Earnings Call Transcript - TRMK Q3 2024

Operator, Operator

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

Joey Rein, Director of Corporate Strategy

Thank you. Good morning. I'd like to remind everyone that our third quarter earnings release and the slide presentation that will be discussed on our call this morning are available on the Investor Relations section of our website at trustmark.com. During our call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and we'd 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 as well as our other filings with the Securities and Exchange Commission. At this time, I'll turn the call over to 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 are Tom Owens, our Chief Financial Officer; Barry Harvey, our Chief Credit and Operations Officer; and Tom Chambers, our Chief Accounting Officer. The third quarter was a very active and productive quarter for Trustmark. Our third quarter results reflect significant progress across the organization. Net income totaled $51.3 million, representing diluted earnings per share of $0.84. Profitability meaningfully increased as evidenced by 26.7% growth in net income from adjusted continuing operations and a 282 basis point improvement in the efficiency ratio. The restructuring of the investment securities portfolio was a major contributor to the 9.5% increase in net interest income in the third quarter. These accomplishments are the result of focused efforts to enhance Trustmark's long-term performance. Now let's turn to Slide 3 for a recap of the strong fundamental accomplishments during the quarter. Loans held for investment were relatively flat, decreasing $55 million linked quarter and increasing $290 million year-over-year. Deposits declined $222 million linked quarter, excluding targeted reductions in public and brokered deposits of approximately $530 million. Deposits increased over $300 million linked-quarter. A significant contributor to our performance in the quarter was the growth in net interest income, which increased $13.7 million or 9.5% linked-quarter to $158 million. The net interest margin expanded 31 basis points during the quarter to 3.69%. Tom Owens will provide some additional color in his remarks here in a minute. Non-interest income from adjusted continuing operations in the third quarter totaled $37.6 million, a decrease of $0.7 million linked-quarter and an increase of $0.6 million year-over-year. From an expense perspective, non-interest expense increased $4.9 million during the quarter. There are three primary drivers of this increase. First, our annual salary merit increases were effective July 1; second, annual incentive accruals and commissions increased due to strong operating performance and third, we had an increase in ORE expense related to the establishment of a reserve for a single property that is under contract to sell and scheduled to close in the fourth quarter. Year-over-year expenses from adjusted continuing operations actually declined $500,000. Diligent expense management continues to be a focus of the organization here moving forward. Trustmark's capital ratios expanded meaningfully during the quarter, as tangible equity to tangible assets increased 55 basis points to 9.07% while the CET1 ratio expanded 38 basis points to 11.3% and the total risk-based capital ratio expanded 42 basis points to 13.71%. Tangible book value per share was $26.88 at September 30, 2024, an increase of 6.5% from the prior quarter and 32.9% from the prior year. The Board declared a $0.23 dividend payable on December 15 to shareholders of record on December 1. From a credit quality perspective, net charge-offs totaled $4.7 million during the quarter, representing 0.14% of average loans. The allowance for credit losses represented 1.21% of loans held for investment and nearly 500% of non-accrual loans, excluding individually analyzed loans. At this time, Barry Harvey will provide an overview of our loan portfolio 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 $13.1 billion as of September 30, which, as Duane indicated, is relatively flat for the third quarter. Increases in the third quarter came from existing multifamily loans, our Equipment Finance line of business and 1-4 family mortgages. They were offset by declines in C&I, state and political loans and other CRE. We continue to expect loan growth of low single digits for 2024. As you can see, our loan portfolio remains well diversified by both product type as well as geography. Looking on to Slide 5. Trustmark's CRE portfolio is 95% vertical with 70% in the existing category and 30% in construction land development. Our construction land development portfolio is 82% construction. Trustmark's office portfolio, as you can see, is very modest at $262 million outstanding, which represents only 2% of the overall loan book. The portfolio is comprised of credits with high-quality tenants, as well as low lease turnover, strong occupancy levels and low leverage. Turning to Slide 6. The bank's commercial loan portfolio is well-diversified, as you can see, across numerous industries with no single category exceeding 14%. Looking to Slide 7. Our provision for credit losses for loans held for investment was $7.9 million during the third quarter, which was driven by specific reserves for individually analyzed credits and net adjustments to our qualitative factors. The provision for credit losses for off-balance sheet credit exposure was a negative $1.4 million which resulted primarily from a decline in unfunded commitments. At September 30, the allowance for credit losses for loans held for investment was $158 million. Turning to Slide 8. We continue to post solid credit quality metrics. The allowance for credit losses increased to 1.21% of loans held for investment, representing 497% of non-accruals, excluding those loans that are individually analyzed. In the third quarter, net charge-offs totaled $4.7 million, as Duane mentioned earlier, both non-accruals and non-performing assets increased during the quarter, primarily as a result of two commercial credits. However, they materially declined year-over-year due to continued efforts to effectively manage and resolve problem assets in a timely manner. Duane?

Duane Dewey, President and CEO

Great. Thank you, Barry. Now Tom Owens will cover deposits, net interest margin and non-interest income.

Tom Owens, Chief Financial Officer

Thanks, Duane, and good morning, everyone. Turning to deposits on Slide 9. We had another good quarter, which continued to show the strength of our deposit base. Deposits totaled $15.2 billion at September 30. There was a linked-quarter decrease of $222 million or 1.4% and a year-over-year increase of $139 million or 0.9%. However, as Duane indicated, a significant driver of that decline was targeted intentional runoff of deposits. Specifically, the linked-quarter decrease was driven by a $200 million decline in brokered CDs, which we allowed to run off at maturity rather than replace. And we had $330 million in public fund balances, which are really targeted declines related to large accounts that tend to be somewhat volatile quarter-to-quarter. Looking beyond that, we had a solid quarter of deposit growth with growth of $155 million in personal balances and about $152 million in commercial balances, representing linked-quarter growth of about 1.9% and 3.5% respectively. Non-interest-bearing DDA balances remained resilient, declining by $11 million linked-quarter and remaining above 20% of our deposit base. Time deposits increased by $124 million linked-quarter, excluding the decline of $200 million in brokered CDs. As of September 30, our promotional and exception price time deposit book totaled $1.4 billion with a weighted average rate paid of 4.97% and a weighted average remaining term of about five months. Our brokered time deposit book totaled $400 million at a weighted average all-in rate paid of 5.41% and a weighted average remaining term of about two months as of September 30. And our cost of interest-bearing deposits increased by 6 basis points from the prior quarter to 2.81%. Turning to Slide 10. Trustmark continues to maintain a stable, granular and low exposure deposit base. During the third quarter, we had an average of about 460,000 personal and non-personal deposit accounts, excluding collateralized public fund accounts, with an average balance per account of about $28,000. As of September 30, 65% of our deposits were insured and 12% were collateralized, meaning that our mix of deposits that are uninsured and uncollateralized was relatively unchanged linked quarter at 23%. We maintained substantial secured borrowing capacity, which stood at $6.2 billion at September 30, representing 176% coverage of uninsured and uncollateralized deposits. Our third quarter total deposit cost increased 4 basis points linked quarter to 2.22%. The favorable variance to prior guidance reflects proactive strategic pricing actions that we took during the quarter in anticipation of the Fed September rate cut. Based on those cuts, as well as the cuts that we're currently contemplating in anticipation of a possible cut by the Fed on November 7, we're currently projecting a linked quarter decline in deposit costs for the fourth quarter of about 13 basis points to 2.09%. And as a frame of reference for that guidance, we are on track for deposit costs of approximately 2.11% month-to-date here in October. Turning our attention to revenue on Slide 11. Net interest income FTE increased $13.7 million linked-quarter, totaling $158 million, which resulted in a net interest margin of 3.69%. Our net interest margin increased by 31 basis points linked-quarter. As Duane said, driven by securities portfolio restructuring as well as ongoing accretion from loan rate and volume. The deposit pricing actions taken in the third quarter as well as the actions that we'll likely be taking in the fourth quarter to offset the anticipated Fed rate cut on November 7 should enable us to achieve a minimum of 3.65% to 3.70% for the second half of '24. Turning to Slide 12. Our interest rate risk profile remained essentially unchanged as of September 30 with loan portfolio mix of 52% variable rate coupon. The cash flow hedge portfolio, which is structured to mitigate asset sensitivity had an active notional of $875 million and a weighted average maturity of 3.5 years, including the effect of $390 million in forward settled swaps and $125 million in forward settled floors. The weighted average received fixed rate on the $850 million active notional swaps is 3.12% and the weighted average SOFR rate on the $25 million of active notional floors is 4%. Turning to Slide 13. Non-interest income from adjusted continuing operations totaled $37.6 million in the third quarter, a linked-quarter decrease of approximately $700,000 and a year-over-year increase of about $600,000. The linked quarter decrease was driven primarily by seasonal and one-time items that have increased during the second quarter rather than fundamental recurring drivers that decreased third quarter revenue. Mortgage banking net hedge ineffectiveness normalized somewhat linked-quarter to negative $2.5 million, but remained unfavorable year-over-year by $1.5 million. Excluding net hedge ineffectiveness, non-interest income increased by $2.1 million or 5.6% year-over-year, which is consistent with our full year guidance. And now I'll ask Tom Chambers to cover non-interest expense and capital management.

Tom Chambers, Chief Accounting Officer

Thanks, Tom. Turning to Slide 14, we'll see a detail of our total non-interest expense. During the third quarter, non-interest expense totaled $123.3 million for a linked-quarter increase of $4.9 million or 4.2%. The increase was mainly driven by an increase in salary and benefits of $1.9 million, resulting from an increase in annual performance incentive accruals of $1.2 million and salary expense of $523,000 due to annual merit increases beginning July 1. If you'll look, services and fees increased $981,000 mainly as a result of increased third-party professional fees during the quarter. Other real estate expense net increased $2.1 million, driven by establishing a reserve related to one property during the quarter. When you remove other real estate net for each period and the litigation settlement expense incurred during the third quarter of 2023, there was a decline in adjusted non-interest expense when comparing the third quarter year-over-year of approximately 2.4%. Turning to Slide 15. Trustmark remains well positioned from a capital perspective. As Duane previously mentioned, our capital ratios remain solid. At the end of the quarter, common equity Tier 1 ratio was 11.30%, a linked-quarter increase of 38 basis points. Total risk-based capital was 13.71%, a linked-quarter increase of 42 basis points. Although we currently have a $50 million share repurchase program in place, our priority for capital deployment continues to be focused on organic lending. As Duane indicated, we will continue to evaluate the share repurchase program as the market and capital levels dictate. Back to you, Duane.

Duane Dewey, President and CEO

Great. Thank you, Tom. Now turning to Slide 16. We expect loans held for investment to be up low single digits for the full year 2024 and deposits, excluding the brokered deposits to remain relatively stable for the full year 2024. Securities balances are expected to remain stable as we reinvest cash flows. We anticipate net interest income to increase in the mid-single digits in 2024, reflecting continuing earning asset growth, stabilizing deposit costs and accretion from balance sheet repositioning, resulting in full year 2024 net interest margin of approximately 3.50% based on market implied forward interest rates. We expect the net interest margin to be in the range of 3.65% to 3.70% in the second half of 2024. From a credit perspective, the provision for credit losses, including unfunded commitments is dependent upon credit quality trends, current macroeconomic forecast, and future loan growth. Net charge-offs from continuing operations are expected to remain below the industry average based on the current economic outlook. Non-interest income from adjusted continuing operations for full year 2024 is expected to increase low to mid-single digits while non-interest expense from adjusted continuing operations full year '24 is expected to be approximately unchanged reflecting the heightened cost containment initiatives. We will continue our disciplined approach to capital deployment with a preference for organic loan growth, potential market expansion, M&A or other general corporate purposes depending on market conditions. We will also continue to assess the Board of Directors approved 2024 share repurchase program as the market and balance sheet dictate. That concludes our prepared comments this morning and we now open the floor to questions.

Operator, Operator

We will now begin the question-and-answer session. And the first question will come from Will Jones with KBW. Please go ahead.

Will Jones, Analyst

Hi, thanks. Good morning everyone. I wanted to start with the margin. I mean the trends were obviously really impressive in the quarter as we saw the first kind of full quarter impact with the securities restructuring, the margin perhaps came even a little bit better than expected. Tom, you alluded multiple times to some of the deposit pricing actions that you guys were able to take. Could you just walk us through a little bit of what you were able to do there towards the end of the quarter and whether or not you saw any pushback from clients or just any general commentary about what you're able to achieve on the deposit front?

Tom Owens, Chief Financial Officer

Thank you for your question, Will. The reductions we made to deposits in the third quarter were intended to significantly lessen the impact from the 50 basis point decrease on our floating rate loan coupons. We are very pleased with our monitoring and reporting processes, reviewing account activity and deposit flows on a daily basis, and we are currently feeling positive about the situation. We believe we can effectively maintain our deposit base. The challenge, however, is that we may face another 25 basis point cut soon on November 7, with the possibility of an additional one in December. As we enter a period of consecutive Fed cuts, we are always balancing our objectives. Our goal is to preserve our net interest margin and address the negative effects on our floating rate loan portfolio while continuously monitoring deposit activity. At this point, we feel optimistic, and our guidance reflects our current expectations. There is potential for better performance, as we have exceeded our guidance in the last couple of quarters. Tactically, it may become more challenging, but our intent remains to sustain our net interest margin moving forward.

Will Jones, Analyst

Yes, that sounds great. I appreciate the thorough answer. It seems like we have a solid understanding of what deposits and deposit costs might do next quarter, but can you provide any estimates on the impact you anticipate on loan yields, considering your increased exposure to variable rates and some hedging as well?

Tom Owens, Chief Financial Officer

So again, about half of the portfolio is floating rate. Will, it gets a little trickier with the Fed cutting rates. Half of the loan portfolio is floating rate, and half is fixed in very round numbers. Each has its own repricing characteristics. Absent Fed rate cuts, as mentioned in prior calls, we still see an effect that could be considered as a couple of basis points each month or 5 to 6 basis points per quarter in lift to loan yield without the Fed's influence. It's also interesting to note that post-Fed rate cut, we've seen some steepening of the yield curve. Looking at a 3-year swap rate or a 5-year treasury, which is where most of our fixed-rate pricing is based, it's notable that these rates are increasing, even with expectations that the Fed may cut in November. This is beneficial as it adds some lift in the background.

Will Jones, Analyst

Okay. That's great. Really appreciate that. And just as a point of clarification on the fee and expense guidance. Do you guys happen to have just handy the adjusted continuing ops, fees and expenses from 2023, just so we are all kind of comparing off the same base?

Tom Owens, Chief Financial Officer

We do Will, and I'm going to ask Tom Chambers to address that.

Tom Chambers, Chief Accounting Officer

So, Will, this is Tom Chambers. To understand this, you should refer to our 2023 10-K filing. If you examine the non-interest income from the income statement and subtract the revenue from the insurance segment in the segment revenue footnote, that’s the base we are considering for non-interest income. For the non-interest expense base, you should do the same but also exclude significant non-recurring items from last year, specifically the litigation settlement expense of $6.5 million and the reduction in force expense of $1.4 million we incurred in the fourth quarter last year. By performing this exercise, you'll get the base we're targeting. The non-interest income will be approximately $148 million, and the adjusted non-interest expense will be about $488 million.

Duane Dewey, President and CEO

You might note also, Will in the deck, we put in the addendum where we had at the front of the deck last quarter, we have in the back of the deck the adjusted continuing operations calculations and that may help some as well to get the baseline numbers.

Will Jones, Analyst

Yes, yes. All right. That makes a lot of sense. That's very helpful. If you kind of look at the expense guide and you just kind of see what implied that would be for the fourth quarter of this year, it feels like we may see a little bit of an uptick in expenses in the fourth quarter. Are there any puts or takes that we should be considering as we kind of think about the run rate into the next quarter and what that potentially implicates for 2025?

Tom Chambers, Chief Accounting Officer

This is Tom. I believe your reasoning is correct. We are anticipating a slight increase in the fourth quarter. If you consider the numbers for 2025, we will continue to focus on our expense reduction initiatives and tackle that challenge as vigorously as we did in 2024. However, at this time, I don't think we are prepared to provide guidance for 2025.

Tom Owens, Chief Financial Officer

No, but we will reiterate that we feel really good on a year-over-year basis, excluding the sort of unusual-ish items we are down what, 2.5% year-over-year in non-interest expense from adjusted continuing operations. Third quarter of this quarter of 2023. So we feel good about that accomplishment, particularly in the inflationary environment in which we've been operating.

Will Jones, Analyst

Yes. I mean, no doubt that the profitability for this quarter. So that's it for me. Everybody thank you.

Duane Dewey, President and CEO

Thank you Will.

Operator, Operator

Your next question will come from Tim Mitchell with Raymond James. Please go ahead.

Tim Mitchell, Analyst

Good morning everyone. This is Tim in for Michael. I just want to start out on loans. We've heard a lot of your peers talk about maybe some elevated payoff activity in the third quarter. You saw some declines in C&I. I was just hoping if you could discuss kind of what you saw that drove the modest decline kind of flat balances in the third quarter. And then based on the guide, it would seem you maybe expect some modest growth here in the fourth quarter?

Barry Harvey, Chief Credit and Operations Officer

Yes, this is Barry. I want to confirm that our guidance for the year remains unchanged, with expectations of low single-digit growth. In the third quarter, we experienced a slight reduction in loans amounting to $55 million, primarily due to paydowns on corporate and commercial lines toward the end of the quarter. However, our average loan balances for the quarter actually increased because those payoffs occurred late. We believe these paydowns are simply part of the usual fluctuations in line utilization, which historically averages around 37%. This quarter, our utilization dipped from 37% to 35%, but we anticipate that these lines will increase again soon. Our corporate, commercial, and CRE pipelines are very strong, and our production activity is performing well. Like other banks with real estate exposure, we have some payoffs we need to manage due to runoff, but we are very satisfied with the current state of our pipelines.

Tim Mitchell, Analyst

Great. Appreciate the color. And then maybe more strategically, you talked about market expansion a little bit. We've seen some M&A activity pick up in the past few months. Just hoping you could discuss maybe your approach to building out new markets, whether it be via M&A or maybe some team lift-outs and maybe any markets that are particularly attractive to you right now?

Tom Chambers, Chief Accounting Officer

We find all the mentioned opportunities very appealing. We are actively developing a pipeline for mergers and acquisitions as we move forward. We are confident about the company's overall performance and our capital situation, which aligns well for potential opportunities. There is a noticeable increase in our pipeline and discussions, with more interested parties in the marketplace, indicating a strong possibility ahead. On the organic growth side, we are focused on expanding our business lines and entering markets where we already have a presence. This includes locations like Houston, Birmingham, Atlanta, and parts of South Alabama, where we have knowledge, visibility, and viable teams to work with. Additionally, we have had success in Equipment Finance, with almost two years of experience now. We understand the underwriting standards well and see significant expansion potential within our production teams in that area. Lastly, the mortgage market is revitalizing. We had strategically decreased our mortgage production previously, but opportunities are emerging again, which could allow us to add production teams throughout our franchise. We see considerable organic growth potential but are also keenly interested in M&A, making it a defined focus for us.

Tim Mitchell, Analyst

Great. I appreciate the color. Thanks for taking my questions.

Operator, Operator

Our next question will come from Gary Tenner with D.A. Davidson. Please go ahead.

Gary Tenner, Analyst

Thanks good morning. I wanted to ask about the loan yields here in the third quarter relative to the commentary about the fourth quarter NIM outlook. It looks like loan yields were up 1 basis point. I'm wondering if there was any impact either way regarding loan fees or anything just as I'm trying to think of the kind of upward repricing portion of the loan portfolio from a fixed or hybrid perspective?

Tom Owens, Chief Financial Officer

So Gary, this is Tom Owens. No, I don't think there was really anything particularly unusual about loan fees in the third quarter relative to where we've been running on average, I'd say very probably for the last six or eight quarters, right? I mean been pretty much steady state.

Duane Dewey, President and CEO

Go ahead.

Gary Tenner, Analyst

Just as it relates to the increase in NPAs, can you just kind of give any color around the kind of credits, the type of credit location, et cetera?

Barry Harvey, Chief Credit and Operations Officer

You said the first part about it again NPAs, as far as what was the question.

Gary Tenner, Analyst

Give any color on the NPAs in the third quarter and fourth quarter increase.

Barry Harvey, Chief Credit and Operations Officer

I wasn't sure if you were referencing the year-over-year changes for the third quarter. Yes, we had two credits I mentioned earlier, both from corporate customers. One of these credits had been non-accrual for several years but had turned its situation around. It began to struggle again, leading us to move it back to non-accrual status. We made a reserve as part of our individual analysis process, adjusting it based on our current appraisal, and took a closer look at the appraisal to apply what we believed were reasonable reductions to ensure we've set aside an appropriate reserve. The other credit was from a different industry, but it too had faced challenges for a quarter or two, prompting us to make certain concessions. We determined that it was not only substandard but also non-accrual, so we moved it back to non-accrual status. While this second credit is smaller, we anticipate it will result in liquidation. They have started marketing the assets, and we have a solid understanding of their value, allowing us to establish a reserve on that credit based on the letters of intent we've received. We feel confident that we have accounted for it properly.

Gary Tenner, Analyst

Thanks for the color.

Operator, Operator

The next question will come from Christopher Marinac with Janney. Please go ahead.

Christopher Marinac, Analyst

Thanks good morning. I just want to continue on Gary's questions. And if you looked at the interest rate move in September, does that help at all on upgrading credits in future quarters? Or is it too early to kind of use that as a catalyst?

Barry Harvey, Chief Credit and Operations Officer

This is Barry. I think it's a bit too soon to tell. A 50 basis point decrease certainly improves the outlook. After a 550 basis point increase, many banks would prefer to see an increase of 100 or even 125 basis points. This would benefit many commercial real estate projects that have been struggling under the current funding costs, even if they are still in the early stages of construction or just starting to stabilize. Looking at the pro forma, a decrease of 100 or 125 basis points would likely make a lot of previously marginal projects viable. The 50 basis point drop is a significant first step, and we are hopeful for the additional decreases mentioned for the remainder of this year. Next year remains uncertain, but some positive adjustments would be helpful. The encouraging side is that from both a risk rating and reserving perspective, this situation is advantageous. However, as interest rates decrease, there may be some credit migration away from us as potentially better sale prices or financing options become available in the permanent market. We are noticing some of this already and expect improved pricing to continue in that market. The potential downside is that parts of our portfolio that are stabilized may start to move on before maturity.

Christopher Marinac, Analyst

Got it. Thank you for sharing all of that. And then is there anything from your normal tax return work and client interaction on the commercial book sort of thinking C&I that would lead to more inflows there?

Barry Harvey, Chief Credit and Operations Officer

There's not.

Christopher Marinac, Analyst

Great. Thanks again for taking the questions.

Barry Harvey, Chief Credit and Operations Officer

Thank you.

Operator, Operator

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

Duane Dewey, President and CEO

Well, thank you again for joining us for this quarter's report. We're very excited where the company is positioned and look forward to a great fourth quarter and look forward to getting back on our call at the January time line. And you all have a great rest of the week.

Operator, Operator

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