Simmons First National Corp Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the Simmons First National Corporation Second Quarter Earnings Call and webcast. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Massanelli. Thank you. Please go ahead, sir.

Good morning, and thank you for joining our second quarter earnings call. My name is Steve Massanelli, and I serve as Chief Administrative Officer and Investor Relations Officer at Simmons First National Corporation. Joining me today are George Makris, Chairman and Chief Executive Officer; Bob Fehlman, Chief Financial Officer and Chief Operating Officer; David Garner, Executive Director of Finance and Accounting and Chief Accounting Officer; and Matt Reddin, Chief Banking Officer. The purpose of this call is to discuss the information and data provided by the company in our quarterly earnings release issued this morning, and to discuss the company's outlook for the future. We will begin with prepared comments followed by a Q&A session. We have invited institutional investors and analysts from the equity firm that provide research on our company to participate in the Q&A session. All other guests in this conference call are in listen-only mode. A transcript of today's call, including our prepared remarks and the Q&A session, will be posted on our website under the Investor Relations page. During today's call, we will make forward-looking statements about our future plans, goals, expectations, estimates, projections and outlook. I remind you that actual results could differ materially from those projected in the forward-looking statements due to a variety of factors. Additional information concerning some of these factors is contained in our SEC filings, including without limitation, the description of certain risk factors contained in our most recent annual report on Form 10-K and the forward-looking information section of our earnings press release issued this morning. The company assumes no obligation to update or revise any forward-looking statements or other information. Lastly, we will discuss certain non-GAAP financial metrics we believe provide useful information to direct investors. Please note that additional disclosures regarding non-GAAP metrics including the reconciliations of these non-GAAP metrics to GAAP are contained in our earnings press release, which is included as an exhibit to our current report filed this morning with the SEC on Form 8-K and available on the Investor Relations page of our website.

Thanks Steve. I'd like to begin today's call by thanking the Simmons associates for their commitment and dedication during the past three months. The special debt of gratitude goes to our branch, call center, and digital banking support staff, who were here every day to fill the needs of our customers. We will continue to make operational adjustments to help meet the needs of our customers and communities in the coming months as we navigate these very uncertain times. I'm very proud of our team and their demonstration of our community banking values. My prepared comments today will be brief. We have posted an extensive presentation on our website along with our press release and financial data, which gives much more detail regarding our quarterly results and other important information about our company. In our press release, we reported net income of $58.8 million for the second quarter of 2020, an increase of $3.2 million compared to the same quarter last year. Diluted earnings per share were $0.54 for the quarter. Included in the second quarter earnings were $3 million in net after-tax merger-related, early retirement program, and branch rightsizing costs, as well as a $1.6 million gain on the sale of branches. In May, we sold three branches in Colorado, and on June 27th, we closed 11 additional branches. Excluding the impact of these items, the company's core earnings were $60.1 million for the second quarter of 2020, and core diluted earnings per share were $0.55 for the quarter. Our return on average assets was 1.1%. Our return on average common equity was 8.2%. Our return on tangible common equity was 14.6%, while our efficiency ratio was 49.1% for the second quarter. As of June 30th, total assets were $21.9 billion, with a loan balance of $14.6 billion and a deposit balance of $16.6 billion. Our loan pipeline of approved and ready to close loans was $72 million at the end of the quarter, signaling a major slowdown in new loan activity in the markets we serve. At June 30th, our PPP loans totaled $964 million with an average loan balance of $123,000. We've also modified approximately 4,600 loans totaling $3.3 billion. Our net interest margin for the quarter was 3.42%, and our core net interest margin, which excludes accretion, was 3.18%. The allowance for credit losses on loans totaled $232 million or 1.6% of total loans on June 30th. In addition, our reserve for unfunded commitments is $24 million at quarter end. Total deposits at June 30th were $16.6 billion, an increase of $1.1 billion since last quarter. The increase was primarily in the non-interest-bearing deposit category but was partially offset by a decrease in our brokered funds of $309 million during the quarter. Our non-interest income for the second quarter was $50 million, an increase of approximately $10 million compared to the same period last year, mainly due to mortgage lending income, driven by the current rate environment. Non-interest expense for the second quarter was $112.6 million, while core non-interest expense for the quarter was $108.6 million. On a linked quarter basis, our non-interest expense decreased $13 million and core non-interest expense decreased $16 million. Our capital remains very strong at quarter end. Our total risk-based capital ratio was 15%. Our common equity tier one ratio was 12%, while our tier one leverage ratio was 9%. The ratio of tangible common equity was 8.3% at June 30th. Once again, please view additional information on our website. Finally, I'd like to reiterate that we are operating under uncertain conditions. The direction of the economy is unclear, and unfortunately, we don't seem to be close to a consensus as to the severity or duration of the effect. I expect that there will be substantial changes in our world as a result of the pandemic. As we have done to date, we will try our best to be prepared to adjust to those changes. I'm proud of the effort of our Simmons team and look forward to working with them as we navigate through this crisis. I will now turn the line over to our operator and invite questions from our analysts and institutional investors.

[Operator Instructions] Our first question comes from the line of Gary Tenner from D.A. Davidson. Your line is now open.

Just a couple of questions, first, in terms of deferrals. I think you'd mentioned $3.3 billion. You guys have been fairly aggressive on the front end in terms of providing deferrals. And I'm just wondering as you're getting closer to the end of the initial period of deferral for some of those loans, what you're seeing in terms of requests for extensions and what your thoughts are on that program right now?

Let me clarify modifications to make sure that we're all on the same page. Modifications for us meant that we offered some payment modification not to exceed the six-month period. We did that very early on in the process to keep our customers from going deeper in debt by drawing on unfunded line of commitments. We did not change any of the original loan terms. We've also put into place a seven-point scale. Each one of our lenders is going back to those customers in the last three weeks and has rated those from one through seven. One through four tells us that they expect to be back on principal and interest payments within 90 days. Seven tells us that we may need to make some modification to the loan or take any immediate action. I'm happy to report that we have a very small number in that category seven. Not surprisingly, hotels and full-service restaurants appear to be the laggards in the group with regard to getting back on principal and interest. But so far, our analysis has not proven any problem loans at this point. We have to qualify that by saying we don’t know how long the pandemic is going to play out. We don’t know which states may close hospitality as they did early on in the process. So, we're trying to remain as fluid as we can and work with our borrowers. I'll say this though; our borrowers have done an excellent job in mitigating any damage during this period of time. Most of them have applied for PPP loans that got them through. If I’m reading the press correctly, there might be another stimulus package designed for those hospitality areas that are hardest hit by the pandemic. One thing that's very telling is I’m pretty sure you haven’t had a chance to look at our presentation, but on Page 10, we list our unfunded commitments by category. From Q1 to Q2, there are only two categories that declined in unfunded commitments: construction and agricultural funding. That shouldn't surprise anyone that construction is continuing on and that we're funding our agri loans; all other categories increased in unfunded commitments. So, we don't have loan growth shown because we forced our customers to draw on their lines of credit.

And I just had a follow-up on the energy portfolio, which is down around $200 million now, with another $200 million of planned reductions in the back half of the year. I thought coming into the year—and correct me if I'm wrong—I thought that target to get the energy portfolio down to was about $200 million. It looks like now it's $100 million towards the end of the year. I'm wondering if you are moving closer to a full exit of that business? I apologize if I missed you mentioning that previously.

We are moving toward a complete exit except for those borrowers who have a diversified relationship with the company. We have several of those, and that's probably the residual $100 million. The energy is just a portion of our relationship with that particular borrower before we have specific individual energy-related credits. It is our intention to exit.

Thank you. Our next question comes from the line of Brady Gailey from KBW. Your line is now open.

Maybe one more on energy while we're on the topic, but some of the energy shrinkage we've seen to date has been fairly costly. When you look at the continued shrinkage that you expect over the next couple of quarters to a year, do you expect to still see some noise and some elevated costs associated with that shrinkage, like we've seen in the past?

Well, Brady, I would tell you I hope not. We monitor every energy credit and we have an analysis that shows when we expect to exit any issues that we may have and what their hedging position is. The situation we faced was a bankruptcy that was not managed by Simmons; it was a national credit that we bought into. Unfortunately, we did sell one loan at a loss. We have identified one more problem loan in the midstream category that we have a specific reserve against in this quarter. Other than that, assuming that oil prices stay where they are and demand continues to rise proportionally, we think that the rest of our portfolio looks good, and there is an excellent chance for us to exit based on the schedule that we've put in our presentation today.

Regarding the 24 branches to be closed later this year, any comments on whether that is all concentrated in one geography or if that's spread out throughout the Simmons franchise?

It’s spread out throughout the entire Simmons franchise. I think the state with the highest number of branch closures is six in that state. We are not through evaluating our physical locations. Let me give you an example: as we have acquired banks, we have acquired some very impressive physical facilities. There’s one corridor of about 100 miles where we’ve required two banks, and we have about 120,000 square feet of building housing about 160 associates. Those were back-office locations for banks that we’ve consolidated. In addition to branch reductions, we're also taking a look at the utilization of the square footage that we have in our entire footprint. Earlier this year, we talked about this year being an adjustment period, and I think it’s evident that that's the case. We have hired a new director of real estate. We're in the real estate business whether we like it or not. He has done a fantastic job of giving us an unbiased view of the viability of some of these locations. I would say that by the end of the year, we'll be down to 200 branches across our footprint. Whether that 200 is the right number or not, we don't know, but that is a constant evaluation for us.

And then finally, just with the net interest margin. I know there's a lot of moving parts with PPP and then the upcoming reinvestment into the bond book. But as you look at the margin in the back half of the year, how do you think that will trend?

Well, I would tell you, first off, obviously, the biggest impact this quarter was the additional liquidity, just like everybody else. We had $2.5 billion in cash invested basically at 10 to 11 basis points. The PPP loans are great but they're lower yielding loans at about 2.3% to 3%. Going into Q3 and Q4, you know the biggest impact is going to be first off when do the PPP loans get forgiven or paid off? If it goes like we expected on the front end, which would be a larger portion paid off in the third quarter, that yield would obviously go up quite a bit. However, when Congress changed the rules and extended the submission period, it could delay the PPP forgiveness and pay off period, potentially pushing it into the fourth quarter and into the first quarter next year. So, that may result in lower yields for this period. But I would say, definitely, it's going to cause some lumpiness in the numbers for the next quarter. On the liquidity side, we are continuing to look at reinvesting that in the security portfolio. As you know, in the first quarter, we derisked some of our security portfolio and built up liquidity before we knew that the government was going to provide liquidity to the market as they did. We're controlling our own destiny there. When we're able to reinvest that we are really reinvesting over a period of time and getting good rates. It just takes a lot of time to be able to get these opportunities in this rate environment, obviously. Our goal is to have that reinvested to the tune of $750 million to $1 billion dollars in the security portfolio by the end of the year. So, these two factors will drive the margin. Whether it goes back up to our target level of around 3.40 depends on timing. We do think there is continued opportunity in our deposits and funding costs, a little bit in our transactions. You can see we did a lot of work at the end of the last quarter that really paid off this quarter. But there's still some timing on the time deposits and federal home loan bank pricing that we think will provide some opportunities in the coming quarters. If we normalize our margin, it's in the 3.40 range. But just like everybody, due to the circumstances, it’s going to be a wild guess for the balance of the year, whether it bumps significantly higher due to forgiveness and pay off or if it continues at the same lower levels due to liquidity.

Thank you. Our next question comes from the line of Matt Olney from Stephens. Your line is now open.

I want to follow up on that last question around securities reinvestments. Bob, you mentioned hoping to reinvest, I think between $750 million to $1 billion by the end of the year. I'm just trying to get a better idea of if you're going to be opportunistic and see how that plays out if the spreads become more attractive or if you really expect that range to be reinvested, regardless of the shape of the curve? Just trying to understand the sensitivity behind that.

You hit it right on the first one. We're going to be very opportunistic in our reinvestment. We're not going to be forced. Our goal is to have it reinvested by the end of the year; if we can't get the opportunities we’re looking for, it may take a little longer, but we’re not going to force it. This quarter, we selectively reinvested in some payoffs. We're investing in select markets in municipal bonds to get a good tax-equivalent yield, along with some other investments in corporate bonds and sub-debt securities. We’re mostly focused on the munis and the agencies on a shorter term basis but definitely being opportunistic.

On the deposit cost, the bank did a really nice job this quarter bringing down the overall deposit cost. I think the interest earnings are now at about 59 basis points. If we go back four or five years, those costs were down in the 30 basis point range. I’m trying to weigh that against the outlook that called for stability for the remainder of the year versus where it was four or five years ago when we were in this zero-rate environment. Any color you can give on that?

Well, I’ll say a couple of points here. George may want to add his thoughts on re-pricing. As you saw, interest-bearing deposits re-priced nicely. We also showed on Page 22 of the presentation, the last time in the Great Recession saw what happened with rates. It took a long time for rates to drop to the lowest level; it took from ‘07 to ‘12 before they gradually dropped to 34 basis points. Therefore, we think there’s a little bit of opportunity still in the interest-bearing accounts. The time deposit have only been a small portion of that that's re-priced, so we think there are opportunities. It’s also worth mentioning that the market has gotten closer to the bottom this time compared to the Great Recession, which took a few years to approach the lowest levels.

I would add that through our acquisitions we have some long-term CD commitments that we will certainly have the opportunity to re-price over the next 12 to 18 months. Our time deposits currently average 142 basis points, which is certainly higher than anything that's in the marketplace today. So, we expect to see that bucket decline. Our transaction and savings rate decreased to 32 basis points. There is some room for continued reduction, but at 32 basis points it isn't significant. I believe time deposits provide the best opportunity for re-pricing in the immediate future.

Switching gears to service charges. These were down sequentially, I assume because of fee waivers. Are you still waiving fees as of today? I'm just trying to get a better idea of when that will rebound.

Matt, we are still waiving fees, and we were very specific about any account that received a stimulus payment. We made sure that there were no overdraft charges associated with any of that revenue. I can’t remember the specific number, but it was six digits in fee refunds or waivers. Looking at Moody's projections, retail sales and other consumer expenditures have declined. Therefore, there’s more money in those accounts than there would have been otherwise; I think it’s simply a reflection of less spending in the marketplace. The stimulus package has helped some folks who really needed it. I would hate for us to hang our hat on overdraft fees from our customers. I believe it's a positive sign in the economy that they aren’t spending money they don't have.

Good comments there. I would also mention that we had a commercial customer from whom we collect fees amounting to $300,000 to $350,000 a year, and their business was shut down for a period of time. During that time, we collected no fees because it is based on transaction volume. That just serves as one example. As George mentioned, there were significant amounts of waivers trying to help out customers. We did some of that early on in the quarter. The positive news is that our June numbers showed improvement over May and April, although still below our budget for the year. I believe long-term, when the economy recovers and everyone is back in business, the decline in service charges will prove to be a temporary issue; however, it may take a long time to return to normalized levels.

I guess I want to go back to the loan growth commentary. George, you mentioned a few things in your remarks earlier. I think the outlook calls for loan balances to be flat or down 5%. Can you add some more color on this? Does that include or exclude PPP? And I appreciate the energy loan contraction. What else would be contracting in the back half of the year at Simmons?

Well, Matt, probably has more detail. I’ll remind everyone that in the back half of the year, our agricultural portfolio is certainly going to contract by about $250 million to $300 million. We expect about $100 million or $150 million in other pay downs before the end of the year. Matt, if you would like to provide additional detail regarding loan growth or the lack thereof?

At a high level, outside of energy, there’s no specific category where we expect accelerated pay-offs. As we noted in our release for the second quarter, we have observed substantial pay downs in commercial real estate, and I think we will continue to see that trend. However, there is no acceleration in any product type. We are seeing customers who may take advantage of opportunities or have good projects, but as indicated, our approved rate of close at $72 million is dramatically down. Thus, we expect continued declines due to natural pay downs and amortization.

Thank you. Our next question comes from the line of David Feaster from Raymond James. Your line is now open.

I just wanted to start on the reserve. There’s a lot of uncertainty in the operating environment, as you noted in your remarks. Given the pretty significant deterioration in Moody’s economic forecast when comparing the June to March figures, I was kind of surprised to see only a 1-basis point increase in the reserve ratio as PPP. I’m curious how you think about the reserve ratio? Were there any changes to the weighting of the scenarios? Would you expect the bulk of the reserve build is over or would you possibly see more in the second half of the year?

David, here's how we weighted the Moody’s forecast: 68% weighting to the baseline scenario, 22% to the adverse scenario, and 10% to the severely adverse scenario. It's important to mention that these are not geographic-specific. When analyzing the DFAST methodology, we apply national projections to our unique footprint. Let me provide you some unemployment data: Moody's projected 14% in Q2 and over 10% at the end of the year. Here's what the actual numbers are in our markets as of June 30th: Oklahoma 6.6%, Kansas 7.5%, Missouri 7.9%, Arkansas 8%, Texas 8.6%, Tennessee 9.7%. We determine our view of the economy based on these statistics with a more conservative outlook. All these scenarios are applied to our various categories, and they result in a very static number, which we further adjust with qualitative factors that tend to be conservative. Thus, we add substantially to our reserves. Our belief is that 1.7% of our loan portfolio is a conservative assurance based on the risk as we currently understand it. As Moody’s forecasts improve over the next 12 months, we feel we should be fine, and adjustments to our allowance will respond accordingly. If there are any unforeseen charge-offs or loan growth impacts, those factors will influence our provisions, but we are comfortable with our current stance based on significant analytics.

Following up on that question about loan growth. Matt mentioned that originations are down. I’m curious how much of this is strategic where you tighten the credit box and pass on more loans, versus losing deals to competitors who are being more irrational, or are customers simply paying down debt using excess cash? I’m interested in how your pipeline looks heading into the third quarter?

Matt, could you address that question?

It's really a combination of all three scenarios. We indeed tightened our credit criteria to ensure our new originations maintain the highest quality underwriting with a COVID overlay. Customers are also paying down faster, and the marketplace offers fewer opportunities now. We're seeing competitors take on riskier terms and lower yields that don’t fit our criteria. Our pipeline entering the third quarter shows a decline in our approved rate to close, and we expect that to continue until economic conditions stabilize.

Certainly, we must consider opportunities based on changes prompted by the pandemic, and some effects may be permanent. Our digital channel investments have yielded excellent results, and we plan to continue enhancing our digital offerings over the next 18 months, including credit cards and investments in additional products and services. I anticipate that the trend toward self-service will persist, putting more pressure on our physical locations. This will also require us to adapt to a more consultative approach rather than reactive. You can expect to see significant changes in the skill sets of our customer-facing staff, particularly in branches, where they will transition from traditional tellers to universal bankers. We also had two excellent executives join us recently. Kent Eastman is our new Division Chairman for Taxes, bringing an impressive banking background. Jimmy Crocker has joined as the Head of our Wealth Group, which is an area with substantial growth potential. Regarding work-from-home strategies, we’re still evaluating the implications. Certain roles may adapt well, but personal interaction is invaluable in our people-centric business. We must find a balance, which we’re still assessing. On the digital growth front, our continued investment in technology has paid dividends, contributing to improved efficiency—as evidenced by our decreased efficiency ratio and expense reduction in the second quarter. We are optimistic about sustaining this trend moving forward. If I missed a specific question, David, I apologize, and you are welcome to follow up.

Thank you. Our next question comes from the line of Garrett Holland from Baird. Your line is now open.

It’s a great position to be in with your very strong CET1 ratio in this downturn. But where do you expect that to run from a near-term standpoint with CET1, and how are you able to use that strong capital position and profitability to be a bit more opportunistic and drive organic PPNR growth albeit in this challenging operating environment?

Bob, would you like to discuss the capital outlook first, and then I will mention some opportunities for utilizing that capital?

Garrett, our capital is in pretty good shape right now, especially when you back out the PPP impact of $1 billion in loans. While this does not negatively affect our ratios, it does affect our tangible common equity. For now, in this uncertain environment, we’re focused on building capital and being prepared for opportunities when they arise. This approach involves operating efficiently and enhancing profit levels while maintaining our current dividend levels, which is crucial for our investors.

As Bob mentioned, protecting our dividend history is paramount to us. We’re disappointed about not being able to repurchase our stock right now; it’s an attractive buy. Some insiders are taking advantage of that, but we are limited to specific periods for purchasing. I expect to see greater buying when the window opens. Additionally, we were engaged in promising discussions with potential merger partners before this situation developed, and we hope to resume those discussions with surviving partners. In the meantime, we are working hard to build our capital position and cash reserves at the holding company over the next year and a half, preparing for favorable opportunities in the marketplace.

Garrett, I want to add that the two most important capital ratios in this environment are the CET1 and total risk-based capital ratios, as they appropriately risk-weight your balance sheet. While investors tend to focus on TCE, it doesn’t reflect the current scenario as accurately as the other two.

Thank you. At this time, I am showing no further questions. I would like to turn the call back over to George Makris for closing remarks.

Thanks to each of you for joining us again this quarter. We’re very proud of our results, and while I wish I could provide more clarity about what’s going to happen in the third quarter, we’re dealing with uncertainties regarding school reopenings. This could significantly impact the economy and our ability to bring our associates back to work. We will continue to operate as we have and remain hopeful for the best. We appreciate your support, and hope you have a great day.

Ladies and gentlemen, this concludes today’s conference call. Thanks for participating. You may now disconnect.