Good morning. Welcome to Hancock Whitney Corporation's second quarter 2018 earnings conference call. As a reminder, this call is being recorded. I will now turn the call over to Trisha Carlson, Investor Relations Manager. You may begin.
Thank you. 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 risk and uncertainties identified therein. Our 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. We undertake 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 measure 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 Chief Executive Officer, Mike Achary, Chief Financial Officer, and Sam Kendricks, Chief Credit Risk Officer. I will now turn the call over to John Hairston.
Thank you, Tricia. Good morning, everyone. We are pleased to introduce ourselves on this morning's call as Hancock Whitney. Many of our team members worked tirelessly on the brand combination for many months, so that effective May 25th, we officially became Hancock Whitney Corporation. We opened trading that day with a new ticker of HWC and also changed the bank name to Hancock Whitney Bank with new signage across our physical and virtual footprint. The brand consolidation cost us about $10 million, or $0.09 this quarter, and is included in total non-operating items. Moving on to overall second quarter performance, I hope you will agree the company delivered another good period of continuing progress.
Results exceeded expectations in many areas and reflect a continued improvement in operating measures with EPS of $0.96, up 7% linked quarter, ROA of 1.22%, up five basis points, an improved efficiency ratio of 57.4%, and ROTCE of 16.12%, up 56 basis points. Loan growth was in line with our guidance, and we reported NIM expansion this quarter. Our balance sheet grew over $600 million with operating revenue up $7.5 million or 3% linked quarter. The growth did drive both a higher level of expense and lower level of TCE. Expenses were up across the board, however, were diversified in various categories of manageable linked quarter increases. Mike will share details regarding those items in just a moment. Regarding TCE, we did not close the gap to our 8% target this quarter, but the primary drivers were related to overall asset growth and the impact of OCI.
We remain focused on returning our TCE to the 8% level and will continue to manage capital opportunistically for our stakeholders. Our priorities have not changed. With organic growth as our top focus, there's no change to our M&A posture with tactical end-market transactions as our primary interest. Another key positive for the quarter was the improvement in our credit metrics. Total criticized loans declined $187 million or 17% from March 31, with energy criticized down $115 million or 22%, and non-energy criticized loans down $72 million or 13%. Some of the reduction in criticized loans were from credits which we expected to have resolved in the first quarter but carried into the second quarter. The resolutions did occur, albeit a little later than anticipated, and the combination of all that good news led to an outsized improvement in only one quarter.
Even with that notable improvement, we remain expected of additional progress in future quarters toward bringing our overall criticized credit metrics in line with our longer-term expectations. Non-accrual loans were down $48 million linked quarter, another attractive improvement in credit, and our provision for loan losses nicely outperformed the previous quarter. Moving on to M&A, we're very pleased to have completed the acquisition of Capital One's Trust and Asset Management business this past Friday on July the 13th. With the acquisition closed, we now have $26 billion in assets under administration, $10 billion in assets under management, and expect to add approximately $6 million per quarter in trust fees to our results beginning in the third quarter of this year.
As we begin the second half of 2018 operating with a new name, a new logo, and ticker, we remain relentlessly focused on our CSOs, maintaining credit performance, and being opportunistic with our capital, all with the primary focus of achieving our stated targets. I will now turn the call over to Mike for a few additional comments.
Thanks, John. Good morning, everyone. Reported earnings for the second quarter were $71 million or $0.82 per share. That included about $16 million or $0.14 per share of non-operating items. Those non-operating items include costs of about $10 million related to our brand change. We also had the non-operating cost in the quarter related to the Capital One Trust and Asset Management purchase of about $2 million, as well as a $3 million charge for restructuring a portion of our bank-owned life insurance investments. Finally, we also had another $1 million or so related to a few other miscellaneous items. Excluding those non-operating items, earnings for the company were $84 million or $0.96 per share. That's up about $5.4 million or 7% from last quarter.
As John just mentioned, the quarter saw a pretty sizable growth in our balance sheet and revenue, along with a higher level of expenses, which all drove a nice increase in the company's operating leverage. Operating revenue increased about $7.5 million from last quarter, with expenses up about $3.7 million. Our balance sheet growth was led by a nice increase in EOP loans, which totaled about $278 million or 6% annualized from last quarter. Growth was reported in all regions across our footprint and in many lines of business. As noted on slide seven in our earnings deck, the only segment showing a decline was energy, which was down about $69 million and brought us to our 5% targeted level. We do expect additional payoffs and paydowns in the energy portfolio as the cycle nears its end and remaining issues are resolved.
For the third quarter, we expect net loan growth of $250 million to $300 million, with year-over-year guidance unchanged at 5%-6%. Deposits for the company declined about $250 million from last quarter, with much of that drop related to typical seasonality. Our cost of deposits came in at 54 basis points for the second quarter, an increase of only four basis points. That drove our deposit betas lower to about 17%, compared to 29% last quarter. As mentioned last quarter, controlling deposit costs was and continues to be a focus point, and with our great core deposit franchise, will continue to be so. As a result, we reported expansion in our NIM of three basis points this quarter to 340. The wider NIM was largely in line with our guidance of a one- to three-basis-point increase for each 25-basis-point rate hike.
We also had two basis points of positive impact from interest recoveries this quarter versus three basis points of reversals last quarter. That's a five basis-point change quarter to quarter. As expected, the full quarter impact from the sale of HFC did compress the margin an additional five basis- points, basically offsetting the activity from non-accrual interest recoveries and reversals. Going forward, we expect the NIM, all else equal, to remain stable. We also expect any additional Fed rate hikes will drive a two- to four-basis-point expansion in the margin. As expected, the impact of deposit betas will be a driver. Our fee income was up about $1.4 million or about 8% annualized from last quarter, after adjusting for the $1.1 million loss from the sale of HFC in the first quarter.
Seasonal increases in trust and mortgage contributed to the higher level, along with increased card activity, driving higher bank card and ATM fees. As John mentioned earlier, we closed the Capital One trust and asset management transaction this past Friday. We expect that transaction will begin adding about $6 million per quarter to fee income starting in the third quarter. Operating expense was up about $3.7 million linked quarter, with much of that net increase related to our previously mentioned balance sheet and revenue growth. The drivers of the expense increase are detailed on slide 17 in our earnings deck. We still expect year-over-year expense growth to come in between 3% and 4%, again, with a bias closer to 3%.
The Capital One closing will add about $5.5 million-$6 million in quarterly expenses beginning in the third quarter, and we are focused on getting cost saves once we operationally convert. John touched on our TCE ratio earlier. It came in at 7.76% at June 30th, so down about four basis points from March. Growth in assets and the impact of OCI offset the increase to capital from earnings. We are focused on getting the TCE back to the eight-plus % range and continue to manage capital prudently. Our near-term guidance on slide 19 remains relatively unchanged, and we continue to work on achieving our CSOs as noted on slide 20. I'll now turn the call back over to John.
Thanks, Mike. Sabrina, let's go ahead and open the call for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Again, that is star then one to ask a question. Our first question will come from the line of Michael Rose with Raymond James. Your line is now open.
Hey, good morning, guys. How are you?
Morning, Michael.
Hey, just wanted to get some color and some greater detail on credit. You mentioned at the outset that there was some paydowns that you might have expected in the first quarter that came through in the second quarter. We finally did see trends reversing non-energy, non-accruals, and then criticized classified. Is this the beginning, do you think, of a trend, or should we think about credit as maybe stabilized from here? I know that coming into the quarter, there's a lot of concerns around healthcare and some energy credits. Just how do you think about the general credit landscape at this point? Thanks.
Hey, Michael. This is Sam. I'll start it off. As you know, we've been working on the energy book for quite some time. We're continuing to see some improvements in cash flows and risk profiles there. We're not surprised to see that resolution on the energy book continue despite some of the challenges as we've talked about in the offshore segment that we're continuing to deal with. As it relates to the non-energy book, we've been talking about that trend since the third quarter of last year. Between the identification of those credits, articulating resolution plans, et cetera, and then putting those plans into action. We've been about that business for three quarters now. As John said, the expectations for activity in the first half of this year panned out, although the timing bled over into the second quarter from the first quarter.
We will continue to have, as John likes to say, relentless focus on improving all our asset quality metrics. That does not mean that from time to time, we might have some bumpiness here and there because resolutions are not linear, but we do not see any systemic issues. We will continue on the resolution path for credit. I can't promise you that we'll see the same level of resolution in the third quarter that we saw in the second quarter, but we will continue to focus on that, and we will, from time to time, see hiccups here and there. I do not expect to see a return to that elongated upward trend that we saw through 2017.
Okay, that's helpful. Maybe just to follow on that, if I look at your provision guidance for the back half of the year at 8%-10%, that would imply that you'd come in at the lower end of what you had previously laid out for the year, which was 39%-46%. Does that imply, I guess, more confidence that things are perhaps a little bit better than you might have thought?
Michael, this is Mike, and I think what it means is obviously we feel good about credit. As Sam indicated, it's something that's been a focus point for quite some time. Again, I don't think going forward, we're going to show a 17% drop each and every quarter in our total criticized loans. I also think we would be disappointed if we didn't continue to show a positive trend in that regard. I think all that plays into our outlook and tone certainly on credit, which I think is good.
Okay. Maybe one more from me, just as it relates to capital. You guys did announce the share repurchase plan, your TCE ratio is still below your target. Would you need to get there, to that target, before you would look to repurchase shares?
I don't think all things equal, we necessarily have to be exactly at 8% before we consider buybacks, or even a dividend increase. As of right now, buybacks are really something that's not on the table. It's something that we review and look at certainly each and every quarter, but right now, it's not a priority. I think as John mentioned in the opening remarks, we're focused as our number one priority on funding organic growth in the company going forward.
Okay. Thanks for taking my questions.
Okay.
You bet. Thanks, Michael.
Thank you. The next question comes from the line of Jennifer Demba with SunTrust. Your line is now open.
Hey, morning guys. It's actually Steve on for Jennifer Demba.
Hey, Steve.
Just kind of two questions here. First, just following up on some of the credit stuff. Can you go into a little more detail on your non-energy NPL book? Any trends or granularity in that book still out there worth calling out?
No. We saw a little bit of an improvement there in the non-accrual level in NPLs for the non-energy book. As we've said, we've been in the resolution process for the better part of three quarters now. We'll continue on that track. Those that are in the NPL category, we fervently pursue a resolution and mitigation strategy on each of those. We have strategies articulated for every one of those. We'll continue down that path for resolution. Again, nothing systemic there where we expect to see any building issues. We're just about the business of resolving problem credits and working with those clients.
Perfect. Then, kind of moving over to your forward NIM guidance for rate hikes. Are you seeing less pressure on deposit costs, or was there something else for the reason for the increase there?
Well, again, as we talked about last quarter, controlling our deposit costs have absolutely been a focus point for us. We believe and think it should be given the quality of our deposit franchise. We were able to effect that decrease in our deposit betas. I think going forward, while certainly there's some potential for volatility as rates continue to rise and customers react to those increases, we feel good about where our deposit beta is, and certainly would not expect a sizable increase therein.
Thanks, guys.
You bet.
Thank you. The next question will come from the line of Kevin Fitzsimmons with Hovde Group. Your line is now open.
Hey, good morning, guys.
Morning, Kevin.
Just a few quick questions. I know there's been a lot of attention on deposit beta and deposit costs. One thing I noticed is service charges within fee income declined linked quarter. Just curious, are there any levers getting pulled behind the scenes there in terms of cutting or waiving maintenance fees in order to make some of your commercial deposit customers happy and help in terms of keeping deposit costs where they are?
No. No accommodations in that regard, Kevin. I think more than anything else, the drop in service charges was, in some part, seasonal and probably in bigger part, just related to the number of our processing and statement days that we had during the quarter. Absolutely no effort on our part to trade service charges to get people to not move their deposits or look for a rate increase.
Okay, great. Just one quick follow-up on the question before about the TCE ratio and the target. With buybacks being, it sounds like further down the priority scale now in terms of capital levers, is that more a reflection of the organic growth or deal opportunities you see out there, or where the stock is trading today, or a combination of both?
Well, I think as much as anything else, again, as John mentioned, we're focused on organic growth. Certainly, M&A is a strategy that we employ to grow our company. It's certainly something we look at, and would be open to opportunities. No, there's nothing that needs to be read into those priorities or guidance other than a focus on organic growth.
I guess what I'm asking, Mike, is the focus kind of implies you feel good about that opportunity based on what you see.
We do. We absolutely do. Yes. We do.
Okay, great. Thank you. Thanks very much, guys.
You bet.
Thank you. The next question will come from the line of Casey Haire with Jefferies. Your line is now open.
Thanks. Good morning, guys.
Good morning.
Wanted to touch on the M&A strategy. You mentioned in your prepared remarks that tactical in-market transactions will be of interest. When I hear tactical, I equate that to a bite-size or a smaller size transaction. There is a lot of chatter about you guys potentially going after larger transactions. Just wondering if you could potentially size what tactical means in terms of target size.
Sure, Casey, this is Mike, be happy to. I think one of the bigger takeaways here related to M&A is that we've affected no change in our strategy or tactics. Again, we describe those in terms of really priorities. The top priority is what we refer to as infill transactions. Infill transactions by their nature are more tactical or financial opportunities, and so tend to be on the smaller size. Think of the two First NBC transactions. While certainly unique in the way those came about, would really kind of fit the criteria of what you think about in terms of an infill opportunity. Let's call it maybe $2 billion on the low end, to as much as maybe $4 billion or so on the high end. Again, that remains kind of our priority for right now.
The other second priority would be opportunities in our bookend markets. Again, we define our bookend markets on the western side of our franchise as Houston, and then on the eastern side, places like Tampa, Jacksonville. We certainly would be open to kind of rationalize or growing our presence in those very large markets. Those transactions, again, just by their nature, could be a little bit bigger than what I articulated around kind of the infill. Instead of two to four, they could be as high as maybe five, six, seven, somewhere in that range. The third priority, which really is kind of a distant priority, would be truly tactical deals, which again, by definition would be much larger.
Having said that though, we are focused on the infill transactions first, and there's really nothing that we're looking at or working on that would fall into the tactical category right now.
Great. Thanks for that clarification. Switching to sort of the Capital One transaction. You mentioned, I think there's some opportunities for cost saves down the line. Could you just clarify the magnitude and what the timing might be on that?
Sure. The timing of those cost saves would happen when we affect the systems conversion, which will be at some point in the first half of 2019. Late first quarter into the second quarter, potentially. We haven't quantified the magnitude of those cost savings at this point. As we get closer to that date, we'll articulate that.
Okay, great. Thanks for taking the questions.
Okay.
Thank you. The next question will come from the line of Joseph Fenech with Hovde Group. Your line is now open.
Morning, guys. You've now hit your 5% target in terms of energy as a percentage of total loans. You said you expected earlier continued payoffs and pay downs. Assuming we could still see energy decline as a percentage of total, just looking for an update, guys, as to when you think that diminishes as a headwind to loan growth for you, and maybe we see a natural lift in that loan growth guidance towards the upper single-digit range or so.
Hey, Joe, this is John. Thank you for the question. Thanks for recognizing we're at the 5%. We have set that as a target several quarters ago, and it's certainly a good day to finally reach that target. That said, there could be a little bit more decline in that overall concentration as we remix the portfolio a little bit out of the Gulf of Mexico and into land and more in midstream and reserve-based lending. It could dip a little bit down into the mid-fours, but I would be surprised and disappointed if it lowered much more than that before it began to tick back up.
I think the range to look at would be somewhere in the 4.5%-5% on a going-forward basis, which would intimate that the net interest income bleed because of the overall energy book diminishment is at or very near an end. We wouldn't expect to see that as a scale of a contra as we've had the last couple of years. That may take a quarter or two for that rebalancing to happen. We do continue to see payoffs, primarily on the services side, and we're being very selective about accepting new clients in the energy space. There are great opportunities out there, but we're being very selective, and it may take a quarter or two for that balance to be completed.
I guess the takeaway, John, thanks for that, is that, would that mean we should have enhanced confidence in that 5%-6% overall loan growth total? Once the energy headwind's behind you, maybe that ticks up a little bit, just given the higher growth rate in the other areas?
Little too early to tell. I think probably the better way to state it would be, we've delivered energy pay-downs as a caveat to going forward loan growth estimates for probably the last two years now. The size and magnitude of the caveat is dramatically shrinking, if that makes sense. We just don't expect to see that $100 million and $200 million every half year of energy payoffs like we've had in the past. There will be a couple more, I expect, in the third quarter, and it'll begin to diminish after that. I think our confidence in the 5%-6% is pretty good.
Got it. Mike, on the two to four basis points NIM guidance with every Fed rate hike, as you look out, do you think we hit an inflection point where it becomes tougher to get that NIM expansion with every rate hike, or do you still see that as a ways out, and that guidance you think would apply to the next several rate hikes?
I think that, again, we make that note about all things equal, that we're looking at two to four basis points of benefit from each 25 basis point rate hike. Feel really good about our loan betas in that regard, and I think the wild card really is what happens with deposit betas. If we're not able to get to the two to four, it's probably going to be related to deposit betas and volatility therein.
Okay. Understood. Last one for me. I know you guys touched on the capital earlier. Dividend payout to 26%, below the 30%-40% target. You said you would revisit it around mid-year with the dividend. I know that was partially tied into the TCE target, which you're not at yet, and the closing of the Capital One deal. Is TCE still the governing factor at this point, or any other considerations we should be thinking about as it relates to the dividend?
TCE is certainly important to us, I think as everyone knows and realizes. Again, it doesn't preclude us from doing something with the dividend right now. Again, we did say that that was under review at mid-year, and that analysis is ongoing right now.
Got it. Thank you, guys.
You bet. Thank you.
Thank you. The next question will come from the line of Matt Olney with Stephens. Your line is now open.
Hey, thanks. Good morning, guys.
Good morning, Matt.
Just wanted to clarify the margin guidance. We got the Fed rate hike in June. You expect two to four basis point benefit in the third quarter as well?
That's what we're looking at and working on.
Got it. Okay. Going back to the Capital One transaction, definitely appreciate the fee income guidance, the OpEx guidance, potential for some cost saves down the road. Is there anything else there could be a benefit from, and specifically, any opportunities to help out on loan growth or deposit growth down the road?
This is John, that's a great question. As we look at the balance sheet and the trends therein, I've said on, I think, a few calls that I believe we can do a better job at overall mix in the loan portfolio by improving the growth we have in the smaller end, where the spreads are more attractive. The enhancements that we have made in our digital offerings and continue to make, I believe will eventually give way to a little bit more impressive growth in those smaller end segments, which would deliver a little bit better ROE and NIM over time. I'm not ready to talk about numbers on that at this point in time, but it's a keen focus strategically for the company.
We believe we're a very good C&I lender, and we believe we have a wonderful deposit in branching franchise, and I would like to see us do a little better job at growing the smaller end of the book for the benefit of ROE overall. Just not satisfied quite yet where we are, and I believe we can do better. While the growth % numbers wouldn't be eye-popping simply because of the magnitude of our C&I book, the impact on the P&L would be somewhat more attractive. Does that make sense?
Yeah, John, that makes sense. Can you just clarify, when you say the smaller end of the book, just help us out in terms of what the average loan size would be on that smaller end.
Yeah. We tend to look at that client book in segments. What I'm really talking about is below middle market. In the commercial banking and business banking and retail banking segments, I think that we can maybe punch a little stronger in those areas, given the quality of the branching franchise. A lot of the dollars that we have been pumping into the digital offerings are targeted toward delivering some additional benefit toward the 2019 and 2020 timelines. It would be premature for me to try to size that for you at this point in time, but it is something that's strategically important to us.
Okay. I appreciate that those loans could be more profitable. Can you help us understand from a relative yield perspective, what the relative yield would look like on the smaller end of those loan balances compared to maybe a middle-market loan?
Well, it somewhat depends on the collateral methodology and whether we're talking about cards or things like that. If you use credit cards as an example, the yields are 3X what you'd expect to see in a business loan. The consumer segments are yielding somewhere around 2.5X. I think it's not something that we could quantify without looking at the mix overall, but it's much better than what we'd have today.
I think also, Matt, it gets into the risk-return dynamics related to your larger loans versus smaller loans. Certainly, there's a yield trade-off in that regard.
Right.
Understood. In this discussion, are we talking about both consumer and smaller end commercial loans, John?
Well, the benefit on the commercial side is you're going to get a good bit more deposit inflow, and therefore, your liquidity coverage a little bit better. On the retail side, it's simply leveraging the deposit franchise more effectively than we are today. We have a really strong deposit franchise in the retail bank, and I think we can do better to loan that money inside the retail segments for the benefit of spread.
Very helpful. Thank you.
I believe there's an upside there.
Matt, this is Mike again. Just one other quick comment. Just wanted to clarify something on an earlier question around our M&A strategy. I may have swapped the words tactical and strategic. Just to clarify, what we're working on is tactical smaller deals. What we're not working on right now is larger strategic deals.
Thank you. I'm showing no further questions at this time. I'd like to turn the conference back to Mr. John Hairston for further remarks.
Okay. Thank you, Sabrina. Thanks for moderating the call. Thanks, everyone, for your interest. We look forward to speaking with you again next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude your program. You may all disconnect. Everyone, have a great day.