Earnings Call: Q2 2021

Jul 28, 2021

Good morning, ladies and gentlemen, and welcome to the Trustmark Corporation second quarter earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation this morning, there will be a question and answer session. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. As a reminder, this call is being recorded. It is now my pleasure to introduce Mr. F. Joseph Rein, Jr., Director of Investor Relations at Trustmark. Good morning. I would like to remind everyone that a copy of our second quarter earnings release, as well as the slide presentation that will be discussed on our call this morning, is available on the investor relations section of our website at trustmark.com. During the course of our call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We want 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 Corporation. Thank you, Joey. Good morning, everyone. Thank you for joining us. 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. For the second quarter of 2021, Trustmark is pleased to report net income of $48 million, or $0.76 per share. We'll review the second quarter financial highlights starting on slide 3. loans held for investment increased to $169.2 million, or 1.7% from the prior quarter, and $493.1 million, or 5.1% year-over-year. During the quarter, Trustmark sold $354.2 million in PPP loans that were originated in 2021. That accelerated the recognition of unamortized PPP loan origination fees of approximately $18.6 million. Pre-Provision Net Revenue totaled $57.2 million for the second quarter, a 38.2% increase linked-quarter. Net Interest Income increased $17.2 million from the prior quarter, and Non-Interest Income totaled $56.4 million at June 30th. Adjusted Non-Interest Expense totaled $116.3 million in the second quarter, a 3.3% decrease from the prior quarter. Our Efficiency Ratio improved to 64.3% for the quarter. Credit quality remained solid as non-performing assets declined 17.9% from the prior quarter. Net charge-offs totaled $1.2 million in the second quarter. We maintained strong capital levels with Common Equity Tier 1 capital of 11.8% and a total risk-based capital of 14.1%. During the second quarter, Trustmark repurchased $20.8 million or approximately 630,000 shares of common stock. As of June 30th, we maintained $75 million in remaining authority under our repurchase program that will expire December 31st of 2021. The board of directors declared a quarterly cash dividend of $0.23 per share payable September 15th to shareholders of record on September 1st. At this time, I'd like to ask Barry Harvey to provide some color on loan growth and credit quality. Be glad to, Duane. Looking on the slide 4, our loans held for investment totaled $10.2 billion as of June 30th, an increase of $169 million from the prior quarter and $493 million year-over-year. The loan growth during the quarter was centered in public finance and mortgages. As anticipated, our CRE payoffs slightly outpaced our fundings in that book. The loan portfolio remains well-diversified, both by product type as well as geography. On slide 5, you can see Trustmark's CRE portfolio is approximately 65% existing and 34% or 35% construction land development. Our construction land development book is 80% construction or vertical. The bank's owner-occupied portfolio has a good mix between real estate types or categories, as well as industries. Looking on the slide 6, the bank's commercial loan portfolio is well-diversified across all industries and with no single category exceeding 10%. Typically, these loans are well secured, governed by formulaic borrowing bases, coveted to protect both the income statement and the balance sheet. On slide 7, we have a minimum exposure, as you can see, to restaurants and energy. Trustmark has never been in the high-risk C&I lending business, and currently, we only have 1 customer for roughly $10 million in that category. The bank's portfolios in the highest impacted COVID-19 industries have held up extremely well. The bank has always underwritten both hotels and retail CRE in a very conservative manner. Moving on to slide 8. We conducted an analysis, as we have in the previous quarters, of our COVID-19 portfolio of those that we have seen have either a COVID concession or fit into 1 of the categories that's been highly impacted. We looked during the quarter at those in specific categories, mainly retail and hotel, but we looked at those that were watch or worse, that have received a concession during the COVID-19 downturn, and those credits specifically that were over $1 million. Collectively, we reviewed roughly $482 million in the balances. We reviewed 99% of our hotel book and 69% of our restaurant portfolio. As a result of this review, we're pleased to indicate that we had about $4.5 million in downgrades into the criticized category. On the other side, we had about $14.5 million that was moved from two paths from the unclassified or criticized category. Looking at slide 9, our allowance for credit losses decreased $5 million from the previous quarter. Our reserve calculation included decreases in individually analyzed credits, and the qualitative changes were due to the reduction in the impact of COVID-19 on our portfolio. The quantitative portion of the reserve was impacted by improvements in the macroeconomic forecast, which resulted in releases of reserves. We also implemented a probability of default and a loss given default floors inside of specific portfolios, which actually resulted in provisioning. On June 30th, 2021, the allowance for credit losses on loans held for investment totaled $104 million. On slide 10, we continue to post solid credit quality metrics. On June 30th, our allowance for credit losses represented 537% of non-performing loans, excluding those that were individually analyzed. Net charge-offs totaled $1.2 million in the second quarter, and recoveries have exceeded charge-offs by the same $1.2 million year to date. Non-accruals declined $12 million in the second quarter and $1.5 million from this time last year. On June 30th, non-performing assets had declined $13 million from the prior quarter and $7 million from the previous year. On slide 11, we can take a quick look at our PPP program during the second quarter. As Duane indicated, we sold $354 million of our PPP loans originated in 2021. This sale of loans accelerated the recognition of unamortized PPP loan origination fees by $18.6 million net of cost. On June 30th, 2021, our PPP loans totaled $166 million, net of deferred loan fees and cost of $2.1 million. Duane? 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, net interest margin, and Non-Interest Income. Thanks, Duane, good morning, everyone. Looking at slide 12, deposits totaled $14.6 billion at June 30th, a $249 million increase linked quarter and $1.1 billion increase year-over-year. Growth during the quarter was driven primarily by public fund balances, while personal and non-personal balances were both relatively flat. Perhaps we're beginning to see long-anticipated inflection point where balances begin to roll over as the economy continues to recover and consumer spending continues to normalize. Our cost of interest-bearing deposits declined 3 basis points from the prior quarter to total 19 basis points, and we continue to maintain a favorable deposit mix with 30% of balances in non-interest bearing. Turning to slide 13, Net Interest Income FTE totaled $122.4 million in the quarter, resulting in a net interest margin of 316 and representing a linked quarter increase of $17.2 million. Interest and fees on PPP loans totaled $25.6 million, which was an increase of $16.3 million linked quarter and as Barry Harvey and Duane Dewey referred to, the $18.6 million in origination fees, which were accelerated by the sale of the PPP loans. Core net interest income FTE was $96.8 million, which was an increase of $800,000 linked quarter, driven primarily by ongoing decline in deposit cost while earning asset growth basically offset ongoing declines in loan and security yields. Core net interest margin was 294 basis points, a decline of 5 basis points linked quarter. Turning to slide 14, non-interest income for the second quarter totaled $56.4 million, a $4.2 million linked quarter decrease, and a $13.1 million decrease year-over-year. The linked quarter and year-over-year decreases are primarily attributable to lower mortgage banking revenue. For the quarter, non-interest income represented 32.1% of Trustmark's revenue, continuing to demonstrate a well-diversified revenue stream. On slide 15, mortgage banking revenue in the second quarter totaled $17.3 million, a $3.5 million decrease linked-quarter, and a $16.4 million decrease year-over-year. Mortgage loan production remained strong, but declined 3.9% linked-quarter and 13.7% year-over-year from historically high levels. For the second quarter, retail production remained strong, representing 77% of volume, or $571 million. We've added a trailing quarterly chart to the slide illustrating gain on sale margin as well as the mix of loans sold versus retained on balance sheet. You can see the gain on sale margin declined about 20% linked quarter, dropping from 391 basis points in the first quarter to 315 basis points in the second quarter. Origination volume declined about 4% linked quarter, dropping from $767 million to $737 million. We hope the addition of this chart will help the reader understand the dynamics of the mortgage banking gain on sale. Now I'll turn it over to Tom Chambers, who will cover non-interest expense on slide 16. I'll be glad to, Tom. Turning to slide 16, you see the detail of our Non-Interest Expenses broken out between adjusted, other, and total. Adjusted Non-Interest Expense totaled $116.3 million in the second quarter, a $3.9 million decrease from the prior quarter. Salaries and employee benefits decreased $1 million linked quarter, principally due to the seasonality of payroll taxes from the prior quarter. Additionally, services and fees decreased $715,000 and equipment expense decreased $677,000 on a linked quarter basis. Turning to slide 17, Trustmark remains well-positioned from a capital perspective with our Common Equity Tier 1 capital ratio of 11.76% and a total risk-based capital ratio of 14.10% as of June 30th, 2021. For the first six months of 2021, we repurchased approximately 775,000 common shares totaling $25 million. At June 30th, we had $75 million under our existing stock repurchase plan, which expires December 31st, 2021. At this time, I'll turn it back over to Duane, who will now cover our outlook commentary on slide 18. Thank you, Tom. Again, this is a new add to our deck to give you some insight into our outlook. Looking at the balance sheet, we are expecting loans held for investment to grow low to mid single digits for the year, with potential headwind in the second half of 2021 from accelerated repayment activity in the commercial real estate book. Our security balances are targeted at 20% of earning assets. Growth in deposits is expected to flatten in the second half of the year. We're expecting the net interest margin to remain under pressure from the low interest rate environment and excess balance sheet liquidity. Our core net interest income is expected to stabilize during the second half of the year as core earning asset growth offsets continued modest linked quarter compression in the core net interest margin. Based on the current outlook, the total provision for credit losses, including unfunded commitments, is expected to remain in line with the second quarter results for the remainder of the year. Net charge-offs are expected to be muted for the remainder of 2021 based upon the current economic outlook and the overall portfolio. Non-interest income category, we expect service charges and bank card fees to rebound modestly from depressed levels as the economy emerges from the COVID-19 crisis. Mortgage banking is expected to continue trending lower in production and show a lower gain on sale margin. Wealth management and insurance are both expected to grow by mid-single digits for the year. For expenses, our adjusted non-interest expense is expected to increase by low-single digits for the year, subject to the impact of commissions in mortgage, insurance, and the wealth management businesses. We will continue to work on initiatives like the voluntary early retirement program and market opt for opportunities to improve efficiencies and workflow. We'll also continue a disciplined approach to capital deployment with a preference for organic loan growth, potential M&A, and opportunistic share repurchase. We will continue to maintain a strong capital position to implement corporate priorities and initiatives. With that, I trust this second quarter discussion has been helpful and the financial results and outlook commentary has been insightful. At this time, I'd like to open the floor for questions. Our first question will come from Graham Dick with Piper Sandler. Please go ahead. Hey, good morning, everybody. Morning. Good morning. You just mentioned taking securities to 20% of earning assets from today's levels. I'm just wondering, I guess what your all's plan would be for the remainder of whatever liquidity might be there after you reach that 20% threshold. Maybe if you're expecting, I guess, a large chunk of that to flow out of the bank. Just trying to get an idea of what the overall balance sheet might look like in a few quarters. Graham, good morning. This is Tom Owens. Thank you for the question. Yeah, we do continue to target 20% of earning assets for the securities portfolio. Came up a little bit short of that in the second quarter. Our deposit growth in the second quarter was sort of back-loaded. As we got towards the end of the second quarter, we had quite a rally in bond market and investment alternatives were less appealing at that point. Some of it is tactical. I think you should expect us to continue to target at least 20% of earning assets. As we've discussed in the past, there's really two big considerations there. One, as you alluded to, is the uncertainty around the effective duration of the deposits, the deposit growth that we've experienced here over the last five quarters or so. As I said in my prepared comments, we really started to see that flatten out with respect to personal and non-personal in the second quarter. If we're at a point here where we've stabilized and we start to see some attrition that looks more consistent with the back book, I think that will increase our confidence in terms of the amount of liquidity that we have to deploy. The second part of that, as we've discussed in the past, is the desire to maintain a competitive level of asset sensitivity in terms of our interest rate risk profile. As of the first quarter, our peer median securities to earning assets was about 25%. I think you should expect us to set the stay below that. For that to be the range, 20%-25%. Sort of dimensioning your question there, as you said, over the next few quarters or so, I would think that we'll be more towards the lower end of that range. Okay, awesome. That was very helpful. I guess just turning to securities, I know you said that you probably have more color on the impact of the voluntary retirement program with 3Q 2021 earnings. I was just wondering if you guys maybe have any early idea of how many people might be planning to participate in that, or even just a rough estimate of how it might impact or reduce salaries at the point of its implementation. Yes, this is Duane. We're not in position really to comment on the overall program at this point in time. It closes here before too long, and we'll be disclosing the full results at the end of the third quarter. If you recall, we had an early retirement program in early 2020, right as COVID-19 was starting to take shape. This program is in somewhat following that as COVID-19 now has started to lessen and the markets are improved and other things that have happened during that 18-month period. Really don't have a lot more color at this point. We'll give you full details at the end of the third quarter. Okay, that's understandable. I guess just a quick one here on expenses. I was wondering, salaries are lower quarter-over-quarter. How much of a benefit did you guys see from the lower mortgage-related comp versus last quarter? We're flipping pages here to get the exact answer to that question. As volume declines, commissions decline. I don't know that, Tom, do you have that? Mortgage commissions actually increased by about $700,000 this quarter, second quarter versus first. Because? We have a lag. We have a month in arrears payment for the third month of the quarter. We do expect that to trend lower over time as volumes decline. Yeah. It's coming down the last half of the year. Yeah, it's a good question. You would expect with decreases in origination volume, decrease in commission expense, Graham. I think in this case, it's just a question of timing, as is the case with a lot of the mortgage banking business, right? As we said, it's projecting forward lower origination volume certainly would lead to lower commission expense. Okay, awesome. That's it for me. Thanks, guys. Thank you. Our next question will come from Jennifer Demba with Truist Securities. Please go ahead. Pardon me, Jennifer, your line might be muted. Hey, this is Brandon King on for Jennifer. How you doing? I'm sorry, could you say your name again? Hey, this is Brandon King on for Jennifer Demba. How's everyone doing? We're doing well. Good morning. Morning. Yeah, could you please talk about what you're seeing in CRE with pay downs? I know you expect there to be potential headwinds going into second half of the year, could you see that abating somewhat as we get into 2022? Brandon, this is Barry. I will be glad to address your question. What we are seeing just after we have got past the end of second quarter, we have reassessed, of course, what we think the second half of the year will look like and as we move into 2022, that you referenced. One thing we are seeing within our CRE book, we are seeing some shifting of scheduled payoffs either later into this year. Some that we expected to see in Q2, we saw a shift of some of that into the third quarter and fourth quarter of this year. We also saw a meaningful portion of it shift into 2022. I think from a loan growth perspective, if that's where you're heading, is we're probably a little more comfortable thinking about mid-single digits for 2021 than we were at the first of the year. It's mainly because we're seeing some of those scheduled payoffs getting pushed back into either later this year, which really doesn't have a big impact on 2021. We are seeing a meaningful amount pushing into 2022. On the flip side of that, we're seeing a higher than anticipated unexpected payoff, those that we didn't have slated to come out in 2021. That's occurring at a pretty rapid pace. They do seem to be offsetting each other to an extent. We're feeling like from a CRE perspective for the year, we're going to end up being around flat based on what we know today. We are pleasantly, not surprised, but encouraged by the fact that we're seeing growth in both our public finance line of businesses as well as in our mortgage business. Those loans we're choosing to portfolio. We are seeing growth during Q2 from a couple areas that we've previously not had meaningful growth. We do expect for the real estate, the CRE portion of our book to not be too much of a drag on our loan growth for the year. We are more comfortable now thinking in terms of mid-single digit growth as opposed to low single digit growth as we move out through the rest of 2021. Okay. Thanks for the color on that. You mentioned as far as higher activity in your markets and how that'll eventually benefit service and bank card fees. Is there a certain level that you're targeting when it comes to level of fee income in those areas in relation to pre-pandemic levels? This is Duane. I'll take a stab. Not really. We're not targeting anything specific. It's been a little hard to forecast. Again, based on the deposit conversation, the amount of liquidity out there in the marketplace, we do expect the overall economic activity to pick up, which means more service charges, more activity. It's just so hard to forecast how quickly now with maybe the second wave of COVID-19 related stuff. We don't really have a target to give you at this point in time. Okay. Finally, I know your preference is for organic loan growth, but with all these mergers being announced, does it change the calculus for you guys to use some of that capital for M&A? If so, what are your thoughts there as far as potential whole bank acquisitions versus non-bank acquisitions or certain businesses? This is Duane. As you note, it's a very active market out there. We are hearing and seeing a lot of different opportunities. We continue to stay focused on the things that will improve and impact Trustmark moving forward. As we stated in our outlook commentary, organic loan growth continues to be a priority. It's the most efficient use of capital. M&A is something that we are monitoring and are evaluating on a continuous basis. As you note, there is increased thought and discussion in some of the non-bank categories that could be of interest. The third use of capital is the opportunistic buyback. High volume on the M&A side, but we're staying disciplined and focused and are going to be opportunistic and really haven't changed our view on that from prior guidance. Okay. Thanks for the answers. Again, if you have a question, please press star then one. Our next question will come from Michael Rose with Raymond James. Please go ahead. Hello, good morning. This is Carl Doran for Michael Rose. Thank you for taking my questions. Just to piggyback off the expense questions. Basically, a while back you had talked about certain initiatives on top of growth and innovation, which includes improving efficiency. With the Efficiency Ratio currently running in the mid-60s, do you perhaps have a target for where you would want that to be eventually? You kind of went in and out. We missed a portion of that question. I apologize. Could you, Carl, repeat? Sure, no problem. Are you hearing me clear now? Yeah, a little bit muffled. Okay. Basically, you had talked about the improving efficiency as part of your initiatives a while back. Just wanted to know, with the voluntary retirement program and the closing of branches, do you happen to have perhaps a target for where you would want the Efficiency Ratio to eventually be at, given it's currently running in the mid-60s right now? The answer is no. We don't have a target Efficiency Ratio. As I've stated in prior calls, we are laser-focused on efficiencies. That includes things like the voluntary early retirement programs to reduce headcount. Along with that means back-office efficiencies, process improvement, and the entire leadership management team is laser-focused on those topics. We have a number of technology initiatives we completed so far this year. Two more that will begin or are completed in the latter part of the year that we think over time will create continued efficiency improvements and opportunities to reduce expenses across the board. We don't really disclose a target for Efficiency Ratio at this point. Well, this is Thomas C. Owens. I would add that, as Duane Dewey said, we're keenly focused on the numerator in the Efficiency Ratio, but let's not lose sight of the denominator either. Clearly, the Fed's emergency rate cuts and super accommodative monetary policy have had quite an impact on our net interest margin and our Net Interest Income. We do believe that we are well-positioned relative to peers in terms of our interest rate risk profile. We do believe that as the economy continues to recover and as the Fed eventually normalizes monetary policy, that we should outperform the peer groups. It's part of why you hear me each call talk about the desire to maintain a competitively asset-sensitive interest rate risk profile. Got it. Thank you. On capital, I know you talked about buybacks previously. With the share price, I guess, a bit down from where it traded at during last quarter, I'm assuming it's more attractive for you guys, and I assume you're still buying shares. Again, we're pretty consistent with how we go about capital management. We have a disciplined process, a disciplined framework in place for evaluating the returns available from various forms of capital deployment. Yes, we were active in the second quarter as the opportunity presented itself. We had a good quarter in that regard. If you think about the amount of balance sheet growth that we achieved in the second quarter, if you think about the amount of capital we deployed via share repurchase, and yet our capital ratios still increased linked quarter. A very good quarter in that regard. Each of our regulatory capital ratios continues to remain above the top of our operating target ranges for the ratios. As Duane indicated in his comments, we continue to have $75 million of authorization remaining between now and year-end. Yes, I would think that you should expect us to continue to manage capital consistent with the way we've done so in the past. Sounds good. All right. Thank you for taking my questions. Our next question will come from Catherine Mealor with KBW. Please go ahead. Thanks. Good morning. Morning, Catherine. Morning. wanted to just go back on the PPP sale. Can you remind us what your remaining unamortized fees are to come in for the rest of the year? Catherine, this is Tom Owens. It is approximately $2 million in unamortized origination fees that would be recognized, as you know, sort of straight-line amortization over the life of the loans, but would be accelerated as we continue to experience forgiveness on the loans. Okay, great. Back on the mortgage conversation, your slide was really helpful that showed the gain on sale margins. As we look at the gain on sale margin for the quarter, is there any sense as to what that margin looked like towards the end of the quarter that may give us a sense as to where that margin may be heading in the back half of the year? Catherine, this is Tom. I don't know that we can slice it quite that finely. We're hoping. This is obviously a hot topic, and it's one of the primary reasons we added that chart to slide 15. We do want to try and be as transparent as we can and give you as much guidance as we can with respect to the key drivers of the mortgage banking business and the revenues generated from that business. Again, we saw about a 20% linked quarter decline in the gain on sale margin. It remains, as you know, at high levels historically speaking. Just in very round numbers, probably 2x what was considered normal pre-pandemic. We can't slice it that finely, but I think in general, we think that we expect continued pressure both on the gain on sale margin as well as origination volume. We're hoping that chart can kind of give you a visual in terms of what that trend has looked like. It looks like you've kept more on balance sheet as well. Should we expect to see that trend continue as gain on sale margins continue to come down? That puts more pressure on the mortgage revenue, but in theory, instead, you've got better loan growth as a result. The answer to that, Catherine, is yes. We would expect to hold more on balance sheet. Okay. Catherine, this is Duane- Reflected in your increased mid to single digit guidance that you've already put out or would that be additive to that, do you think? It is reflected. It's reflected. Catherine, that's going to be typically going to be your some 10-year type jumbo, but predominantly it's going to be 15-year pay to zero. It's going to be a fairly short duration as far as what's being added to the book on a quarterly basis. Great. Very helpful. Thank you so much. Thank you, Catherine. This concludes our question and answer session. I would like to turn the conference back over to Duane Dewey for any closing remarks. Well, thank you for participating on our call this morning. We hope the information presented is helpful and useful. We look forward to getting back together at the end of the third quarter, and we will talk to you in October. Thank you.