Earnings Call Transcript - TRMK Q1 2023

Operator, Operator

Good morning, everyone, and welcome to Trustmark Corporation's First Quarter Earnings Conference Call. Please note that this call is being recorded. Now, I’m pleased to introduce Mr. Joey Rein, Director of Corporate Strategy at Trustmark.

Joey Rein, Director of Corporate Strategy

Good morning. I'd 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, and 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.

Duane Dewey, President and CEO

Thank you, Joey, and good morning, everyone. Thank you for joining us this morning. 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. Our first quarter financial performance reflects solid loan and deposit growth, strong performance in our mortgage insurance and wealth management businesses and diligent expense management. For the fourth quarter, Trustmark reported net income of $50.3 million or $0.82 per diluted share. This level of profitability resulted in a return on average tangible common equity of 18.03% and a return on average assets of 1.1%. Let's look at our financial highlights in a little more detail by turning to Slide 3. At March 31, 2023, loans held for investment totaled $12.5 billion, an increase of $293 million linked quarter, while deposits totaled $14.8 billion, an increase of $346 million linked quarter. Revenue in the first quarter totaled $189 million, a decline of 1.5% linked quarter and an increase of 23.1% from the same quarter in the prior year. Net interest income totaled $141.1 million in the first quarter, a decrease of $8.9 million or 6% linked quarter. Noninterest income totaled $51.4 million, an increase of $6.2 million or 13.7% from the prior quarter and represented 27.2% of total revenue in the first quarter. Noninterest expense in the first quarter totaled $128.3 million, a decline of $2.2 million or 1.6% compared to the prior quarter, excluding the litigation settlement expense. Credit quality remained solid as the allowance for credit losses for loans held for investment represented 320.8% of nonaccrual loans. Net charge-offs totaled $1.2 million and represented 4 basis points of average loans. Nonperforming assets represented 0.58% of total loans held for investment and loans held for sale at March 31. We continue to maintain strong capital levels with common equity Tier 1 of 9.76% and a total risk-based capital ratio of 11.95%. The Board declared a quarterly cash dividend of $0.23 per share payable to shareholders on June 15 to shareholders of record June 1. At this time, I'd like to ask Barry to provide some color on loan growth and credit quality.

Barry Harvey, Chief Credit and Operations Officer

I’ll be glad to, Duane. Thank you. Turning to Slide 4. Loans held for investment totaled $12.5 billion as of March 31, an increase, as Duane mentioned, of $293 million linked quarter. We're pleased with our Q1 diversified loan growth. We do expect continued solid loan growth throughout the remainder of 2023. Our loan portfolio continues to be well diversified based upon both product type as well as geography. Looking at Slide 5; Trustmark's CRE portfolio is 93% vertical with 62% being existing and 38% being construction land development. Our construction land development portfolio was 81% construction. Trustmark's office portfolio, as you can see, is very modest at $297 million outstanding, which represents 2% of the overall loan book. This quarter, the bank performed a review of all non-owner occupied office credits over $1 million, resulting in no additional risk rate or accrual status changes. 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 strong. Turning to Slide 6; the bank's commercial loan portfolio is well diversified, as you can see across numerous industry segments with no single category exceeding 13%. Moving now to Slide 7; our provision for credit losses for loans held for investment was $3.2 million in the first quarter, primarily attributable to loan growth, increases in the remaining life of our mortgage portfolio and a little bit of deterioration in our credit quality metrics and our qualitative metrics. The negative provision for credit losses for off-balance sheet credit exposure was $2.2 million for the first quarter, primarily driven by a decrease in unfunded commitments on March 31. The allowance for loan losses on loans held for investment was $122.2 million. Looking at Slide 8, we continue to post solid credit quality metrics. The allowance for credit losses represents 0.98% of loans held for investment and 321% of nonaccrual loans, excluding those that are individually analyzed. In the fourth quarter, net charge-offs totaled $1.2 million or 0.04% of average loans, both nonaccruals and nonperforming assets remain near historically low levels. Duane?

Duane Dewey, President and CEO

Okay. 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.

Tom Owens, Chief Financial Officer

Thank you, Duane, and good morning, everyone. Looking at deposits, we were pleased with our ability to drive growth during the quarter. Deposits totaled $14.8 billion at March 31, reflecting a $346 million increase from the previous quarter. This increase was primarily due to higher promotional time deposits, which outweighed decreases in other personal deposit products. Nonpersonal balances fell slightly by about $17 million, while public fund balances rose by $122 million. As of March 31, our promotional time deposit book stood at $920 million with an average rate paid of 4.27% and an average term of about 9 months. We also transacted $150 million of brokered CDs during the quarter with an average rate paid of 4.63% and an average term of about 3 months as of March 31. The deposit mix shifted during the quarter with a 7% decline in noninterest-bearing DDA, which aligns with the industry median. Our cost of interest-bearing deposits increased by 82 basis points to 1.53%. Trustmark has a stable and granular deposit base with low exposure. During the first quarter, we had about 457,000 personal and nonpersonal average accounts, excluding collateralized public fund accounts, with an average balance of around $26,000 per account. Average accounts rose by about 8,000, or 1.8% from the previous quarter, driven mainly by promotional campaigns. By March 31, 62% of our deposits were insured and 16% were collateralized, meaning only 22% were uninsured and uncollateralized. We maintain a significant secured borrowing capacity exceeding $5 billion at March 31, representing 156% coverage of uninsured deposits. Our total deposit cost for the first quarter stood at 1.13%, showing a linked quarter increase of 62 basis points, reflecting a beta relative to the Fed funds rate of 22%. For the remainder of the year, we expect deposit costs to continue rising, reaching approximately 1.91% in the fourth quarter, which would mark a cycle-to-date beta of 43%. This forecast is based on expected market interest rates, projecting a peak Fed funds target range of 5.25% in May before tapering to 5% in July, 4.75% in September, and 4.5% in December. Consequently, we anticipate ongoing upward pressure on deposit pricing in the third and fourth quarters despite potential moderate easing. Regarding revenue, net interest income decreased by $9 million from the previous quarter to $141.1 million, resulting in a net interest margin of 3.39%, a decrease of 27 basis points. Higher loan balances and yields contributed approximately $7 million and $12.4 million, respectively, while costs from deposits rose by $22.5 million and net borrowing expenses increased by $6.1 million. The factors affecting the linked quarter net interest margin included rising deposit betas in a competitive market, changes in deposit mix from noninterest-bearing to interest-bearing, and excess liquidity maintained due to the challenging macroeconomic environment. Our balance sheet is well-prepared for higher interest rates, supported by substantial asset sensitivity. During the first quarter, we continued our cash flow hedging program by adding a $25 million notional interest rate swap with a three-year maturity and a fixed rate of 3.67%, bringing our total notional to $850 million with an average maturity of 3.1 years and a fixed rate of 3.12%. We also added a $25 million notional sulfur floor at 4% with a 2.9-year maturity. This program has significantly reduced our adverse asset sensitivity to potential interest rate declines while preserving the potential benefits from higher rates. In the first quarter, noninterest income totaled $51.4 million, a linked quarter increase of $6.2 million but a year-over-year decrease of $2.7 million. The increase was primarily due to a rise in mortgage banking net revenue by $4.2 million and a seasonal increase in insurance commissions of $2.3 million. Noninterest income constituted 27.2% of total revenue, showcasing a diverse revenue stream. Mortgage banking revenue reached $7.6 million in the first quarter, up $4.2 million from the previous quarter due to a $1.8 million drop in amortization of the mortgage servicing asset, a $500,000 increase in gains on sales, and a $1.8 million reduction in negative hedge ineffectiveness. Year-over-year, mortgage banking decreased by $2.2 million, mainly due to lower gains on sales. Mortgage loan production was $361 million in the first quarter, down 7.6% from the previous quarter and 33.7% year-over-year. Retail production was strong, accounting for 80% of volume at around $287 million. Loans sold in the secondary market made up 72% of production, while loans on the balance sheet constituted 28%. Most loans entering the portfolio are primarily 15-year and hybrid ARMs, with a preference to sell rather than retain conforming 30-year loan originations. The gain on sale margin fell by approximately 39% from the previous quarter, declining from 196 basis points to 120 basis points. Now, I'll hand 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 noninterest expenses broken out between adjusted other in total. Adjusted noninterest expense was $127.5 million during the first quarter, a linked quarter decrease of $2.2 million or 1.7%, mainly driven by a decrease in services and fees resulting from lower professional fees during the quarter. As noted on Slide 16, Trustmark remains well positioned from a capital perspective. At March 31, our capital ratios remained solid with a common equity Tier 1 ratio of 9.76% and a total risk-based capital ratio of 11.95%. This market enough repurchased any of its common shares during the first quarter. Although we have a $50 million authority for the remainder of 2023 under our Board authorized share repurchase program, we are unlikely to engage in stock repurchase in a meaningful way. Our priority for capital deployment continues to be through organic lending. Back to you, Duane.

Duane Dewey, President and CEO

Okay. Thank you, Tom. Turning to Slide 17; let's review our outlook. Let's first look at the balance sheet. We're expecting loans held for investment to grow mid-to-high single digits for the year. Securities balances are expected to decline by high single digits as cash flow runoff of the portfolio is not reinvested. And this, of course, is subject to the impact of changes in market interest rates. Deposit balances are expected to grow mid-single digits, driven by promotional campaign activity. Moving on to the income statement. We are expecting net interest income to grow mid-single digits, driven by earning asset growth and reflecting flat full year net interest margin based on current market implied forward interest rates. The total provision for credit losses, including unfunded commitments, is dependent upon future loan growth and current macro forecast and is expected to be above 2022 levels. Net charge-offs that require additional reserving are expected to be nominal based on the current economic outlook. From a noninterest income perspective, we expect service charges and bank card fees to remain stable, reflecting the elimination of consumer NSF fees and the implementation of transactional de minimis levels on consumer checking accounts as we previously announced. Mortgage banking revenue is expected to stabilize at or above the prior year level. Insurance revenue is expected to increase high single digits full year with wealth management expected to increase mid-single digits. Noninterest expense is expected to increase mid-single digits for the year. This reflects the general inflationary pressures and is subject to the impact of commissions in mortgage insurance and wealth management. We remain intently focused on our Fit to Grow initiatives as discussed throughout 2022. As noted, we've expanded our team of talented production staff, added a significant new line of business, expanded in growth markets, all of which will begin to contribute in 2023. Additionally, we've invested in technology across the franchise to better serve customers and become more efficient. We will continue to optimize the retail franchise, streamlining offices and deploying new ATM and ITM technology. We believe this focus and investment position Trustmark for profitable growth into the future. Finally, we will continue a disciplined approach to capital deployment with a preference for organic loan growth and potentially M&A. We will continue to maintain a strong capital base to implement corporate priorities and initiatives. With that overview of our first quarter financial results and outlook commentary, we'd like to open the floor for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. The first question will be from Kevin Fitzsimmons, D.A. Davidson.

Kevin Fitzsimmons, Analyst

I was wondering if we can dig into the margin outlook a little more. So first of all, Tom, I just want to make sure I was trying to keep up with you, I want to make sure I got it right. So the cumulative beta at the end of the first quarter was 22%, and you expect it to be 43% by the end of the year. Was that right?

Tom Owens, Chief Financial Officer

That's right, Kevin.

Kevin Fitzsimmons, Analyst

And is that a total deposit beta or that's an interest-bearing deposit beta, right?

Tom Owens, Chief Financial Officer

That is a total deposit beta.

Kevin Fitzsimmons, Analyst

Total. Okay, got it. And you I guess, your cost of interest-bearing deposits was 1.53% for the quarter. And the $1.91 you cited, but in fourth quarter, what was that? That was total?

Barry Harvey, Chief Credit and Operations Officer

That's total deposits.

Kevin Fitzsimmons, Analyst

So coming from the $1.13 we got incorrect? Okay. I just wanted to make sure I was looking that way. Okay. That's good. And then can we talk about just having established all that, do you happen to have handy what your margin, what that cost of total deposits or interest-bearing deposits was for March or at the end of the quarter? And then just more generally, how you see the margin trajectory. I think a lot of banks are saying there's further pressure in the second quarter, but not at the pace we saw in the first quarter and then generally more stable in the back half of the year. I don't want to put words in your mouth, but just interested in that kind of commentary.

Duane Dewey, President and CEO

So first of all, yes, I will be able to put my hands on that here momentarily. I will say that we are in general agreement with what you just said. So one way to think about it, Kevin, is...

Tom Owens, Chief Financial Officer

If you look at our sequential increase in total deposit costs of 62 basis points, as shown in the chart on Slide 10, we're guiding to a 51 basis point increase in the second quarter, followed by a 22% increase in the third quarter, and a 5% increase in the fourth quarter. This suggests a slowing rate of compression in our net interest margin. It's also important to note that we lagged significantly in the fourth quarter with a 37 basis point increase in total deposit costs. When we add the 62 basis point increase from the first quarter to that, we have a total of 99 basis points, which averages to about 50 basis points per quarter, aligning with our guidance for the upcoming quarter. We expect this to drop by half in the third quarter. Our forecasts are based on market implied forward rates, which show the Fed potentially hiking rates one more time in early May and then making a couple of cuts in July and September. We anticipate deposit costs will still rise somewhat in that scenario. However, if market expectations suggested more significant easing, our outlook might differ. Furthermore, if the actual trajectory of interest rates and the Fed funds rate were to decline more sharply in the latter half of the year, that would create different dynamics as well. This is what makes the current environment quite challenging.

Kevin Fitzsimmons, Analyst

Okay, that's very helpful. Maybe just a question about how you're feeling about loan growth? I know, Barry, you mentioned that you expect it to be solid and I see what's in the commentary. But based on the last time you put this commentary out, which in the commentary doesn't seem to have changed too much, it seems like we're in a little different view of the economy. But I'm just wondering, within that scope of loan growth, what you might be expecting to be a bit slower and what maybe there's some tailwinds like loans that are funding up that we have to be taken into account.

Barry Harvey, Chief Credit and Operations Officer

And Kevin, this is Barry. That's exactly correct. We are noticing a slowdown in production opportunities. For commercial real estate, particularly in new construction and mini-farms, there is a significant decline in new opportunities. This also applies to refinancing existing deals in the commercial real estate sector. This trend was evident in the first quarter. In terms of commercial and industrial loans, we are also experiencing a slowdown in good opportunities. Like all banks, we are being very selective, even in public finance opportunities where bidding is occurring. There are fewer bidders, but we are being particularly cautious regarding not only the deals we pursue but also the pricing in public finance, as we aim to maintain pricing discipline due to the rising cost of funds. Given all this, we are observing a decrease in production. However, as mentioned earlier, on the commercial real estate side, we continue to fund existing deals that were previously approved. Additionally, we have a few well-performing projects utilizing an extension option that was established when the loans were initially underwritten, and they meet all the requirements to take advantage of this additional year. Consequently, some balances are staying with us longer than we initially expected, and we are pleased to see this because these are high-quality projects that are well-priced and floating rate. Everything about them is encouraging, and we are excited to see a few of these transactions today, especially after having previously experienced a quick turnover that did not allow us to fully benefit from the balances remaining on our books. These factors combined are what we envision will drive our growth going forward.

Kevin Fitzsimmons, Analyst

Okay, great. Very helpful.

Catherine Mealor, Analyst

Just one follow-up on the CRE comment you just made, Barry. On the projects that you're seeing take extension options, are you seeing examples yet where you're needing to add additional collateral or there's any weakening in the underwriting to where you can get more capital or you need to, I guess, enhance the deal at all to protect yourself? Or to your point, most of these are still performing well, they're just looking to extend that they can maybe get a better rate in the permanent financing market if rates are cut at some point in the future?

Barry Harvey, Chief Credit and Operations Officer

Yes, Catherine, we don't see a need to make any changes from the original underwriting or how the extension option was determined. I can say clearly that most projects at this stage, particularly in the apartment category, have experienced significant rate increases since they were completed. These increases have enabled them to perform much better than initially projected, even with the higher interest rates currently in effect compared to when we first underwrote them. In general terms, these projects are doing better than expected, allowing them to take advantage of the extension options without needing improvements in collateral or other adjustments. They are meeting all the requirements set during underwriting to qualify for the additional year. Furthermore, we are beginning to see attractive longer-term rates in the secondary market, prompting some developers to consider moving into the permanent market. This interest in extending may be driven by the desire to wait for a more favorable entry point into that market. The prime market remains accessible to them, and they are simply awaiting the right timing regarding interest rates.

Catherine Mealor, Analyst

Great. Okay. What is the process you follow to determine whether to grant the extension? What financial metrics do you consider to ensure that there is no need for additional collateral?

Barry Harvey, Chief Credit and Operations Officer

Sure. Typically, the determining factors are established during underwriting. As the project matures, those hurdles are set, and they're subject to floating rates, meaning they need to meet the current rate environment. Generally, there is a three-part approach to determining the interest rate. The current rate is likely the primary factor, but it is also linked to a 10-year rate plus a spread, among other methods of establishing potential interest rate hurdles that need to be met. There is also a debt service coverage requirement based on the project category, with some categories requiring higher hurdles than others. Usually, a debt service coverage of around $130 million to $140 is necessary for the hurdle to be met, although this could be higher depending on the category.

Catherine Mealor, Analyst

Okay, that's very helpful. Now, Tom, regarding the margin, are the expected total deposit costs higher because you're becoming a bit more cautious about the shift in deposit balances? How do you see noninterest-bearing deposits as a percentage of total deposits evolving over the next year?

Tom Owens, Chief Financial Officer

Catherine, good question. The answer to that is a little bit. So obviously, our mix change has continued. I think we ended the quarter at about 22% in terms of noninterest-bearing and our internal forecast, we are projecting continued pressure there. I think we have it going down a few more points between now and year-end. What's interesting is you look back historically over a very long period of time, it historically would never really dropped below 20%. So as I said, we've got to go in a few points lower from where we are now at 22%, and we're going to have to continue and monitor that. So yes, it is a factor. I mean, I would characterize our outlook with respect to deposit dynamics and deposit cost as very pretty unchanged from the guidance we gave on last quarter's call. Obviously, what we've done with this quarter's deck, we added a slide to try and provide greater transparency in terms of our expectations for the beta to Kevin Fitzsimmons' questions earlier. I understand the questions and maybe just wanting to make sure we're precise about interest-bearing deposit costs versus total deposit costs because in the past, I've always talked about interest-bearing deposit costs. And I know people think in terms of total deposit costs, including the potential mix change. And so we're giving you views of both of those things now. And long-winded answer, the short answer again is yes. We are modeling internal continued pressure. We're just going to have to continue to monitor that.

Catherine Mealor, Analyst

It was interesting to feel like you were ahead of everyone in understanding where these deposit betas were coming from. Have you seen anything that has worsened since the recent bank failures and the situation intensified? Or is everything playing out as you originally expected in your more conservative outlook at the start of the year?

Tom Owens, Chief Financial Officer

Well, clearly, what we have seen, and there's not much of it, right, but with Silicon Valley Bank, Signature Bank, and First Republic under pressure. I mean, clearly, you have seen some heightened interest on the part of some depositors, usually larger, let's call them maybe more sophisticated or more aware depositors, but we have seen really no unusual attrition or unusual deposit dynamics. I think we've fared very well here. And I think, again, it's this type of environment that demonstrates the quality of our deposit base.

Operator, Operator

Thank you. This concludes our question-and-answer session. Now, I'd like to turn the conference back over to Duane Dewey for any closing remarks.

Duane Dewey, President and CEO

Okay. Well, thank you again for joining us this morning. We appreciate your participation and look forward to being back with you at the end of the second quarter in July. We hope everybody has a great week, and we will talk to you then.

Operator, Operator

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