Trustmark Corp Q1 FY2021 Earnings Call

Good morning, ladies and gentlemen, and welcome to Trustmark Corporation's First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation this morning, there will be a question-and-answer session. Operator provided instructions. As a reminder, today's conference call is being recorded. It is now my pleasure to introduce Mr. Joey Rein, Director of Investor Relations at Trustmark. Please go ahead.

Good morning. I would like to remind everyone that a copy of our first quarter earnings release as well as the slide presentation that will be discussed on our call this morning is available on the Investor Relations section of our website at trustmark.com. During the course of our call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We would like to caution you that these forward-looking statements may differ materially from actual results due to a number of risks and uncertainties, which are outlined in our earnings release and our other filings with the Securities and Exchange Commission. At this time, I'd like to introduce Duane Dewey, President and CEO of Trustmark Corporation.

Thank you, Joey. Good morning, everyone, and thanks for joining us. With me this morning are Tom Owens, our Chief Financial Officer; Barry Harvey, our Chief Credit Officer; and Tom Chambers, our Chief Accounting Officer. Trustmark was pleased to report net income of $52 million or $0.82 per diluted share for the first quarter of 2021. We will briefly review these financial results by turning to Slide 3. Loans held for investment, excluding PPP loans, increased $159.2 million or 1.6% from the prior quarter and $415.8 million or 4.3% year-over-year. During the quarter, we originated 4,774 loans through the SBA's Paycheck Protection Program, which totaled $301.5 million, net of $16.5 million in deferred fees and other costs. Both insurance and wealth management businesses experienced revenue growth linked quarter with insurance revenue increasing 22.1% and wealth management revenue growing 7.4%. Adjusted noninterest expense totaled $120.2 million for the first quarter, a 7.05% increase from the prior quarter. We continue to focus on efficiency enhancements throughout the organization, including investments in technology to gain efficiencies and better serve customers as well as rationalization of the branch network. Our credit quality remained solid as recoveries exceeded charge-offs by $2.4 million, and the provision for credit losses was a negative $10.5 million, driven by decreases in the quantitative reserve resulting from an improving economic forecast. We maintained strong capital levels with a common equity Tier 1 ratio of 11.71% and a total risk-based capital ratio of 14.07%. During the first quarter, Trustmark repurchased $4.2 million, or approximately 145,000 shares, of its outstanding common stock as of March 31. Trustmark had $95.8 million in remaining authority under its existing repurchase program, which will expire December 31 of this year. The Board of Directors declared a quarterly cash dividend of $0.23 per share payable June 15 to shareholders of record on June 1. At this time, I'd like to ask Barry to provide some color on loan growth and credit quality.

Be glad to, Duane. Looking over to Slide 4. Our loans held for investment, excluding PPP loans, totaled $10 billion as of March 31st. That's an increase of $159 million from the prior quarter and $416 million from this time last year. Our loan growth came in CRE with both public finance and C&I getting some positive traction. The loan portfolio remains well diversified based upon both product type and geography. Looking on to Slide 5, Trustmark's CRE portfolio is approximately 67% existing and 33% construction and land development. Our construction and land development book is 79% construction. The bank's owner-occupied portfolio has a nice mix between real estate types as well as industries. Looking on to Slide 6. The bank's commercial portfolio is well diversified, as you can see, across numerous industry segments with no single category exceeding 10%. Typically, these loans are well secured, governed by formulaic borrowing bases, covenanted to protect both the income statement and the balance sheet. On Slide 7, you can see we have a minimum exposure to restaurants and energy credits. Trustmark has never been in the higher risk C&I lending business. And currently, we only have one customer totaling $11 million worth of outstandings in that category. The bank has always underwritten both hotels and retail CRE loans in a conservative manner. Looking at Slide 8. Our allowance for funded credit losses decreased $8.1 million from the prior quarter. Our loan loss reserve levels decreased primarily due to continued improvement in the economic forecast, along with some improvement in our COVID-19 qualitative factor. At March 31, 2021, the allowance for funded credit losses on loans held for investment was $109 million. Looking at Slide 9, you will see we continue to post solid credit quality metrics. At March 31, our allowance for credit losses represented 437% of nonperforming loans, excluding those that are individually assessed. Other real estate declined 8.6% from the previous quarter and 57% from a 1-year ago level. Recoveries exceeded charge-offs this quarter by $2.4 million. Looking on to Slide 10, the bank actively participated, as you know, in the PPP protection programs both in 2020 as well as 2021. We successfully assisted a significant number of local businesses that have been negatively impacted by the COVID-19 pandemic. During the first quarter, we originated, as Duane mentioned, 4,774 PPP loans totaling $301 million net of deferred fees and cost. At March 31, 2021, our PPP loans totaled $680 million, net of deferred loan fees and cost of $22 million. Duane?

Thank you, Barry. Now turning to the liability side of the balance sheet. I'd like to ask Tom Owens to discuss our deposit base and net interest margin.

Thanks, Duane. Turning to Slide 11. Deposits totaled $14.4 billion at March 31st, up $335 million or 2.4% from the prior quarter and up $2.8 billion or 24.3% year-over-year. Average balances increased $600 million or 4.4% linked quarter, primarily reflecting additional customer liquidity associated with the PPP loan program and government stimulus payments. Our cost of interest-bearing deposits declined 5 basis points from the prior quarter to total 22 basis points. We continue to maintain a favorable deposit mix with 33% in noninterest-bearing deposits, and our liquidity remains strong with a loan-to-deposit ratio of 74%. Turning our attention to revenue on Slide 12. Net interest income FTE totaled $105.2 million in the first quarter, representing a linked quarter decrease of $9.1 million. Interest and fees on PPP loans totaled $9.2 million, which was a decrease of $5.6 million from the prior quarter, reflecting a linked quarter decline in payoff activity. Core net interest income FTE was $96 million, which was a decline of $3.5 million from the prior quarter as a reduction of $3.9 million in core interest income more than offset a decline of $400,000 in interest expense. About $2 million of the linked quarter decline in interest income was driven by an 8 basis point decline in loans held for investment yield, while the remaining $1.5 million of the linked quarter decline in interest income was driven by a 22 basis point decline in securities yield, of which about half the decline in the securities yield was driven by continuing high residential mortgage prepayment speeds and relatively lower reinvestment yields; while the remainder was driven by the $301 million increase in the size of the investment portfolio during the quarter. Net interest margin in the first quarter of 2.81% decreased by 34 basis points from the fourth quarter, driven by an approximate doubling in other earning assets from $860 million in the fourth quarter to $1.6 billion in the first quarter, resulting from continued strong deposit growth. Core NIM ex PPP loans and Fed balances of 2.99% in the first quarter declined by 10 basis points from the fourth quarter. I do want to point out that when we refer to core NIM, we're now excluding Fed balances from the calculation. And in Note 5 of our consolidated financial information, we have recast historicals accordingly. I've talked in prior calls about the distortion to our core net interest margin from the excess Fed balances and we felt that excluding them from calculations of the core NIM is a practice we've seen others in the industry adopt and we've decided to do so as well. We think this helps clarify for the reader the true fundamental dynamics of our core net interest margin. And now Duane will continue with an update on noninterest income.

Thanks, Tom. We will now look at noninterest income by turning to Slide 13. Noninterest income for the first quarter totaled $60.6 million, a $5.5 million decrease from the prior quarter and a $4.7 million decrease year-over-year. The linked quarter change reflects increases in insurance, wealth management and bank card revenues, which were more than offset by decreases in mortgage banking revenue and service charges on deposit accounts. For the quarter, noninterest income represented 37.2% of Trustmark's revenue, continuing to demonstrate a solid diversified revenue stream. Now looking to Slide 14, we will cover mortgage banking revenue. For the first quarter, mortgage banking revenue totaled $20.8 million, a $7.4 million decrease linked quarter and a $6.7 million decrease from the prior year. Mortgage loan production had a decline of 2.8% from the prior quarter, although still very strong first quarter production and an increase of 67.7% year-over-year. For the first quarter, retail production represented 75.0% of volume and $575 million. I'll now ask Tom Owens to cover noninterest expense and capital management.

Thank you, Duane. So turning to Slide 15, noninterest expense is broken out between adjusted, other and total. Adjusted noninterest expense totaled $120.2 million in the first quarter, an increase of 0.5% from the prior quarter. This increase was mainly due to the $1.5 million increase in salaries and benefits related to increased payroll taxes and performance-based commissions. Credit loss expense related to off-balance sheet credit exposures was negative $9.4 million in the first quarter. Other real estate expense totaled $324,000 in the first quarter compared to a negative $812,000 in the prior quarter, reflecting gains on sales of other real estate in the fourth quarter. As noted on Slide 16, Trustmark remains well-positioned from a capital perspective with a common equity Tier 1 capital ratio of 11.71% and a total risk-based capital of 14.07% as of March 31. During the first quarter, we deployed $4.2 million via the repurchase of approximately 145,000 common shares. At March 31st, we had remaining authorization of $95.8 million under our existing stock repurchase plan. Duane?

Thanks, Tom. I’m hopeful this discussion has been helpful and insightful for everyone. At this time, we would open the floor to questions.

Operator provided instructions. Our first question comes from Jennifer Demba with Truist Securities. Please go ahead.

Thank you. Good morning.

Good morning, Jennifer.

Just wondering if you could talk about the major levers you feel like you have to offset spread revenue growth challenges and mortgage comparison challenges this year and what we should expect in terms of 10-year term security portfolio growth for Trustmark? Thanks.

Jennifer, I'm going to ask you to repeat the question. We got bits and pieces. It was a bit jumbled and did not get the first part of your question. I apologize for that.

I'm sorry, can you hear me better now? Okay. I will talk louder here, hopefully, it will work. Can you just talk about the major levers Trustmark has to kind of offset spread revenue growth challenges and a difficult mortgage lending comparison this year? And how much securities growth you're willing to put on while the industry is waiting for loan demand to get better?

Okay. I think we got most of that. There are a couple of different questions. I will start out and Tom and others can add in. First of all, as we reported in our last call, we continue to remain very, very focused on expense controls and efficiency measures across the organization. We are doing extensive work in our branch system, looking at every opportunity to deploy ATMs and other means to serve customer needs and reduce the overall branch network as well as headcount. So continued focus there. I think in our prior call, we guided to 10 to 13 closures in the year. In the first quarter, we had a net closure of 5, with 7 closures and 2 new adds. The closure level could get as high as 16 or 17 for the year with several new additions. So that 10 to 14 net closure level is about right for the year, but we're intently focused on the branch system. We are continuing to invest in technology. We announced a major digital program that kicked off this month that we think serves customer needs very well and is a digital marketing enhancement, which over time will drive significant efficiencies and provide better insight into customer needs. And then we are, as a leadership and management team, intently focused on headcount. We have a program in place for every replacement or new headcount addition. We're focused on reducing headcount across the organization where appropriate, and we are intently focused on that topic and that issue moving forward. Tom, do you want to pick up from there and talk about some of the other metrics?

Sure. Good morning, Jennifer. Thank you for the question. Regarding the securities portfolio and the excess liquidity, during the first quarter we averaged about $1.5 billion of excess Fed balances. The driver is the deposit surge — we are up $2.8 billion year‑over‑year and were up $300 million just in the first quarter in deposits. We grew securities, the investment portfolio, by $300 million in the first quarter. Of the $2.8 billion deposit surge year‑over‑year, LHFI growth was about $400 million and securities growth about $300 million, roughly $700 million deployed, so we've deployed about 25% of that deposit growth year‑over‑year. Going forward, we will continue to opportunistically increase the size of the portfolio. In the second quarter, we might add something in the neighborhood of $150 million or so, depending on deposit trends. In managing that liquidity, we are triangulating between assessing the effective duration of the deposit surge, balancing that against our outlook for the economy and interest rates, and maintaining a competitive interest rate risk profile. Trustmark has a powerful countercyclical noninterest revenue engine in mortgage banking, which has kicked in with historically low interest rates. We want to ensure we have a competitively positioned asset sensitivity as we come out of the pandemic and as market interest rates begin to rise and the Fed eventually normalizes monetary policy. We think we are probably a bit underinvested in securities relative to our peer group and there is an opportunity to do more, but we are balancing those considerations. For example, $1.5 billion sitting at the Fed, if deployed today to pick up 100 basis points, would add about $15 million to annual net interest income. But deploying it would put on assets with a duration of about four to five years, and the opportunity cost when market interest rates rise and the Fed normalizes policy can be enormous. We don't want to put ourselves at a competitive disadvantage. Those are our considerations, and in summary, we will continue to opportunistically increase the size of the portfolio.

Did we answer, Jennifer? Did we answer every part of your question?

I think so. Is there a limit in terms of securities to assets that you would target?

No, not a limit. Historically we've looked to be in the neighborhood of 20% of earning assets, which in round numbers would put us close to $3 billion. We are currently at $2.8 billion. As I said, you could absolutely see us increasing the size of the portfolio, perhaps by about $200 million in the second quarter. When you balance those things out for the time being, our view is that we want to run a little light in the securities portfolio, although that could change. Interest rates are low, the yield curve is flat, and spreads are tight. If those variables move in a more attractive direction, you could see us deploy some of that liquidity more rapidly. We are also keeping an eye on deposit dynamics. We would have thought, and many in the industry would have thought, that by now we would have started to see some rollover or hit an inflection point in deposit balances. Nobody necessarily anticipated the additional stimulus from the American Rescue Plan, so as you can imagine we diligently monitor monthly trends in balances. That will be part of the calculation: how much of those balances demonstrate an effective duration consistent with the back book versus how much shows effectively shorter duration. At the end of the day, we want to maintain a competitive asset sensitivity in our interest rate risk profile.

Thank you.

The next question is from Catherine Mealor with KBW. Please go ahead. Ms. Mealor, is your line muted?

Thanks. Good morning. Can you hear me? I just wanted to follow-up on your loan growth outlook. As Rob said last quarter, you were a little bit more cautious on loan growth this year versus last, but had really nice momentum this quarter. And so just curious how you're thinking about what loan growth could look like in 2021? Thanks.

Hey Catherine, this is Barry. I'll address that. During Q1, our growth was influenced by some funding in our other construction book. Some of that funding was for credits we put on the books and felt good about during Q2, Q3 and Q4 of last year. We anticipate those fundings will continue to be strong throughout the year. We have seen some improvement in public finance growth this quarter and expect that trend to continue. We are focused on making sure we don't miss opportunities and are prudent in our approach. On the commercial and industrial side, we didn't have much forward momentum this quarter. It's a very competitive environment, but we are exploring different alternatives. Going forward, our guidance remains low single digits, mainly because of expected payoffs in Q2, Q3 and Q4 on our commercial construction book, which will move out of the construction categories as projects stabilize and shift to permanent financing or are sold. If those payoffs are delayed, which can happen and often pushes activity from Q4 into Q1, we could see loan growth in the mid single digits rather than the low single digits. Those timing shifts within the year are accounted for within our low single-digit guidance. Overall, it is more a function of scheduled payoffs we expect and some unexpected items we are seeing than a slowdown in production, because we are still active, reviewing many deals and putting loans on the books. Construction loans generate nice fees but typically fund slowly due to significant equity contributions, and they remain on the books as long as it is attractive to borrowers relative to the permanent market or the opportunity to sell if cap rates remain low and the permanent market is open. We expect those projects to exit as anticipated, but if we allow them to stay longer for stabilization, we could generate mid-single-digit loan growth instead of the low single digits we are guiding to.

Got it. Okay. That makes sense. And then maybe just on the reserve, how do you think about where you believe the reserves will bottom? Do you think we're headed toward the day one CECL reserve to loan ratio? And did you see that ratio falling below one? Or just how do you kind of think about where we're headed toward the bottom?

And this is Barry then Catherine. Our challenge, and I think everybody's challenge, is to forecast, and our forecast continues to improve. As you know, we use Moody's baseline and we forecast four quarters and we revert to the mean over four quarters, which in today's world is a positive because the mean is higher than any of the four quarters in our forecast in terms of higher unemployment, whether national or southern. So that's actually beginning to work to our advantage. I think we looked at April's numbers coming out of Moody's baseline or their S-1. They did improve slightly with southern and national unemployment, which are two of our bigger drivers, but not to the same extent that we've seen over the past several quarters. So we are cautiously optimistic that the continuing improvement in the forecast will persist, but to a much lesser degree than we’ve seen previously. That would be a headwind that would help us not move back toward where we were day one, which for Trustmark, just for reference purposes, was 88 basis points on funded debt. Obviously, we’re 109 today on funded debt versus the 88. It's not our intention at all to be moving back that direction. I will say we also have a qualitative reserve for COVID loans. As you could imagine, over time those loans will either get upgraded if they're in a non-pass category or we will decide we don't need the additional reserves that were added to the pass category. If that does occur, then that will be another headwind we will need to deal with. But I think that's a little more controllable by Trustmark in terms of how we see the economy unfolding. When we see the vaccine fully distributed to everybody who wants it, availability is unlimited, and all those things, then we can begin to determine whether we think we don't need that COVID reserve. If we don't, then in a systematic manner we will begin to release those reserves as we should. I think it's a combination of that as well as the forecast not continuing to have the large improvements in unemployment, both national and southern, that we've seen previously. Those are the two things that are going to drive us lower with our reserving levels. As long as we can have some moderation in the forecast from the economic side and then be patient, which we intend to be, on releasing the qualitative COVID reserve to make sure we really see the signs of recovery and everything is moving forward, and the economic engine has turned back around and the hotels, restaurants, and retail are all back on solid footing, then we can begin to release some of those reserves that were specifically assigned to the credits most impacted by COVID-19.

Very helpful. Thank you.

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

Hey, good morning guys.

Good morning, Brad.

Thanks for taking my question, I just wanted to quickly go back to the mortgage business. If my calculations are correct, it looks like your gain on loan sale margin was down maybe more than expected linked quarter. Obviously, I understand there's pressure across the industry, but it doesn't look like your mix, in terms of retail, wholesale was all that different. Just kind of curious kind of what trends you're seeing. Are we getting close to a bottom in terms of that gain on loan sale margin? Or if you continue to kind of see weakness as you moved into the second quarter?

Yes. Thanks. I will start. Tom can add, if needed. But so first of all, mortgage business, as noted earlier, the production in the business remains very solid, very strong. $767 million in the first quarter is 70% higher than any prior first quarter we've ever had. So still volumes were being strong. I think, in the last call and toward the end of the year, the industry was forecasting volumes to be down 30%-ish to 35% across the industry. We were in that same kind of category. We're seeing more like a 10% decline now over the year in terms of overall volumes. So that's what we are expecting moving forward, especially in the closing quarters next quarter and beyond in that 10%-ish range of volume decline. We are still seeing the gain on sale margin tighten for sure. That one is much more difficult to forecast, much more dependent on a lot of other factors and the like. And to your point, in your question, we've not necessarily seen it stabilize or bottom yet. We do see it continuing decline, probably down another 25 or more percent in the second quarter from what we are seeing now. Further into the year, it's much more difficult to see or get any visibility there.

Yes. No, that's great. And just maybe on the flip side of that, I mean, I know that mortgage lenders are paid on production and not profitability. So based on your view, if you think volumes are going to be down 10%, it doesn't seem like you're going to have much expense leverage even though the revenue is going to come down at a faster clip. Is that a fair assessment?

I would say that's fair. Yes. I mean, I think that's right on the button. We do pay on production. And so, if you look at the first quarter expense totals and the 2020 expense totals that was included higher commissions than normal. And as we see the production come down, they will come down proportionately in that range. So I think, yes, you've hit it right on the expense side.

Yes. And just back to Jennifer's question, it sounds like you're working on some branch-related expense levers, but you're still running a high single-digit expense growth run rate, which seems a little higher than what Trustmark has done historically. Do you think those branch rationalization efforts are enough to bring that run rate down?

So Brad, this is Tom. I'll take a stab at that. It depends how you look at the expenses. If you look at adjusted noninterest expense, we think we are tracking year-over-year, full year 2021 versus 2020, in the low single-digit range. To give you an idea, full year 2020 adjusted noninterest expense was $455.4 million. It very much depends. Mortgage origination production and commissions are a swing factor. Excluding that elevated expense, we'll probably be in a 1% to 2% increase year-over-year in adjusted noninterest expense. If mortgage origination volume remains somewhat elevated for the remainder of the year, you'd probably be closer to 3% year-over-year for that metric.

Great. That’s helpful. I appreciate it.

Operator provided instructions. The next question is from Michael Rose with Raymond James. Please go ahead.

This is Carl Doirin for Michael Rose. Good morning. I appreciate all the color on loan growth. To piggyback on that question, in addition to the CRE roll-offs you guided to, you also mentioned elevated paydowns were a factor for the lower loan growth. You previously noted a pickup in C&I activity; where are paydowns relative to what you expected?

And I didn't quite catch your name. Is it Carl? Carl, this is Barry. Let me speak to some of that. It's a funny thing, when you look at what we anticipated for payoffs in Q1, they're pretty close to being spot on. But I will say that some of the ones that we had scheduled for payoff in Q1 moved down into Q2 or Q3 and some of the ones that probably were slated for 2022 moved into Q1 of 2021. So it's a fluid situation because of the opportunities our borrowers have from time to time to be able to move a project out, do a sale, especially where they're getting paid based upon the velocity of lease-up as opposed to the stability being achieved. So we do get surprised every quarter by some that moved from one year into this year. And some that was scheduled for this year who slide down to another quarter, probably still in this year for the most part. We do budget a significant amount when we are trying to forecast or plan for, when we are trying to forecast a significant number of unexpected payoffs just because of the uncertainty around when things are going to leave us. We do survey our customers quarterly, or our relationship managers do to make sure they know exactly when they would expect the project to leave. Our relationship managers do a good job of that because they understand that we have limits on things. And if the better we can forecast when things are going to leave us, the better off we are in terms of not shutting off the spigot on something that we are going to have a lot of payoffs on. If we don't know about it, we can't plan for them. And if we think we're filling up in a bucket, then we will end up stopping or slowing down production, when it was unnecessary if we'd only had the best information from the customer. So our folks do a good job of assessing that on a quarterly basis. We reforecast every quarter, our CRE, in every category to make sure we are anticipating with the best information possible what’s going to transpire. And so to answer your question, we were about where we expected to be from a payoff standpoint in Q1. We do anticipate the scheduled payoffs for Q2, 3 and 4 being heavier. But as I mentioned earlier on Catherine's question, that fourth quarter is a heavy payoff quarter for us. Historically, you will see things slide from quarter-to-quarter, either because the stabilization is just not quite where they want it to be, while they would rather wait a couple of more months and get the maximum amount of value out of the project when they sell it or they still need to have a little more funding that they can do before they actually move to the permanent market, depending on what stage it is, whether it's just out of construction or whether it's just about stabilized. So for all those reasons, it does vary, but I think we feel comfortable with our forecasting process, and we feel comfortable that we do have heavier volumes of payoffs coming in the remainder of the year than we experienced in Q1, but Q1 was in line with what we expected.

Got it. Thanks for the color. If I can ask about M&A versus buybacks: you started using the repurchase program in Q1. Regarding M&A, and I know you previously said you are looking to pursue an acquisition, can we expect that doing an M&A will affect how much stock you buy back going forward, considering the related interactions and activity?

This is Duane. I'll start. There's a tremendous amount of activity and discussion in the M&A market right now, and we are being approached with many opportunities of different shapes and sizes. Our position on M&A hasn't changed: we're still very interested in the Southeast region of the U.S. and are being opportunistic. We're looking for new growth markets, expertise and talent to supplement our team, product additions and categories we know and understand, and ways to enhance our capabilities for growth. Equally important are efficiencies we could gain through an acquisition. We continue to think in the $500 million to $5 billion range for potential partners. It is a very active time with lots of industry discussions. On buybacks, our capital planning committee meets regularly to evaluate opportunities. We still have most of our allocated buyback program in place and will be opportunistic based on market conditions. At this time we have $98.5 million of approved capital available for buybacks.

All right. Thank you very much. Pretty helpful for me.

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

Thank you again for joining us for our first quarter call. We hope we answered questions, and we appreciate you being on the call and look forward to getting back together at the end of the second quarter. Have a great rest of the week. Thank you.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.