced significant margin expansion in Q3 and believe we are set for additional expansion in Q4, although not as pronounced. This is primarily due to the positive performance of our deposits, which we are pleased with. Our beta in the third quarter was approximately 7%, and we anticipate that it will increase. Previously, we mentioned expecting a mid-30s beta on interest-bearing deposits throughout the cycle. A few data points that may be useful: for the quarter, the yield on new and renewed loans was about 5.25% for September, totaling $582 million. As for the margin, core margin was $350 million for the quarter, and specifically for September, it was $367 million. I hope this information aids your understanding. We expect notable growth in that margin during Q4, and based on current knowledge, it seems reasonable to project that our margin may stabilize in the early part of 2023. We’ll see how things develop, but I believe we are well positioned for further growth or expansion in that margin in Q4.

Hey Jim, just wanted to clarify that mid-30s deposit beta for the cycle, is that a total deposit beta? Is that just interest-bearing? And how does that compare with where you guys were at last cycle?

It's interest-bearing, and it's very comparable to where we were last cycle.

Okay. I have a follow-up question about credit. On one hand, you maintained a stable ACL ratio and experienced strong loan growth. I believe you mentioned the economic forecast as well. However, you also have a very strong reserve ratio compared to your peers. I'm curious about your thought process—did you decide that it was more prudent and conservative to keep that ratio stable instead of allowing it to decrease? I would appreciate any insights you can share on this. Thank you.

Good morning Kevin, this is David. Our reserves for this quarter were influenced by loan growth, and we just addressed net charge-offs, which remain stable. We have forecasted our intent to largely maintain stability, particularly in light of the economic impact from COVID. We probably won't see the final outcomes of that situation for some time, which is why we've decided to keep our ACL at its current level until we gain more clarity on the end results, whether that's related to excess distribution, government programs, or other factors. We are hoping to see a return to normalcy in many of the economic ratios we typically evaluate. Our current plan is to maintain stability, support loan growth, cover charge-offs, and respond to any economic changes.

Got it. Okay. Thank you very much.

The next question comes from Brad Milsaps with Piper Sandler. Please go ahead.

Hey good morning.

Good morning Brad.

Thanks for taking my question. Mitch, appreciate your sentiments on Lisa Ferris. You guys had a great quarter of loan growth, maybe one of the best you've ever had. I joined a couple of minutes late, so I apologize if you addressed this. But Mitch, can you just talk a little bit about kind of what you're seeing in terms of future loan growth, kind of how you're thinking about 2023, most banks saying, a bit of a slowdown coming off the record quarter? Just kind of curious how you're thinking about it.

So, Brad, I'll begin with production and pipeline, discussing both geographically and by products our business lines where we're experiencing production and growth. I'll also comment on payoffs, which both production and payoffs moderated this quarter. At the beginning of the quarter, we anticipated a moderation in production, and we indeed observed that. Our production reached $753 million, a decrease from $877 million, which shows moderation but remains historically strong. A year ago, production was $700 million, so we continue to see solid deal flow. The current pipeline started the quarter at $270 million, down from $297 million in the previous quarter, indicating moderation in production while still being strong. Looking back over the last several quarters, it's encouraging to see where this production is coming from, primarily related to talent and markets. Within the $753 million, 15% came from Tennessee, another 15% from Alabama and the Florida Panhandle, 24% from Georgia and Central Florida, 17% from Mississippi, and 29% from our corporate business lines. Geographically, we have strong production and participation across the company. Breaking it down by product type and business line, 28% is in consumer, non-real estate, one to four-family residential loans. Another 12% comes from small business credits, which have consistently performed well for us. General commercial loans, including C&I and owner-occupied loans over $2.5 million, account for 31%, while our corporate banking group represents 29%. We have remained consistent in production across both geographic and product types, hitting on multiple fronts, though we've seen moderation this quarter, as expected. However, there was a more pronounced moderation in payoffs, which decreased by about 36% this quarter. This reduction was driven primarily by the sale of underlying assets securing loans, which had been elevated in the past, alongside a natural reduction in the loss to term rate and a pullback in those credits going to the permanent market. This outcome was logical and contributed to strong net growth alongside production. We maintain discipline in underwriting and are optimistic about our ability to produce and grow net loans, driven by our markets, business lines, and the talent within the company. Additionally, our operations in the Southeast are seeing economic activity expand, despite the headwinds we face, particularly in manufacturing, distribution, medical, government, military, and education sectors. Recent announcements reflect this activity, supporting a robust economy in the areas where we operate, even considering the challenges we are navigating.

Thanks for all that information. I have a question for Jim. If growth remains strong, even if at a slightly slower pace, how should we approach funding that growth? Will you rely more on the FHLB? Can you remind us how much you're generating from the bond portfolio each quarter? How far will that go in meeting your funding needs?

Good morning, Brad. As you know, we focus on core deposits and aim for our loans outstanding and loan growth to be funded by these deposits. We will monitor how loan growth performs in the upcoming quarters. Currently, our loan deposit ratio is approximately in the low 80s, around 82% to 83%. Ideally, we would like to keep that ratio below the low 90s, preferably around 90%. During this somewhat unpredictable period with deposit behavior and the competitive landscape, we are considering alternative funding sources, including the Federal Home Loan Bank.

Okay. And then for my final question, Jim, you mentioned that expenses might increase somewhat in the fourth quarter. It appears that other expenses in the third quarter were significantly higher than usual. Can you provide any comments on that? It seems like it may stabilize based on your remarks, but I wanted to follow up to see if there are any additional factors at play.

Hey Brad, it's Kevin. I'll take that question from Jim. I think I better answer that question. Yes, if you look at our expenses and how we detail them out, all of them were flat and down except for two line items: salaries and employee benefits and others. As you break down other, there are a lot of small items in there that have seen some increases. For instance, some reinvestments we made in technology in the third quarter compared to the second quarter increased that run rate by over $0.5 million. We also had some changes in our regulatory assessments and a one-time blip in some other losses. It's just a lot of little things but as we look ahead, we still believe our expenses from this point are relatively flat. We continue to address inflationary pressures, and I think we are doing a good job with that. If you look at salaries and employee benefits, it's up $800,000 compared to the second quarter, but included in that is almost $2 million of increase due to salary adjustments we made in the second quarter to adjust our minimum wage. We've significantly offset that with other accountability measures, which I think reflects our approach to addressing this. Inflation pressures are everywhere, and the competition for talent is as intense as it's ever been. However, we continue to believe, as demonstrated in this quarter, in the operating leverage we've discussed regarding our expense base. While expenses are up 1% to 3%, net interest income is up 15% to 17%. We believe there's still room for operating leverage in future quarters, and as Jim mentioned, our margin doesn't peak until sometime next year.

Great. Thank you guys.

The next question comes from Catherine Mealor with KBW. Please go ahead.

Thanks. Good morning. Just one follow-up on what you were just talking about, Kevin, on the operating leverage piece. You've hit your 60% efficiency target this quarter, just given what you've done on the expense side and then the better revenue from the margin. I'm just curious updated thoughts on if you think that ratio can go further down from here? Or if this is kind of a good level before you've been targeting the efficiency ratio to stay for the next few quarters, just given inflationary pressures.

Good question. And the short answer is, no, we feel that, that 60% and our goal around efficiency no different than some of our goals around our profitability measures are a bit fungible. We set short-term goals and try to achieve those goals, but our longer-term goal is to ultimately improve ROA, ROE and, at the same time, add efficiency to that. We think there's always room to continuously improve on that efficiency ratio. So, our short-term goal of 60%. As you've mentioned, we've surpassed that. And now it's on us to continue to improve that ratio because at the end of the day, what you're seeing in the numbers is that leverage that operating leverage that comes from maintaining expenses with the opportunity to build revenues. And that's ultimately what's going to drive our profitability going forward. And so there continues to be a conviction around driving that efficiency ratio lower. We're now back to the levels of efficiency where we were pre-pandemic. And so we're in a real opportunity to continue to improve that, which not only sets a new watermark for the company, but it also allows us to close the gap in some of our peers when it comes to profitability measures. We continue to be a metric that we look at and continuously strive to improve on. That's going to come part through expenses and part through revenue.

Yes, that's helpful. Regarding the margin, could you provide insights on the size of the bond portfolio and whether you anticipate continued contraction, particularly as a percentage of average earning assets and the targets for your bond holdings over the next year?

Yes, I believe I didn't address this aspect of Kevin's question earlier, but the portfolio is contributing about $30 million to $35 million each month, which supports our growth moving forward. If I recall correctly, the size of that portfolio is approximately 18.5% to 19% in relation to total assets. While we don't have a strict guideline, generally speaking, we would be open to reducing that percentage to around 15%.

Great. So, really, just depending on how deposit flows come in, perhaps you could see some of the funding of loan growth coming from your bond book, maybe that shrink just a little bit into next year.

Correct. This period is particularly interesting regarding deposits. Our goal and intention continue to be the growth of core deposits. This may be quite challenging in the next quarter or two, but it has been a long-standing focus for the company and remains a fundamental part of our business strategy. You should be aware that we may experience slightly higher loan-to-deposit ratios in the near term. However, the objective is to grow our core deposit base over the long term.

Great. Thank you. And also, Mitch, I appreciate your sentiment on Lisa. She certainly a big fan of Renasant, she'll be missed greatly in this industry. So, thank you for making that comment about her. Great quarter. Thanks so much guys.

Thank you, Cath.

The next question comes from Jordan Ghent with Stephens, Inc. Please go ahead.

Hey, good morning. Thanks for taking my call. I got a quick question on your kind of the fee income guidance. You guys had a good quarter and you had the gain on sale of the mortgage servicing. What are you guys seeing, I guess, in the near-term? Or what are you expecting, I guess, from here?

So, Jordan, just to be clear, on mortgage or just all of fee income.

Sorry, just fee income?

Yes. As we assess fee income, it remains a developing situation, particularly regarding service charges on deposits and the regulatory pressures affecting them. We noted earlier this year that changes will slightly reduce service charges on deposits. Overall, while there may be challenges in mortgage and some consumer fees, we also experience growth in other areas such as wealth management and insurance. Our investment in the capital markets group two years ago is now starting to contribute significantly to non-interest income. Therefore, we see our non-interest income outlook as stable, though it involves various factors due to the historical generation of this income compared to future expectations, especially as the mortgage sector normalizes and regulatory uncertainties influence our income statement. We also have some other investments in place to support the stability of non-interest income.

Perfect. Thank you. And then maybe just one more question. Looked like there wasn't any buyback activity in the third quarter. What's your appetite for share repurchases, I guess, in the near-term and kind of looking into 2023?

Jordan, this is Jim. And you're correct. We did not have any repurchase activity in the third quarter. It remains a lever that we know that we can deploy, and we are constantly sort of evaluating various uses of capital, and buyback is always on that list. And one thing I will note is that our program, which was due to expire this month, was renewed and increased in size from $50 million to $100 million. But I think to your question, our thinking on buybacks remains their tool. We're open to using stock repurchases as a use of capital. And we'll just sort of take the coming months and quarters and see what alternative uses may present themselves and evaluate those against the returns on a buyback.

Perfect. Thank you for the question.

Thank you, Jordan.

This concludes our question. Mr. Rose, I have opened up your line. Did you have a question?

No, I'll just talk to them afterwards. No problem.

Okay. I just wanted to confirm that this would conclude the question-and-answer session. I would like to turn the conference back over to Mitch Waycaster, Renasant's President and CEO, for any closing remarks.

Thank you. Thank you, everyone, for joining this morning. We appreciate your interest in Renasant. We look forward to meeting with investors at the Hovde Financial and the Piper Sandler Financial Services Conferences in November.

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