Earnings Call Transcript - RNST Q3 2024

Operator, Operator

Good day, and welcome to the Renasant Corporation's Third Quarter Earnings Conference Call and Webcast. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would like now to turn the conference over to Kelly Hutcheson, Chief Accounting Officer for Renasant. Please go ahead.

Kelly Hutcheson, Chief Accounting Officer

Good morning, and thank you for joining us for Renasant Corporation's 2024 Quarterly Webcast and Conference Call. Participating in the 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, changes in the mix and cost of our funding sources, 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 Executive Vice Chairman and Chief Executive Officer, Mitch Waycaster.

Mitch Waycaster, Chief Executive Officer

Thank you, Kelly. We are pleased with the results for the third quarter. They reflect solid financial performance, the sale of our insurance agency and the issuance of common equity earlier in the quarter. I want to acknowledge the hard work by our team to remain focused on our core operations while contributing to the successful achievement of a number of significant transactions for the company. Turning to the merger with The First, a few weeks following the merger announcement, we filed applications with regulators seeking approval for the combination. And yesterday, shareholders of both Renasant and The First approved the merger. We believe we have made solid progress on the other tasks necessary to complete the merger and we still expect the closing in the first half of 2025 followed by a conversion in August. I will now turn the call over to Kevin for comments on financial trends in the quarter.

Kevin Chapman, Chief Financial Officer

Thank you, Mitch. Before discussing our results for the quarter, I would like to echo Mitch's praise of Renasant team members for their outstanding efforts in the third quarter. I've been tremendously impressed by our employees' abilities to both successfully execute their day jobs while also contributing meaningfully to the work necessary to successfully bring Renasant and The First together. We're well underway in our integration plan to come together as one company, and we have not yet identified any operational issues that would interrupt our plans. I will now turn our attention to the third quarter financial results of Renasant. Our reported earnings were $72.5 million, or $1.18 per diluted share. Included in these results is the after-tax gain on the sale of the assets of our insurance agency of $39 million, or $0.63 in diluted EPS, as well as after-tax merger and conversion expenses of $9.5 million or $0.15 in diluted EPS. Excluding these items, our adjusted earnings for the quarter were $43 million or $0.70 in diluted EPS compared to $0.69 in diluted EPS for the second quarter. Net interest income increased $6 million on a linked-quarter basis. Some of this increase was driven from interest earned on the proceeds from our capital raise, but the remainder is attributable to the increase in loan yields outpacing the increase in deposit costs. Our team continues to be diligent in our loan pricing with yields increasing 6 basis points on a linked-quarter basis, but the success of the team is truly evident on the liability side of the balance sheet. Traditional deposits increased over $285 million from the second quarter. Equally important to note, non-interest-bearing deposits were flat quarter-over-quarter. Although pricing for deposits remains competitive throughout our footprint, the continued hard work in managing our deposit base has paid dividends. Our total deposit costs increased only four basis points during the quarter, compared to an increase of 12 basis points during the second quarter. Reported non-interest income increased $50.5 million from the second quarter. Excluding the aforementioned gain on the sale of the insurance agency, adjusted non-interest income decreased $2.8 million quarter-over-quarter, primarily due to insurance commissions foregone as a result of the sale. Income from our mortgage division decreased $1.3 million on a linked-quarter basis. Overall volume was relatively flat. However, an increase in the fallout percentage of our pipeline as rates began to fall during the quarter, coupled with a decrease in the gain on sale margin of 13 basis points, were the primary drivers of the decline in revenue from the second quarter. Reported non-interest expense was $122 million for the third quarter. Excluding merger and conversion expenses of $11.3 million on a pre-tax basis, non-interest expense was $110.7 million for the quarter, representing a decrease of $2.2 million on a linked-quarter basis. Discipline around expenses and leveraging our existing expense base continue to be top priorities as we progress toward integration with The First. I will now turn the call over to Jim.

Jim Mabry, Chief Operating Officer

Thank you, Kevin. As we walk through the quarter's results, I will reference slides from the earnings deck. Total assets grew $450 million, due in large part to the proceeds from our capital raise and the sale of the insurance agency. Loan growth in the second quarter was $23 million. Loan production was strong during the quarter, but we experienced higher levels of paydowns, which resulted in the lower growth. On the liability side, we experienced another quarter of strong core deposit growth, which allowed us to continue to shift away from non-core funding sources. Referencing Slide 8, all regulatory capital ratios are in excess of required minimums to be considered well-capitalized. The capital raise, gain on the sale of the insurance agency, and retained earnings contributed to a meaningful increase in these ratios on a linked-quarter basis. Turning to Asset Quality, we recorded a credit loss provision on loans of $1.2 million. Net charge-offs were $703,000, and the ACL as a percentage of total loans remained flat at 1.59%. Asset quality metrics are presented on Page 9. Our criticized loans and total non-performing assets increased due to the downgrade of a few larger loans. We believe these loans are adequately reserved. Our strategy remains to proactively identify underperforming loans early and work quickly towards resolution in order to mitigate loss. Our profitability metrics are presented on Slides 10 and 11. Excluding one-time items, all profitability metrics with the exception of return on tangible equity improved from the second quarter largely due to growth in net income and discipline around expenses. The capital raise had a negative impact on ROTCE. Turning to Slide 12, adjusted net interest margin, which excludes purchase accounting accretion and interest recoveries, increased three basis points to 3.32% for the quarter. Interest earned on the proceeds from our capital raise and the sale of the insurance agency contributed to the growth in net interest income and margin. And the good work by our team to grow core deposits and remain diligent in pricing continued a trend of declining increases in rates. We continue to focus on growing the core funding base. Kevin commented on the highlights within non-interest income and expense. We expect the balance of the year to include additional expenses related to the proposed merger with The First, but we remain committed to improving the profitability of Renasant on a standalone basis. I will now turn the call back over to Mitch.

Mitch Waycaster, Chief Executive Officer

Thank you, Jim. As you have heard, we had a very active quarter, but do not want the noise of this activity to drown out the success we had during the quarter to improve the underlying financial performance. Our adjusted efficiency ratio decreased 198 basis points, and our adjusted return on average assets increased seven basis points on a linked-quarter basis. We are enthusiastic about the opportunities ahead for Renasant as we work to create a top-performing bank operating in some of the Southeast's most vibrant markets. I will now turn the call over to the operator.

Operator, Operator

We will now begin the question-and-answer session. Our first question comes from Catherine Mealor of KBW. Please go ahead.

Catherine Mealor, Analyst

Thanks. Good morning.

Mitch Waycaster, Chief Executive Officer

Hi, Catherine.

Catherine Mealor, Analyst

I would like to start with the margin, which has seen nice expansion this quarter. I'm curious about how we should approach the margin looking ahead, especially with the possibility of more rate cuts than we previously discussed. Additionally, could you provide insights on Renasant as a stand-alone entity and its margin outlook, particularly in relation to FBMS? Thank you.

Jim Mabry, Chief Operating Officer

Good morning, Catherine. This is Jim. We've discussed over the past few quarters that the recent rate cuts, especially in the near-term, are likely to have a modest negative impact on margins. I maintain that view. If we anticipate two more cuts in Q4, we will feel that impact. The 50 basis point cut we've already experienced usually results in a slight negative effect on margins, which tends to smooth out over time, but that's the situation we face for now. Looking ahead to 2025, there's a lot to consider, especially with the addition of The First. We've mentioned before that The First is less asset sensitive than we are, which should positively influence our net interest margin response to further rate cuts in 2025. Overall, these cuts may reduce the negative impact, but I'm uncertain how the net interest margin will behave, as it will depend on the magnitude and speed of the cuts. There’s just a lot to consider moving forward. So, regarding the short-term outlook, we do expect some modest negative impact on net interest margin.

Catherine Mealor, Analyst

On the deposit side, can you talk about what you've seen so far on your deposit cost just with the 50 basis point cut? It was too late in the quarter to really see the impact in the third. But curious you've got kind of spot rates or just what data you're seeing so far?

Jim Mabry, Chief Operating Officer

We have been very pleased with how our deposits are behaving. At the beginning of the year, during our budgeting and forecasting for 2024, we anticipated a challenging environment for non-interest-bearing deposits and expected a significant decline. However, deposits have remained nearly flat throughout the year. This marks the fifth consecutive quarter where our deposit growth has exceeded our loan growth, and while we would prefer to see more loan growth, the trends in deposits have been very positive. We began reducing our special rates in June, and our five-month special rate is currently around 4.25%, down from 5.25% in June. This allows us to lower rates, and we believe we are entering a period that will bring additional benefits in this area. Overall, our deposit base has performed much better than we anticipated, and I am feeling optimistic about deposits.

Catherine Mealor, Analyst

Great. Thank you.

Operator, Operator

The next question comes from Michael Rose of Raymond James. Please go ahead.

Michael Rose, Analyst

Hey. Good morning, everyone. Thanks for taking my questions. Maybe just going back to the loan question before. I think we've seen a lot of banks see relatively muted growth this quarter a lot, are kind of citing uncertainty around the election and the economy and things like that but still pipelines are good. Mitch, I was wondering if you could kind of give us your usual pipeline breakdown and kind of at least what you would expect to see from a debt growth perspective and if there's any paydowns upcoming that we should be aware of? Thanks.

Mitch Waycaster, Chief Executive Officer

Sure. Good morning, Michael. As you pointed out, let's begin with the pipeline, which stands at $176 million, showing a solid increase from the $130 million at the start of the third quarter. Jim mentioned earlier that we experienced strong production, which totaled $507 million for the quarter, an increase from $390 million. The growth in both the pipeline and production throughout the quarter highlights the robust and resilient markets we are operating in. Regarding payoffs, this quarter saw a modest increase to $551 million, compared to $410 million in the prior quarter. The average over the last four quarters was $400 million. We observed some business sales and activity in seasoned commercial real estate that contributed to the movement in the secondary market, with private equity funds engaging in some of the business sales. Given the current rate environment, it is likely that payoffs may continue to rise in future quarters. For Renasant, our capacity to produce in these markets, evident in this quarter's production and pipeline, remains crucial. While I won't detail the percentages from each market, they show a healthy distribution in both pipeline and production. In this recent quarter, of the $507 million, nearly 15% was from consumer loans of one to four units, which we keep in our portfolio. Additionally, around 26% came from small business banking loans, typically under $2.5 million, while commercial credits over $2.5 million and owner-occupied commercial real estate comprised about 28%. In our corporate banking segment, which includes larger C&I commercial real estate, asset-based lending, equipment finance, and SBA factoring, accounted for an additional 34%. Our average loan size remains around $300,000, reflecting our diverse approaches. We continue to perform well across various sectors and maintain discipline in our pricing and underwriting. Jim mentioned the granularity of our deposit base, which is also true of our loans. We remain optimistic about our ability to grow a diversified loan portfolio funded by a diverse deposit base. Looking ahead, I expect to see net growth in the low to mid-single digits, with payoffs being the main variable in the upcoming quarters.

Michael Rose, Analyst

Mitch, that's great color as always very, very helpful. Maybe as a follow-up, just because I got a headline that home sales hit the lowest level since 2010 and mortgage rates have actually moved higher over the past couple of weeks. Kevin, if you can just give us kind of an update on the mortgage business and kind of the trends that you're seeing there. And then assuming that we get some future additional rate cuts, I would expect hopefully that you'd see a pickup in activity, but just wanted to get some broader color from you? Thanks.

Kevin Chapman, Chief Financial Officer

Thank you for the question, Michael. You summarized it well. We've observed a decline in the short end of the curve, but the longer and mid-range parts have remained flat or increased slightly. This steepness in the curve is beneficial for banking, but it does create challenges for mortgages. The mortgage environment remains tough, and while we initially saw a decrease in rates in Q3, that momentum lessened towards the end of the quarter. Our pipeline is still active; it hasn't completely dried up, but it's not growing as quickly as we anticipated with the expected Fed rate cuts. If longer-term rates decline, we do expect mortgage activity to increase, leading to positive results. We've been focused on rebuilding our mortgage team and successfully hiring production talent, and we believe we'll see the benefits of this once rates become more favorable.

Michael Rose, Analyst

Okay. Great. And maybe just one final quick one. The deal the first acquisition expected to close in the first half of next year. I know it's hard to predict these things, but glad to see the shareholder votes. Any sort of refinement of when we could potentially see the acquisition close either first or second quarter at this point? Or is it just too soon still to really understand?

Mitch Waycaster, Chief Executive Officer

So Michael, I think it's more of the latter commented in the beginning just about the shareholder approval which we both received yesterday. We're some 80 days at this point past the announcement and some 60-plus days past actually the application. And we're early in the process. But as I commented earlier, we've made solid progress on the tasks necessary to complete the merger. And of course, you mentioned the shareholder vote which we both received yesterday, but things are going well. We still expect closing in the first half of 2025 pending regulatory approvals and of course, followed by conversion in August.

Operator, Operator

The next question comes from Matt Olney of Stephens. Please go ahead.

Matt Olney, Analyst

Yeah. Good morning. Thanks for taking the question guys. Going back to the margin discussion. I was hoping to dig into the fixed asset repricing dynamic. Any more color you can provide on that fixed variable rate loans that will be repricing higher over the next few quarters? And specifically, I'm just looking for the dollar amount of these loans. I don't know Jim if you have a three-month or a 12-month schedule, just looking for the dollar amount of that and then also on the yield side kind of what they've been using more recently and color on kind of the new yields on that?

Jim Mabry, Chief Operating Officer

Good morning, Matt. I hope this information is helpful. Currently, we have about $5.5 billion in variable loans priced. This variable portfolio is yielding in the mid-7s right now, and for new and renewed loans in Q3, we've seen yields in the upper 7s. I'm not certain how this will develop, but it gives you an idea of the repricing. On the fixed-rate side, we have approximately $750 million that will reprice over the next 12 months, yielding around 5%. Additionally, we have a couple of hundred million dollars in securities that will produce similar cash flows, yielding about 2%. Although you didn’t ask about it, I also consider the deposit pricing aspect. We have nearly $4.5 billion in funding, which includes a small portion of floating rate debt that has already repriced. These details should help you think about our margin.

Matt Olney, Analyst

Yes. Jim, that's helpful. I appreciate the details there. And I appreciate there are several moving parts there but it sounds like based off your previous commentary you are expecting a little bit of margin compression in the first quarter as the balance sheet digests the Fed move from September. Any way you can size it up for us as far as what to expect in the fourth quarter?

Jim Mabry, Chief Operating Officer

I'm going to return to the description of modest Matt because even though we are well into the quarter, predicting how that will unfold is more of an art than a science. I don't consider it significant or material, but it makes sense to anticipate some modest contraction. In Q1, if we do not have any further rate cuts, we can expect things to even out and plateau. However, by 2025, we will likely see the first changes and have a clearer understanding of additional cuts, their magnitude, and timing. Therefore, the outlook for 2025 is uncertain regarding how everything will come together. But in the near term, while I'm not being precise, I do foresee some modest contraction in that margin.

Matt Olney, Analyst

Thank you, Jim. There are definitely several moving parts, and I appreciate your general commentary. I would also like to ask about credit. In the prepared remarks, there was a mention of the downgrade of a few larger loans. Could you provide any additional details on those downgrades, particularly regarding the industry or any themes?

David Meredith, Chief Risk Officer

Hi Matt, this is David. Good morning. We've observed ongoing stress in certain asset classes, particularly within the senior housing sector, where three loans have contributed to the quarter's downgrades, along with one loan in the non-medical office space. As Jim mentioned in the opening comments, it’s primarily a few loans that are causing stress within these asset classes. We are actively monitoring these loans to ensure we stay ahead of their performance, enabling us to identify issues and work through them effectively. If we exclude the senior housing sector from our criticized loans, that figure drops significantly from just over 3% to around 2.1%. There is stress in one asset class, but we believe it is quite isolated and has not spread to other asset classes at this time.

Operator, Operator

Our next question comes from David Bishop of the Hovde Group. Please go ahead.

David Bishop, Analyst

Yes. Good morning, gentlemen. Regarding the topic of credit quality, there have been good capital inflows from the insurance sale. I'm curious if the CECL accounting, or the accounting guidelines, prevent us from reinvesting a bit more of that back into the reserve or provision, given the recent trends in criticized and classified loans. What are your thoughts on the provision and reserve in this context?

David Meredith, Chief Risk Officer

Hi, David. Good morning. When we applied our CECL model for the quarter, we allowed it to function based on the inputs, loss rates, and qualitative factors. The model indicated a healthy reserve at 1.59%, which remained unchanged from the previous quarter. Despite some repositioning within the asset classes that contributed to the stability of this figure, we continued to rely on the model to guide the output based on loss rates and qualitative factors. We believe that 1.59% is a very healthy number given its current status.

Kevin Chapman, Chief Financial Officer

Hi, David, this is Kevin. I'd like to add that while we're discussing our allowance in the context of this year and last year, it's important to look back at 2020 when we significantly built our allowance because of the pandemic and its lasting effects on certain asset classes. There were shifts in work environments and senior housing that impacted these asset classes, and we anticipated it would take time for these stresses to manifest in our portfolio. We weren't able to recognize real-time losses during the pandemic; it took time for these stresses to appear. Our methodology with the allowance is showing that the provision we made in 2021 is indeed having an effect. In 2021, we recognized concerns across a variety of asset classes, some of which have diminished while others remain. In senior housing, for example, we are still witnessing stress, but we allocated significant provisions back in 2020 and 2021. The situation with office spaces is ongoing as well—it's an area of concern that we are monitoring closely and maintaining reserves for. We'll utilize these reserves if necessary, but we have a track record of quickly identifying problematic loans and working to resolve issues to minimize losses. This process underpins not only our CECL framework but also our overall approach to loss identification and recognition, which is the foundation of CECL.

David Bishop, Analyst

Got it. Appreciate that color. And then final question for me, saw the slide, a little bit of an uptick in excess liquidity, cash and liquidity given the sales think you're going to operate around that level into the merger? Or is that for funding loan growth?

Jim Mabry, Chief Operating Officer

Dave, this is Jim. I hope it's the latter. You heard Mitch's comments about loan growth, and we'll see how that plays out. But we'd like to think that some of that liquidity will transfer into the loan bucket. If not, then you might see us potentially, and I think this could happen anyway due to our deposit behavior, purchasing some securities for the first time in quite a while. However, our preference is to use it in the loan book.

Operator, Operator

The next question comes from Stephen Scouten of Piper Sandler. Please go ahead.

Stephen Scouten, Analyst

Good morning, everyone. Following up on that topic, I’m considering how the security balances will develop moving forward. I assume the approach will be similar to that of cash balances, with a preference to allocate them to loans if possible. However, it seems that they could increase as a percentage of the balance sheet pro forma with FBMS. I’m curious how you view securities as we approach the close and in terms of pro forma percentage of the balance sheet.

Jim Mabry, Chief Operating Officer

Good morning, Steven. You're right. As of today, and certainly based on the June figures, we have not yet analyzed September numbers, but I believe things are relatively unchanged. We expect to maintain a strong liquidity position pro forma for The First. I'm not sure how we'll allocate that liquidity yet, but I appreciate that we'll have significant liquidity available and we'll determine how to utilize it. Ideally, a large portion of that liquidity would be funneled into the loan book. I think this is essentially the focus as we consider the balance sheet. Once we finalize the balance sheet, the Renasant balance sheet will be significantly bolstered by The First and the capital raise we completed. Liquidity has increased notably to your point, and capital will be substantially strong pro forma. Additionally, we have the opportunity to accumulate significant capital. So whether we’re discussing liquidity or capital, I believe we will be in a better position in the latter half of 2025 and 2026 compared to the past couple of years, with substantial excess liquidity and capital. This situation opens up new possibilities for utilizing those funds, which have historically been available but will be more actionable as we progress into 2025 and 2026.

Stephen Scouten, Analyst

Okay, great. That was very helpful, Jim. I appreciate it. Mitch, I also value your earlier comments on the loan pipeline and how you're considering that in relation to paydowns. Given the elevated paydowns we saw this quarter, do you think this might become a more persistent issue in the upcoming quarters as rates continue to decrease? Is there a possibility of a backlog of commercial real estate paydowns that we need to address before we can expect to see improved loan growth trends, possibly in 2025?

Mitchell Waycaster, Chief Executive Officer

So Stephen, I believe it makes sense for the industry, including us and other banks, that there could be seasoned commercial real estate projects that have been on hold, ready to move forward and utilize that capital. This would lead to new projects, which in turn will generate additional loan production. It's somewhat like a treadmill that speeds up. Both production and payoffs are expected to increase. I think that's a reasonable expectation for the upcoming quarters. You made a valid point, and while it may not be overly pronounced, I was reflecting on our ability to produce across various geographic areas and product types. Specifically in the commercial real estate sector, you raise an important point, and it will likely be relevant for our bank and possibly for others as well.

Stephen Scouten, Analyst

I believe it could be a broader industry issue rather than something specific to your bank. However, if that were to occur, I’m interested in how increasing capital and liquidity could provide more resources for deploying those funds. What other options could there be for utilizing that liquidity? Have you considered loan purchases, exploring new sectors, or bringing in new teams? I'm just trying to think about potential avenues for growth, especially if there’s a short-term challenge in deploying that liquidity.

Jim Mabry, Chief Operating Officer

Steven, this is Jim. I'll start and certainly welcome Kevin or Mitch to chime in. But I think it's some of the things you said. I mean whether it's team lift-outs or how we think about remixing that balance sheet. Again, I think it's sort of a different position than we've been in. And we've really enjoyed a great balance sheet, a really strong balance sheet but it just gets so much stronger. And so we obviously, The First goal here is to keep our eyes on The First and a very successful integration. And that's job one to bring over that balance sheet in those earnings and to execute that successfully. But I think on top of that or away from that certainly, whether it's sort of the non-bank. We've done a couple of small non-bank deals, as you know and that's gone extremely well, really pleased with what's happened there, particularly at RBC. That's just been a really good story for us. So whether it's smaller deals or lift outs. And I think all that's open to us and we're going to have as you point out we're going to have the capacity to act on it if those things come along.

Kevin Chapman, Chief Financial Officer

Stephen, it's Kevin. I'll just chime in. I think you laid out a really good answer. Kind of to your question is optionality that that cash and liquidity brings, right? Everything you mentioned is on the table because we have that cash and liquidity and it's only going to be enhanced with The First. And so – but that kind of sums up why we've put such an emphasis on deposit growth. Yes, cash is king, liquidity is king, it's a fundamental of banking, not necessarily lending but deposit generation is a fundamental of banking. And as an industry maybe we took our eye off that ball for 13 years. If you look over the last year 12, 15 months, we are keenly focused on deposit growth. And I think you've seen it in our numbers. And we're okay if that loan-to-deposit ratio creeps down because our deposit generation is outpacing loan growth because it gives us optionality of everything you just mentioned. And that I think that's the position we want to be in. But let's keep options on the table and then let's evaluate what's best for us to execute on at that time. But it all starts with that optionality that the liquidity and cash bring to the equation.

Stephen Scouten, Analyst

Yes. The optionality is definitely exciting. But appreciate the color there. Thank you, guys.

Operator, Operator

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

Mitch Waycaster, Chief Executive Officer

Well, thank you, Alan. We will next meet with investors at the Piper Sandler Conference in Florida on November 14, and thank you to each of you for joining the call today and for your interest in Renasant.

Operator, Operator

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