Earnings Call Transcript - TRMK Q3 2023

Operator, Operator

Good morning, everyone, and welcome to Trustmark Corporation's Third Quarter Earnings Conference Call. This call is being recorded. I am now pleased to introduce Mr. Joey Rein, Director of Corporate Strategy of Trustmark. Please go ahead.

Joey Rein, Director of Corporate Strategy

Good morning. I'd like to remind everyone that a copy of our third 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 the actual results due to a number of risks and uncertainties, which are outlined in our earnings release as well as our other filings with the Securities and Exchange Commission. At this time, I'd like to introduce Duane Dewey, President and CEO of Trustmark.

Duane Dewey, President and CEO

Thank you, Joey, and good morning everyone. Thank you for joining us today. With me this morning are Tom Owens, our Chief Financial Officer; Barry Harvey, our Chief Credit and Operations Officer; and Tom Chambers, our Chief Accounting Officer. Trustmark had a solid third quarter with continued loan and deposit growth, a stable net interest income, strong performance in our insurance business, and solid credit quality. As previously disclosed, Trustmark recognized a litigation settlement expense of $6.5 million in the third quarter. With this charge, Trustmark reported a third quarter net income of $34 million, representing diluted earnings per share of $0.56. Excluding this litigation settlement expense, Trustmark's third quarter net income totaled $38.9 million or $0.64 per diluted share. During the first nine months of 2023, Trustmark's net income totaled $129.4 million, which represented diluted earnings of $2.11 per share, an increase of 22.7% from the same period in 2022. We continue to focus on cost-saving initiatives to improve efficiency as well as technology to enhance our ability to grow and serve customers. We believe Trustmark is well-positioned to respond to changing economic conditions and create long-term value for our shareholders. Let's take a look at our financial highlights in a little more detail by turning to Slide 3. Loans held-for-investment increased $196.3 million, or 1.6% linked-quarter, and $1.2 billion or 10.6% year-over-year. Deposits during the quarter grew $188 million or 1.3% linked-quarter, and $676.7 million or 4.7% year-over-year. Net interest income totaled $141.9 million, resulting in a net interest margin of 3.29%, down 4 basis points, linked-quarter. Noninterest income decreased 2.5%, linked-quarter, to $52.2 million, representing 27.4% of total revenue in the third quarter. Noninterest expense in the third quarter totaled $140.9 million. Excluding the litigation settlement expense of $6.5 million, noninterest expense was $134.4 million, up $2.2 million or 1.7%, linked-quarter. Net charge-offs during the quarter totaled $3.6 million and represented 11 basis points of average loans. The provision for credit losses for loans held-for-investment was $8.3 million in the third quarter. Credit quality remained solid during the quarter as the allowance for credit losses represented 1.05% of total loans held-for-investment and 273.6% of non-accrual loans excluding individually evaluated loans at September 30. We continue to maintain strong capital levels with common equity tier 1 of 9.89% and a total risk-based capital ratio of 12.11%. The Board declared a quarterly cash dividend of $0.23 per share payable on December 15 to shareholders of record as of December 1. At this time, I'd like to ask Barry Harvey to provide some color on loan growth and credit quality.

Barry Harvey, Chief Credit and Operations Officer

I'll be glad to, Duane, and thank you. Turning to Slide 4, loans held for investments totaled $12.8 billion as of September 30. That's an increase, as Duane mentioned, of $194 million for the quarter. Loan growth during Q3 came from CRE, equipment finance, and our mortgage line of business. We do expect continued solid loan growth throughout the remainder of 2023, resulting in mid-single-digit loan growth for the year. Our loan portfolio, as you can see, is well-diversified both by product type, as well as by geography. Looking at Slide 5, Trustmark CRE portfolio is 94% vertical, with 68% in the existing category and 32% in construction land development. Our construction land development portfolio was 80% construction. Trustmark's office portfolio, as you can see, is very modest at $288 million outstanding, which represents only 2% of our overall loan book. The portfolio is comprised of credits with high-quality tenants, low lease turnover, strong occupancy levels, and low leverage. The credit metrics on this portfolio remain extremely strong. Looking at Slide 6, the bank's commercial loan portfolio is well-diversified, as you can see, across numerous industries with no single category exceeding 13%. Looking at Slide 7, our provision for credit losses for loans held-for-investment was $8.3 million during the quarter, which was attributable to: reserving for one individually evaluated credit; a weakening macroeconomic forecast; funding provision for the loan growth that we achieved during the quarter; and net adjustments to our qualitative factors. The provision for credit losses for off-balance sheet credit exposure was $104,000 for the third quarter. On September 30, the allowance for loan losses for loans held-for-investment was $134 million. Looking at Slide 8, we continue to post solid credit quality metrics. The allowance for credit losses represents 1.05% of loans held-for-investment and 274% of non-accruals excluding those loans that are individually analyzed. In the third quarter, net charge-offs totaled $3.6 million or 0.11% of average loans. Both non-accruals and non-performing assets remain at reasonable levels. Duane?

Duane Dewey, President and CEO

Okay, thank you, Barry. I'd like to ask Tom Owens now to focus on deposits and income statement.

Tom Owens, Chief Financial Officer

Thanks, Duane, and good morning everyone. Looking at deposits, we experienced another strong quarter with our deposit base remaining robust in a highly competitive environment. As Duane mentioned, deposits reached $15.1 billion as of September 30, marking a linked-quarter rise of $188 million, or 1.3%, and a year-over-year increase of $677 million, or 4.7%. The linked-quarter growth was supported by solid fundamentals, including a rise in personal balances by $288 million, non-personal balances by $148 million, and brokered balances by $125 million. However, this growth was somewhat countered by a decline in public fund balances of $373 million, attributed to seasonal and other factors. In terms of mix, time deposits continued to rise quarter over quarter, with promotional CDs increasing by $344 million and brokered CDs by $113 million. As of September 30, our promotional time deposit portfolio totaled $1.23 billion, with an average rate of 4.65% and a remaining term of approximately six months. Our brokered deposit portfolio amounted to $728 million, with an average rate of about 5.42% and a remaining term of about five months as of September 30. Additionally, the rate of decline in noninterest-bearing demand deposit accounts slowed significantly in the third quarter, decreasing by $141 million, or 4.1%. Noninterest-bearing demand deposits accounted for 22% of the deposit base as of September 30. Our interest-bearing deposit costs increased by 43 basis points from the previous quarter to 2.39%. Moving on to revenue, net interest income decreased by $1.4 million quarter over quarter, totaling $141.9 million, resulting in a net interest margin of 3.29%. The net interest margin saw a decline of 4 basis points as changes in asset rates and volumes largely counterbalanced changes in liability rates and volumes. Our interest rate risk profile remained largely steady, characterized by significant asset sensitivity from our loan portfolio, which includes 49% variable-rate loans. In the third quarter, the average maturity of the cash flow hedged portfolio slightly decreased to 2.9 years, while the average fixed-rate received increased to 3.16%. We also entered into $25 million in forward-starting swaps, raising the portfolio notional at quarter-end to $975 million. This cash flow hedging program effectively mitigates our exposure to potential declines in interest rates. In terms of noninterest income, we registered $52.2 million for the third quarter, a decrease of $1.3 million quarter over quarter and a $382,000 decrease year over year. The linked-quarter decline was primarily driven by lower bank card and other fees by $700,000 and a drop in other income of $1.3 million, which was essentially a return to normal levels following a spike in the second quarter due to non-recurring income. However, these decreases were partially offset by increases in service charges on deposit accounts by $379,000 and insurance commissions by $539,000. For the quarter, noninterest income constituted 27.4% of total revenue, indicating a well-diversified revenue stream. Mortgage banking revenue for the third quarter totaled $6.5 million, reflecting a $142,000 decrease quarter over quarter, primarily due to a $493,000 rise in mortgage servicing asset amortization, largely offset by a $152,000 increase in servicing income and a $338,000 reduction in negative net hedge ineffectiveness. Year over year, mortgage banking dropped by $418,000, largely due to a decrease in gains on sales. Mortgage loan production reached $390 million in the third quarter, marking a 9.6% decrease quarter over quarter and a 23.3% decline year over year. The retail production mix remained strong, making up 76% of volume, or approximately $295 million, with loans sold in the secondary market representing 81% of production and loans held on the balance sheet accounting for 19%. The gain on sale margin decreased by 3 basis points quarter over quarter to 1.21%. Now, I will turn it over to Tom Chambers to discuss noninterest expense and capital management.

Tom Chambers, Chief Accounting Officer

Thank you, Tom. Turning to Slide 15, you'll see a detail of our total noninterest expense. Adjusted noninterest expense was $134 million during the third quarter, a linked-quarter increase of $2.4 million or 1.9%, mainly driven by an increase in salary and employee benefits of $726,000 as a result of higher salary expense. Other expense increased by $1.4 million, resulting from an increase of FDIC assessment expense of $1.2 million. In addition, services and fees decreased $382,000 due to lower professional and consulting fees during the quarter. As noted on Slide 16, Trustmark remains well-positioned from a capital perspective. As Duane previously mentioned, our capital ratios remained solid, with a common equity tier 1 ratio of 9.89%, and a total risk-based capital ratio of 12.11%. Trustmark did not repurchase any of its common shares during the third quarter. Although we have a $50 million authority for the remainder of 2023 under our Board-authorized stock repurchase program, we are unlikely to engage in stock repurchase in a meaningful way. Our priority for capital deployment continues to be organic.

Duane Dewey, President and CEO

Well, thank you, Tom. Turning to Slide 17, let's look at our outlook. First, let's look at the balance sheet. We're expecting loans and deposits to continue to grow mid-single-digits for the year. Security balances are expected to decline in high-single-digits for the year as cash flow runoff of the portfolio is not reinvested, which of course is subject to the impact of changes in market interest rates. Moving on to the income statement, we're expecting net interest income to grow high-single-digits for the full year '23, which is driven by earning asset growth and reflects a full year net interest margin in the high 3.20%s based on the current market implied forward interest rates. The total provision for credit losses, including unfunded commitments, is dependent upon future loan growth, the current macroeconomic forecast, and the credit quality trends. Net charge-offs requiring additional reserving are expected to be nominal based on the current economic outlook. From a noninterest income perspective, insurance revenue is expected to increase high-single-digits for the full year, with wealth management expected to increase low-single-digits. We're expecting service charges and bank card fees to increase low-single-digits, which is offset somewhat by lower customer derivative fees. Mortgage banking revenue is expected to decline low-single-digits for the year. Adjusted noninterest expense is expected to increase mid-single-digits for the year. This reflects general inflationary pressures and added talent throughout our system as well, but it is also subject to the impact of commissions in the various lines of business. We remain intently focused on our FIT2GROW initiatives as discussed throughout 2022 and 2023. Our Atlanta-based Equipment Finance division continues to gain traction as its portfolio has grown to $191 million as of 9/30. We have implemented numerous technology advancements, which will continue into '24 and '25, all of which are designed to improve efficiencies. Moving into Q4, we're intently focused on cost-saving initiatives that will reduce the rate of expense growth in coming quarters. In addition, work continued on the design of our sales-through-service process, which will be implemented across the retail branch network in '24. We believe these actions will enhance Trustmark's performance and build long-term value for our shareholders. Finally, we will continue a disciplined approach to capital deployment with a preference for organic loan growth and potential M&A. We will continue to maintain a strong capital base and implement corporate priorities and initiatives. With that, at this time, I'd like to open the floor up to questions.

Operator, Operator

Thank you. Our first question comes from Graham Dick with Piper Sandler. Please go ahead.

Graham Dick, Analyst

Hey, good morning guys.

Duane Dewey, President and CEO

Good morning.

Graham Dick, Analyst

So, I just wanted to start quickly on the margin, specifically with loan yields. They saw some really nice expansion this quarter. Just wanted to get a sense for the repricing dynamics in that portfolio as we look forward. And then also if you think that there may be a similar level of improvement possible in 4Q and maybe even as we look into 1Q '23?

Barry Harvey, Chief Credit and Operations Officer

Hey, Graham, this is Barry from the credit side. I'll begin with our weighted average yield for the quarter, which is 6.2%. The new bookings we have are at 7.9%, showing a nice increase compared to the makeup of the book itself. This is mainly due to many new opportunities being CRE-related, with slower production than what we experienced in 2021 and significantly lower production in 2022. However, we are seeing good fee income from these opportunities along with favorable spreads to one-month SOFR. Therefore, we expect a solid yield in our new production relative to the overall book.

Graham Dick, Analyst

Okay, that's helpful. On the deposit side, I noticed a slight outperformance in your deposit cost guidance this quarter. Could you share your insights on funding costs as you look forward to 2024? Also, do you have an estimate for when those costs might peak and fully reflect in the deposit cost picture?

Tom Owens, Chief Financial Officer

Hey, Graham, this is Tom Owens. So, yes, we did come in just slightly favorable to our guidance for the third quarter. And as a result, we slightly lowered our guidance on deposit cost for the fourth quarter. Internally, we're continuing to model as we've discussed on prior calls, which is ultimately to a cumulative deposit beta mid-2024 in the mid-40%s. So, I think what you will see is decline in linked-quarter, increase in deposit cost over the next several quarters, right? So the pace of increase will continue to decline and I would not expect that you'll get to flattish deposit cost until the second half of next year. We've got the Fed. We're using market-implied forwards, so the Fed is on hold through I believe July of next year, which is about the same time we've got that cycle to beta topping out and where we have deposit costs topping out.

Duane Dewey, President and CEO

Hey, Graham, this is Duane Dewey. Let me just add real quickly to that just to complement, Tom and the treasury team, as well as the retail banking team here at Trustmark. I think as the year has gone on, we have become more focused and targeted in some of our campaigning on the deposit side, and really honed in on where we have opportunity, where we have opportunity to price better, etc. So I think, in addition to the market pressures that we're facing, I also think the organization has advanced in its targeted marketing campaigns across the system, which has helped manage the costs.

Graham Dick, Analyst

Yes, certainly. So, when you combine those two elements and consider the margin this quarter, which remained stable, do you believe that the asset repricing can at least mitigate the increase in deposit costs until we observe a more stable trend in deposit costs in the latter half of 2024?

Tom Owens, Chief Financial Officer

I think you'll continue to see some linked-quarter compression in net interest margin for the next couple of quarters. Then, as we approach mid-2024, particularly in the second and third quarters, you are likely to see that stabilize and even out.

Graham Dick, Analyst

Okay, great. And then lastly if I could just get one more in. Yesterday, we saw another banking competitor, a peer of yours announce the sale of its insurance business and they're planning to use the capital to pay down some borrowings and restructure part of the bond portfolio. How do you guys view this transaction? Would you ever consider anything like it? Because if I look at the multiple on that business, it looks like your all insurance business will be implied about $300 million in value-based on the revenue multiple that was used yesterday.

Duane Dewey, President and CEO

This is Duane. We're clearly aware of the developments in the bank-owned insurance sector, as a couple of deals have been announced recently. However, we remain committed to this business. We have been in it for 25 years, and it has consistently shown steady growth, particularly over the past decade. It generates a high return on tangible common equity, and we have a strong team and management structure in place. We appreciate the diversification that insurance revenue provides, and as Tom mentioned, noninterest income makes up over 27% of our earnings, which we value. That said, we are mindful of the conditions around us and are aware of how valuations are affecting others financially. We will continue to monitor and evaluate the situation, but at this moment, we have a favorable outlook on the insurance business.

Graham Dick, Analyst

Okay, great. Thanks, guys.

Operator, Operator

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

Kevin Fitzsimmons, Analyst

Hey, good morning, guys.

Duane Dewey, President and CEO

Good morning, Kevin.

Kevin Fitzsimmons, Analyst

Shifting gears to credit, we saw roughly a $20 million increase, I believe in NPAs, I know we're kind of coming off a very low point here. And I saw you mentioned reserving for this newly evaluated non-accrual loan, it looked like non-accruals went up in the State of Alabama and Mississippi. So, maybe just any color you can provide on how many loans? What kind of business they're in? And if there's any concern that there'll be others coming? Thanks.

Barry Harvey, Chief Credit and Operations Officer

Hey Kevin, this is Barry. During the quarter, two credits contributed to our increase in non-accruals, one in commercial real estate and the other in commercial and industrial, both classified as sub-standard accruing as of June 30. We decided to move them to non-accrual during the third quarter to evaluate whether a reserve was necessary. At this point, I don't see this as a systemic issue; it's part of normal business operations. Regarding Mississippi and Alabama, one of the C&I loans I mentioned was originated in Alabama, though the customer is not from there, and that’s how it’s recorded in our distribution. In Mississippi, the rise in non-accruals was driven by our mortgage company, and like many others, we've seen some increases from our mortgage portfolio. We are closely monitoring our portfolios and reviewing many of the credits quarterly. From a CRE perspective, we are assessing the pro forma against current interest rates to evaluate debt service coverage and debt yield, considering today's environment instead of the conditions at the time of underwriting. We continually adjust grades as needed in a timely manner to prevent any breaches or maturity issues.

Kevin Fitzsimmons, Analyst

That's helpful, Barry. While we're on the subject of credit, to choose two kind of side questions, a number of your large Southeast bank peers were involved in a bankrupt syndicated credit. Can you remind us what kind of exposure you have to SNCs? And then equipment finance, I know you guys are just kind of in the infancy stage there of that business and it's ramping up. But with the economy slowing in the mid-higher rates, is there any concern about that book? I know, Duane, when we've talked about this before, you'd really emphasized how you're really being careful and methodical in building that business. So I would assume you feel okay credit-wise, there.

Barry Harvey, Chief Credit and Operations Officer

Sure. I'll start with the shared national credit question and then move to equipment finance. Our outstanding shared national credits represent 8.6% of our total book. There are no significant industry concentrations according to regulatory definitions. It's important to note that while we monitor these shared national credits, their credit quality is typically near or at investment grade, indicating they are high-quality companies. Generally, high-quality companies tend to have less collateral due to the strength and predictability of their earnings, which shapes our credit criteria and reflects the strength of the borrowers we lend to. We take a cautious approach to these shared national credits, recognizing their strength while not leading any shared national credit deals. We prioritize modest sizing for the opportunities we pursue and have established concentration limits for these credits, which we have maintained for many years. This information is shared with our Enterprise Risk Committee on a quarterly basis. We are aware of shared national credits for different reasons than you might expect; we want to ensure we are focused on direct business opportunities since shared national credits provide limited opportunities for follow-on business. Regarding equipment finance, we have a highly experienced team that understands the importance of maintaining a strong credit structure and quality in all the deals we evaluate. While pricing is important, it is secondary to borrower quality, especially as we grow in this new line of business. We are committed to avoiding pitfalls and ensuring our focus remains on solid credit risks and deal quality, with price being a consideration but not our primary concern. I'm confident in the experience and knowledge of our team, which includes credit resources with extensive backgrounds in this field from large institutions. As we evaluate credit opportunities today, our aim will be to maintain a high standard of credit quality.

Duane Dewey, President and CEO

One final note on the equipment finance, Kevin, is that it's mid to large ticket, so we're not focused on small ticket or small business type deals, it's really mid to large and most of the credit in that portfolio is close to what Barry described from a SNC perspective, very top-line credit quality. We feel pretty good about where we are at this point in that business.

Kevin Fitzsimmons, Analyst

Okay, great. I have one last question for you, Duane. I want to highlight your positive comments about the insurance business. I remember the CEO of Cadence mentioned something similar during last quarter's call. Setting that aside, if no transaction occurs, would you consider a securities restructuring transaction on its own to speed up the redeployment or reinvestment of the securities portfolio?

Duane Dewey, President and CEO

Yeah, I'll start quickly and let Tom address the securities portfolio. But again, I mean, we've been in the business 25 years, can't comment much on what Cadence thought process is. But staying abreast, staying aware of what's going on and looking at what's best for Trustmark's shareholders moving forward, that's what we're focused on. And it's been a great business for us and continue to monitor the situation, but at this point in time, that's where we stand. So, I'll let Tom address the securities portfolio.

Tom Owens, Chief Financial Officer

So, Kevin, this is Tom Owens. So, I would probably echo Duane's comments in terms of being aware and monitoring what our competitors and what our peers are doing. Certainly, we're aware of the restructuring, the investment portfolio restructuring activity that's been going on. So, we're aware of it. We look at it. We are not, at this point, seriously contemplating doing that, I guess is the way I would say it.

Kevin Fitzsimmons, Analyst

Okay, that's great. Thanks, guys. Appreciate it.

Operator, Operator

Our next question comes from Will Jones with KBW. Please go ahead.

Will Jones, Analyst

Hey, great. Good morning, guys. This is Will. How is it going?

Duane Dewey, President and CEO

Hey, good morning. Thank you, Will.

Will Jones, Analyst

Hey. So, I just wanted to start out on the margin, I know and I understand that we may take a step down here in the next quarter and I really appreciate the guidance of a little bit of further compression until we moderate into the middle half of next year, but just taking that into account and appreciating the fact that you still plan to grow earning assets. Do you feel like you can grow NII again in 2024? Or does it really feel like more of a leveling out in NII and maybe just trying to protect the margin?

Tom Owens, Chief Financial Officer

So, certainly, earning asset growth will lead to an increase year-over-year in net interest income. However, the challenge of compression in net interest margin is something we won't be able to overcome. When you consider the dynamics in the industry, the compression we have experienced poses a significant challenge as we head into 2024. Mathematically, it makes it difficult to achieve growth in net interest income year-over-year in a meaningful way. If I understood your question correctly, I hope I answered it. If not, please feel free to follow up.

Will Jones, Analyst

It was helpful. However, it seems that achieving high single-digit growth again in 2024 may be challenging. I'm not trying to discuss 2024 guidance right now, but it's more about the context of the question regarding ongoing margin compression while still growing our earning asset base. Assuming the revenue environment remains difficult next year, do you have any measures on the expense side, considering that you are quite active with your FIT2GROW initiative? What is your outlook on where expenses might head in the next year or so?

Duane Dewey, President and CEO

I don't know if I can give you a full year, I can tell you directionally, we are very intensely focused on expenses. As noted in the FIT2GROW initiatives, we've invested in technology. We've invested somewhat in talent and people, like equipment finance in our Atlanta office, etc. So, we've done some things that we think over time really enhance shareholder value. And there have been some other factors in there, some of the legal resolution that we completed here this quarter, etc. that we think there are definite opportunities for cost savings moving into 2024. And you could one-off things like we changed disaster recovery sites, that's a $1 million savings. We renegotiated some big vendor contracts that are additional savings and the like. So those things combined with some third-party spends and then we have some employee initiatives that we're working on as we speak today that we also think will help. That combined with some of the efficiencies of technology that have been implemented, we definitely, moving into 2024, feel the cost-saving side is a big opportunity for us. And we are in position to take advantage of that and will likely at our fourth quarter call give a real thorough guidance on where we think will be for the year 2024.

Will Jones, Analyst

Okay, that's great. That's helpful. And Tom, I just wanted to clarify, did you mention earlier that you expect total deposit cost next quarter in the 2.12% range and a 39% total beta? I just wanted to clarify.

Tom Owens, Chief Financial Officer

That's correct, Will.

Will Jones, Analyst

Okay, thanks for pointing that out. And lastly, I know you guys mentioned buybacks are fairly unlikely in the near-term. Although just with where the stock trades at today and capital remaining in a healthy manner, just curious what the thought process is on maybe not taking a more serious consideration and look at it, it just feels like it could be an opportunity for you guys right now.

Tom Owens, Chief Financial Officer

Yeah, Will, as we've said consistently in the past, I mean, our highest priority in terms of capital deployment is supporting lending growth. And as we've demonstrated, we've continued to have opportunities in that area. And so, I think that will be the case. I mean, I think we've given pretty strong guidance in the last couple of earnings calls that, in all likelihood we would not be engaging in repurchase activity for the remainder of 2023 and I think that's still the case.

Will Jones, Analyst

Okay, that's fair enough. Thank you, guys.

Duane Dewey, President and CEO

Thank you.

Tom Owens, Chief Financial Officer

Thanks, Will.

Operator, Operator

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

Duane Dewey, President and CEO

Thank you again for joining us for today's third quarter call. We look forward to catching up at the end of the fourth quarter in January, and appreciate your interest in Trustmark. Have a great week.

Operator, Operator

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