Good day, ladies and gentlemen, and welcome to the Hancock Whitney Corporation's third quarter 2019 earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require operator assistance, please press star then the 0 key on your touch-tone telephone. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Trisha Carlson, Investor Relations Manager. You may begin.
Thank you, and good morning. During today's call, we may make forward-looking statements. We would like to remind everyone to review the safe harbor language that was published with yesterday's release and presentation and in the company's most recent 10-K, including the risks and uncertainties identified therein. Hancock Whitney's ability to accurately project results or predict the effects of future plans or strategies, or predict market or economic developments is inherently limited. We believe that the expectations reflected or implied by any forward-looking statements are based on reasonable assumptions, but our actual results and performance could differ materially from those set forth in our forward-looking statements. Hancock Whitney undertakes no obligation to update or revise any forward-looking statements, and you are cautioned not to place undue reliance on such forward-looking statements. In addition, some of the remarks this morning contain non-GAAP financial measures.
You can find reconciliations to the most comparable GAAP measures in our earnings release and financial tables. The presentation slides included in our 8-K are also posted with the conference call webcast link on the investor relations website. We will reference some of these slides in today's call. Participating in today's call are John Hairston, President and CEO, Mike Achary, CFO, and Chris Ziluca, Chief Credit Officer. I will now turn the call over to John Hairston.
Thanks, Trisha, and good morning, everyone. Our third quarter earnings were solid despite noise from the late quarter closing and simultaneous integration of MidSouth. We also noted positive operating leverage, reduced NPLs, specifically TDRs, outperformed in fee income, controlled expenses, all leading to a top-line driven beat to Street Consensus. EPS for the quarter was $0.77. This included almost $29 million or $0.26 per share of merger-related expenses. Operating leverage was better by almost $6 million with revenue up $7 million linked quarter and operating expense up only $1.2 million. Again, there were only 10 days of MidSouth included in our results, so no significant operating earnings impact in third quarter. While our NIM narrowed four basis points in the quarter, a recovery from a support services energy credit and a proactive stance on reducing deposit costs helped offset a Fed cut in rates.
Credit results were a bit mixed, with higher charge-offs related to a one-off RBL bankruptcy, and criticized loans were up due to the addition of MidSouth and the recent SNC exam. MidSouth added $82 million of energy loans, mostly support services to our portfolio. This added to our overall energy exposure, our organic reductions in energy exposure resulted with total energy remaining below 5% of total loans. We expect to see continued reductions in our energy exposure through the next several quarters. As previously announced, our acquisition of MidSouth Bancorp closed September 20th, effective September 21st. During that same weekend, we also converted MidSouth clients to our technology systems, closed and/or consolidated 20 branches, and welcomed MSL employees as new Hancock Whitney associates.
I want to take this opportunity to congratulate the teams on both sides of the transaction for an on-time, under-budget integration with exceptional quality and attention to client experience. Our capital remains strong with TCE up seven basis points from June 30th, ending the quarter at 8.82%. TCE declined 15 basis points from the MidSouth acquisition due to a higher level of goodwill booked with the transaction. Net retained earnings were strong enough to help offset that and still build capital. We believe this acquisition is a good example of our overall M&A strategy, infill markets with a high level of cost saves and immediately accretive to EPS. It also gives us opportunities for growth in new markets in North Louisiana and the Dallas metropolitan area.
With a solid stream of earnings and strong capital late in the quarter, our board authorized an increased buyback authorization of 5.5 million shares. This authorization is good through 2020, and we expect to apply it to repurchase stock when the timing is appropriate. As a reminder, we issued just over 5 million shares to former MidSouth shareholders, and we welcome those new shareholders to Hancock Whitney. With regards to CSOs, we do acknowledge the operating environment, especially the interest rate environment, has significantly changed since January. Our goals do not include today's rate environment, which is negative, but they also did not include any M&A or stock repurchase activity. MidSouth is a positive to operating leverage and will partially offset the impact of lower rates. During the fourth quarter, we will finalize our updated business plan and will reset any of these metrics as appropriate during the process.
As we do every January, we will announce new CSOs and discuss positive and negative variances during our January call. With that, I will turn the call over to Mike for a few additional comments and details.
Thanks, John. Good morning, everyone. Earnings for the third quarter, excluding the merger-related expenses associated with the MidSouth acquisition, were $1.03, up $0.02 from last quarter. I'll start off by first running through an update around what we acquired with MSL. The acquired loan book totaled $785 million, net of a $41 million or 5% loan mark.
As a result of an extensive cleanup process by MSL, only $48 million of the acquired portfolio came over as criticized. What we acquired fits nicely with our strategy of a more granular and better-yielding loan book. To that end, the yield on the acquired portfolio was a healthy 5.57%. Slide eight in our earnings deck shows the impact on our loan portfolio of the acquired book, as well as this quarter's organic loan production. MSL's deposit portfolio fits nicely as well. The $1.3 billion of low-cost core deposits were acquired with a 38 basis points cost, which, of course, is beneficial to our overall NIM. We put that money to work right away and paid down some higher-cost borrowings late in the quarter. Changing topics and moving to our operational results. A bright spot, we think, for the quarter, was our NIM management.
Our reported NIM did compress four basis points from last quarter, about what we had guided, but with lots of moving pieces and parts. Slide 14 details the major items driving the change. As we've reported for several quarters now, but once again, interest recoveries were part of our results. In the third quarter, interest recoveries drove a five basis point positive change in the NIM. As a reminder, last quarter, we reported three basis points of recoveries. As we increased the bond purchases this quarter in anticipation of the MSL acquisition, our mix of earning assets suffered a bit as we increased the size of the bond portfolio. That dynamic impacted the NIM by about four basis points. The size of the bond portfolio will come down to our targeted level of about $6.2 billion early in the fourth quarter.
The lower rate environment drove our NIM to the higher end of our two to four basis point guidance, with rate cuts in July and September impacting the quarter's NIM. Also, lower mortgage rates led to a higher level of premium amortization, up almost a million, and compressing the NIM by one basis point. Finally, a favorable change in our mix of borrowings helped the balance sheet as we paid down some higher-cost funding, leading to a three basis point impact to the margin. Looking forward, we will continue to be proactive with our efforts to, as much as possible, offset the impact of future rate cuts by reducing deposit costs. As you can see from the chart on the bottom left of slide 14, we were proactive in lowering deposit costs during the quarter and will continue to do so.
Our guidance for the fourth quarter NIM is for additional narrowing of two to four basis points. Fee income was a bright spot for the quarter. Specialty fee income continued its positive trend within non-interest income, with quarter-over-quarter increases in syndication fees and derivative income. With only 10 days of MSL in the quarter, the impact from that transaction was minimal. As a result of the continued strong performance of most business lines, we increased our overall guidance for year-over-year growth in non-interest income to around 10%. Operating expense was another bright spot for the quarter, with a reported increase of only $1.2 million. The main driver of this increase was the higher level of annual valuation adjustments on foreclosed assets, partly offset by gains on sales of properties.
As we factor in MSL for the full fourth quarter, we increased our year-over-year guidance for expense growth slightly to 7%-8%. We expect to harvest the remaining cost saves by year-end and will have MSL fully integrated by January 1st of 2020. As we noted in our guidance, when fully reflected next quarter, we would expect that the MSL-related merger costs to come in about $4 million-$6 million lower than initially projected. One final item before I turn the call back to John for Q&A. Slide 13 details our current expectations around the impact of CECL. Please note that the guidance of a 20%-30% increase in the allowance for credit losses does not yet include MSL. I will now turn the call back over to John.
Thanks, Mike. Catherine, let's just go straight to questions.
Thank you. As a reminder, to ask a question, you'll need to press star one on your telephone. To withdraw your question, press the pound key. Again, to ask a question, press star one. Please stand by while we compile the Q&A roster. Our first question comes from Michael Rose with Raymond James. Your line is open.
Hey. Good morning, everyone. How are you?
Morning, Michael.
Hey, maybe we could just start on the margin, Mike. Appreciate the 2 to 4 basis points guidance. What does that assume in terms of potential rate cuts? Looks like there's a pretty high probability we get one in October, as well as thoughts around the ability to further reduce deposit costs, and if you can remind us how much of the book roughly is exception priced? Thanks.
Sure. I'd be glad to, Michael. As we think about the fourth quarter, we certainly have a couple of headwinds to kind of overcome. We kind of called out in the numbers that we had had five basis points of interest recoveries this past quarter. Certainly, we can continue to have some level of interest recoveries, but certainly aren't expecting that level or magnitude. The other items, of course, would be the full quarter impact of the September rate cut. We are assuming a late October rate cut as well. Those two cuts, the full impact of September, partial impact of October, is kind of built into our guidance. On the positive side, of course, we'll have a full quarter's impact of MSL.
We're kind of calling out the impact of MSL on our NIM at around four basis points as opposed to the three we had kind of talked about at announcement. Finally, in the fourth quarter, we usually have a pretty nice inflow of DDA deposits. Plus, we did pay down some of our borrowings, specifically brokered CDs in the third quarter. That will kind of round out the guidance to the narrowing of two to four. You also asked about deposit costs. We have been proactive in reducing our deposit costs this past quarter. I think there's a slide and a chart in the materials that really kind of call that out. As we mentioned in the prepared comments, we'll continue to be proactive in reducing our deposit costs. That's something that we did last quarter and we'll continue to do so going forward.
Mike, that's great color. Maybe just as a follow-up, because we've heard on a couple calls this morning, can you just describe just overall the outlook for the energy portfolio? I know there was a charge off this quarter. You guys appear to have pretty healthy reserves, but can you just give us a high-level outlook for energy migration from here? Thanks.
We do. We actually built those reserves a little bit this quarter, but I'll turn it over to Chris to look at and give some color around the energy book.
Yeah. During the quarter, obviously, we had the one-off charge in the RBL, and we did have a little additional migration in the criticized loan levels. We don't really see substantial increased migration in that portfolio. Matter of fact, there is some opportunity for some upside, but as the cycle kind of continues to wind forward, we continue to watch for some credits in the portfolio and where they might head. I don't really see anything dramatic in the near future related to our energy portion of our portfolio.
The issues that you're seeing, are they largely unrecovered credits from years ago on the services side, or are these really new issues kind of popping up at this point, or is it just kind of legacy issues that are just resolving themselves now?
Yeah. Most of them are more legacy-related credits. None of the newer credits that we've booked in the past year or two are really presenting issues for us. We're just continuing to kind of work through some unique issues with those individual credits.
Michael, this is John. Just to give you a little more color that may be helpful. The migration that Chris mentioned earlier was actually in the RBL side, not the services side. We actually saw improvement in the services booked through the quarter and without the migration. I'm removing MSL from this particular comment. We would've actually had a fairly healthy reduction in criticized net of the RBL migration that was really more centered in the SNC exam. To be specific about the credits, these were not new credit issues. These were more organizations that had been grappling with issues for some time. With the lack of liquidity available, specifically areas they had depended on in the past, they went into bankruptcy and it ended up actually showing up in NPLs. Does that help?
Okay. It is. This SNC exam helped drove some of the increase. Okay. Thanks for taking my questions, guys. Appreciate it.
Yeah. As a reminder, and I think we put in the deck, 100% of the SNC exam downgrades were reflected in the numbers. There's no trailing items from the SNC exam we expect to bear in Q4.
Got it. Thanks again.
You bet.
Thank you. Our next question comes from Brad Milsaps with Sandler O'Neill. Your line is open.
Hey, good morning.
Hey, Brad.
Mike, maybe I wanted to start with expenses. Really good cost control this quarter. Obviously, fee income continues to do really well for you guys, which typically also means some higher expense quarters, but it didn't play out that way this quarter. Just kind of curious, kind of the puts and takes on the expense side and kind of how you guys are thinking about controlling those costs going forward, particularly with MSL coming into the fold.
Sure. Absolutely, Brad. Yeah, a good quarter in terms of our ability to control expenses. Expenses only up about $1.2 million. We kind of called out the biggest negative for the quarter, and that was the $1.7 million increase in ORE expense. I think the materials do a good job of kind of calling out and explaining what that difference was. I think the other things currently that we're doing is we're doing a good job of creating opportunities to reduce costs so that we can continue to invest in the company. Last quarter, we talked about some of the digital and other related investments that we're making. We're continuing to make those investments. They don't show up this quarter in the list of variances because, again, I think we were able to create some room for those investments and expenses.
Those items will continue going forward. Now, certainly in the fourth quarter, one item I'll call out is, we'll have some, what we call temporary expenses related to MSL as we kind of complete our process of harvesting the cost saves. Again, reaffirming the previous guidance that we've given around the 50%-55% cost saves and having that fully reflected and in place by year end so that we can walk into 2020 with an efficient operation related to that transaction.
Maybe bigger picture, do you think with the NIM compression that you expect you'll be able to continue to generate positive operating leverage as you move out over the next several quarters? Is the revenue environment as such that it'll make it more challenging?
Certainly, it's challenging with the rate environment, and we kind of talked about our NIM guidance for the fourth quarter. We have, again, a full quarter's impact of the September rate cut, and then we're assuming the Fed does move in October. As of right now, we have no additional rate cuts projected for the rest of the year. Certainly, if that happens in that manner, that will be helpful to our revenue. We also, as a reminder, typically have one of the better quarters for loan growth in the fourth quarter from a seasonal point of view. When we put all that together, certainly we're looking to continue to generate positive operating leverage into the fourth quarter and kind of beyond. The operating leverage that we generate in the third quarter was significant.
I don't know that we'll be at that same level in the fourth quarter, but certainly positive going forward.
Okay, great. One last follow-up. Does your NIM guidance, does that include impact from any additional accretion from MidSouth or any recoveries there? Would that be above and beyond kind of that two to four basis points of compression?
We have some level of accretion kind of built into the fourth quarter numbers. At this point, no specific recoveries though for the fourth quarter.
Great. All right. Thank you, guys.
Thank you. Our next question comes from Matt Olney with Stephens. Your line is open.
Hey, thanks. Good morning, guys.
Morning, Matt.
Wanted to start on the fees. Obviously, a good quarter on fee income. I think MidSouth will bring over a few million dollars of fee income in the fourth quarter. It just looked like the 10% full-year guidance on fee income growth could be a little conservative. Can you just walk us through some of the various lines and help us appreciate what we should be looking for in the fourth quarter? Are there any lines in there that you think could be sequentially lower in the fourth quarter?
Matt, this is John. I'll start, and then Mike can add some commentary if he'd like to. The fourth quarter, let's first talk about those things that have the potential to diminish, and it's purely seasonal. Once you get past the middle of November through about the end of January, typically, mortgage transactional business tails off a bit, as do, even in this environment, the swaps. It's not because any appetite change, it's just things get a little busy that particular time of the year. All other business lines would be expected to perform well. Certainly, with the rate drop in September, and if the one in October late does indeed happen, our team expresses some potential thought that mortgage and swap derivative income may actually outperform that normal seasonal reduction.
It's pretty hard to predict because we don't know what the rate cut may or may not be in October. Generally speaking, from a seasonal perspective, fourth quarter dips a little from Q4, tied primarily to mortgage, and refi specifically. If the rate cut stimulates production, that diminishment may not occur.
And-
The 10% is basically trying to split the gap there and come up with something we think is a reasonable expectation.
That's helpful. Then what about the impact from MidSouth? I know that portfolio's been shrinking, and you've been closing some branches. Could the fee income run rate there also slow compared to what we've seen over the last few quarters from MidSouth?
There's a couple of moving parts. It's a good question. It's worth noting the Hancock Whitney's fee income penetration of revenue is right at 27%, where MidSouth's, at least for the second quarter, which was the only closed quarter we've got to refer to, is 23%. There's a fair number of products that have not yet been offered, at least not from the core bank, to the MidSouth clientele. That's not going to all materialize immediately because there's always some distraction as the team members get comfortable and reach a cadence in offering that type of product line. There is a good fee income potential to come forward.
Note that MidSouth really didn't have a mortgage business to speak of, so there really is no downside Q4 to Q3 in that book for fee income related to mortgage because there wasn't any in the third quarter to cause it to diminish, if that makes sense. The derivatives and swaps were certainly not part of that book either. The reasons for a pullback in Q4 for Hancock Whitney would not apply to the MSL book.
Got it. Okay. That's helpful. Just as a follow-up, I appreciate the details that you gave us on slide eight that talks about the remix of the loan portfolio. It looks like the last few quarters have a pretty high correlation with the prime rate. I'm showing the new loan yields prime minus 25 basis points on average or somewhere close to that. Is that the right way to think about the new loan yields as we move forward the next few quarters in a lower interest rate environment, prime minus 25?
Boy, that's a tough one. I think it's fair to say we are still, even in Q4, excuse me, three, and even in late Q3, even with the rate reduction in September, we're still booking business at a positive gap to portfolio. Get two or three more rate decreases, that certainly becomes more challenging. We still believe that the new loan yields have an opportunity, together with the remix, to help with overall yield. Every two or three-month rate decreases certainly are a challenge to that.
Matt, this is Mike. I think I would add to that the fact that the correlation with prime rate for the kind of loans we're making around our remix focus, I think is pretty coincidental. I don't know that that's a real cause and effect.
Libor is a big bigger driver than prime for us.
Okay, that's helpful. Thank you, guys.
You bet. Thanks for the question.
Thank you. Our next question comes from Catherine Mealor with KBW. Your line is open.
Thanks. Good morning.
Hi, Catherine.
I wanted to ask a question on growth. It feels like we were expecting kind of a mid-single-digit growth rate, excluding MidSouth going into the back half of the year, and now we've got mid-single digit even with MidSouth. Can you just kind of talk about some of the growth dynamics in your portfolio, where you're seeing some of the slowdown, where you see maybe more opportunity going into the fourth quarter, and then if you can provide a growth rate that you would assume to be appropriate for us to think about for next year?
Catherine, I'll go ahead and start and then hand it over to John M. Hairston . Specifically for the fourth quarter, when we think about growth in terms of the guidance that we've given of mid-single digits average growth year-over-year, what we're looking at specifically is probably something between four and a half and five and a half percent. Right at about 5% or so. That should translate into fourth quarter end of period growth of about $275 million-$325 million. As you know, though, as mentioned earlier, the fourth quarter tends to be our better growth quarter from a seasonal point of view. Certainly, there could be some potential to outperform that growth a bit. Specifically related to MSL, we really have assumed no additional growth in the fourth quarter just yet related to that book.
If we're able to grow the acquired book, then certainly that's some upside to those numbers as well. Hopefully that makes sense.
On a dollar basis, you're saying fourth quarter end of period growth should be between $275 and $325.
That's correct, yes.
That's right. Okay. That's a big jump from what we've seen in the past couple of quarters.
It would be, this is John, in addition to the copy, Mike did a good job giving that color. The only thing I would add is the pipeline for end of 3Q is, call it 27% better than end of quarter June. The pipeline improvement coupled with some possibility, it's not factored in the number Mike gave about MSL recovering some business that may have dwindled a tad in the past couple of years, with the seasonal line utilization increases we always get in Q4 are all tailwinds to growth. Just as a reminder, remember we weren't kidding around having that 5% loan concentration in energy being a high water mark and bringing that total down.
The reduction of about $60 million in the organic Hancock Whitney book for energy was a deliberate action that we took in 3Q to make room, if you will, for the additional volume coming in from the MidSouth acquisition. That was a contributor growth, too. The storyline for 3Q, while growth was not impressive, spreads remained good and the mix change was good. It also allowed us to reduce the energy number down below what we have as our tolerance. There were a few moving pieces there, but it wasn't a lack of production. It was more the mix changes we're making in the balance sheet that we believe are good for value in the long run.
Yeah, that's really helpful. Maybe one other question on buybacks. You announced a buyback now that MidSouth has closed. Can you talk a little bit about how aggressive you feel like you'll be on that buyback? Is it more to manage the capital levels or how price sensitive you are with that?
Catherine, this is Mike. Obviously, we disclosed that the board increased that authority to the five and a half million. What I'll say about that is certainly we intend to exercise that authority, and I think you'll see us do that over the coming months.
Great. All right. Thank you.
You're welcome.
Thank you.
Thank you. As a reminder, if you would like to ask a question, press star one on your touchtone telephone. I'm showing no further questions in the queue. I'd like to turn the call back to Mr. John Hairston for any closing remarks.
Thank you, Catherine, and thanks to everyone for your interest in Hancock Whitney organization. I know you're busy, and we appreciate you dialing in this call. Have a great day.
Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now all disconnect.