Renasant Corporation (RNST) Q3 2017 Earnings Report, Transcript and Summary

Good morning and welcome to the Renasant Corporation 2017 Third Quarter Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to John Oxford. Please go ahead.

Thank you, Bran and good morning and thank you for joining us for Renasant Corporation's 2017 third quarter earnings webcast and conference call. Participating in this call today are members of Renasant's executive management team. Before we begin, let me remind you that some of our comments during this call may be forward-looking statements, which involve risks and uncertainty. A number of factors could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. These factors include, but are not limited to, interest rate fluctuation, regulatory changes, portfolio performance and other factors discussed in our recent filings with the Securities and Exchange Commission. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results over time. In addition, some of the financial measures that we may discuss this morning may be non-GAAP financial measures. A reconciliation of the non-GAAP measures to the most comparable GAAP measure can be found in our earnings release, which has already been posted to renasant.com in the press release section under Investor Relations' tab. And now I'll turn the call over to E. Robinson McGraw, Chairman and CEO of Renasant Corporation. Robin?

Thank you, John. Good morning everyone. Thank you again for joining us today. Looking at our results for the third quarter of 2017, net income was $26.4 million, an increase of 13.99% as compared to the same quarter in 2016. Our basic and diluted EPS were $0.54 and $0.53 per share respectively as compared to $0.55 for the third quarter of 2016. During the third quarter 2017, we incurred expenses and charges in connection with certain transactions that are considered to be infrequent or non-recurring in nature. These expenses were primarily associated with merger and conversion expenses and impacted our diluted EPS by $0.09. Excluding these non-recurring items, our 2017 third quarter return on average tangible assets and return on tangible -- average tangible equity were 1.30% and 14.62% respectively. On July 1st, 2017, we completed our previously announced acquisition of Metropolitan BancGroup in an all-stock merger. As of July 1st, Metropolitan operated eight offices in Nashville and Memphis, Tennessee and into Jackson, Mississippi MSA and net assets with the fair value of approximately $1.4 billion, which included approximately $970 million in total loans and total deposits, with a fair value of approximately $940 million. The acquired operations and expenses of Metropolitan since the date of acquisition are included in our third quarter 2017 reported results. Focusing on our balance sheet, total assets at September 30th, 2017 were approximately $10.3 billion as compared to approximately $8.7 billion at December 31st, 2016. Total loans were approximately $7.4 billion at September 30th as compared to $6.2 billion at December 31st, 2016 and $6.4 billion at June 30th, 2017. Excluding loans purchased in previous acquisitions, loans grew to $5.3 billion at September 30th, 2017, as compared to $4.7 billion at December 31st, 2016, and $5.1 billion at June 30th, 2017, which represents an annualized growth rate of 18%. Total deposits were $8.1 billion at September 30th, 2017 as compared to $7.1 billion at December 31st, 2016. Our non-interest-bearing deposits averaged approximately $1.7 billion or 22.40% of average deposits for the first nine months of 2017 as compared to $1.4 billion or 21.79% of deposits for the same period in 2016. Our cost of total deposits for the third quarter of 2017 was 33 basis points as compared to 27 basis points for the same period in 2016. Looking at our capital ratios at September 30th, 2017, our tangible common equity ratio was 9.03%. Our Tier 1 leverage GAAP ratio was 10.05%, our common equity Tier 1 risk-based capital ratio was 11.21%, our Tier 1 based capital ratio was 12.25%, and our total risk-based capital ratio was 14.29%. Our regulatory capital ratios are all in excess of regulatory minimums that are required to be classified as well capitalized. Net interest income was $90 million for the third quarter of 2017 as compared to $75.7 million for the third quarter of 2016. Net interest margin was 4.08% for the third quarter of 2017 as compared to 4.15% for the same quarter of 2016. Our net interest margin adjusted for our purchase accounting adjustments on loans and income collected on problem loans was 3.76% for the third quarter of 2017 compared to 3.72% for the same quarter in 2016. Our non-interest income is derived from diverse lines of business, which primarily consist of mortgage, wealth management, and insurance revenue sources along with income from loan and deposit products. For the third quarter of 2017, non-interest income was $33.4 million as compared to $38.3 million for the same quarter in 2016. Mortgage banking income for the third quarter of 2017 was $10.6 million compared to $12.4 million on a linked-quarter basis as light mortgage volumes declined in the third quarter from previous periods. Non-interest expense was $80.7 million for the third quarter of 2017 as compared to $76.5 million for the same quarter in 2016. Including non-recurring charges from merger and conversion expenses, non-interest expense remained relatively flat when compared to the third quarter of 2016. The contribution by Metropolitan was offset by decrease in data processing costs, which realized the contract renegotiations and expenses on OREO. Our continued focus on expense containment resulted in the achievement of an efficiency ratio below 60%, which has been a key long-term objective for us. Shifting to our asset quality at September 30th, 2017, our overall credit quality metrics continue to remain at or near historic lows in all credit quality metrics, including NPAs, loans to 30 to 89 days past due and our internal watch list on both a linked-quarter basis and when compared to 12/31/16. For more information on our financials, I'll refer you to our press release for specific numbers or ratios. In closing, we're pleased with our third quarter 2017 results, which are highlighted by record quarterly net income along with strong fee income, solid credit metrics, and a continued focus on overall expenses. Our performance along with the recent conversion of Metropolitan has provided us with great momentum as we enter the final stretch of 2017, which we believe positions us to experience another great year for our company. Now Brandon, I'll turn the call back over to you for questions and answers.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Michael Rose with Raymond James. Please go ahead.

Hey, good morning guys. How are you?

Good morning Michael.

Hey, just wanted to start on the loan side. The non-purchase growth was again pretty strong this quarter. Can you just give us some color? And can you talk about pipelines, both on the core side? And then if you could talk about Metropolitan specifically. I would think that with the bigger balance sheet, bigger lending capacities that might actually start to grow here?

Sure, Michael. I'm going to let Mitch answer that.

Good morning Michael. Current pipeline beginning the first -- fourth quarter is $190 million. That compares to $186 million prior quarter, $147 million prior year. If we break that down by state, 33% would be in Tennessee; 21% in Alabama, Florida; 29% in Georgia; and 17% in Mississippi. As to Metropolitan, in the state of Tennessee, they would be adding over 50% in West Tennessee. Middle Tennessee would be approximately 40% of that total, and in Mississippi and Central Mississippi, about 30% of that total. So, very additive to the pipeline as we look to the fourth quarter. And that $190 million should result in about $66 million growth in non-acquired outstandings within 30 days. If we just look at the production for 3Q, production was around $395 million. That resulted in at $235 million or about 18%, as Robin mentioned earlier, growth in non-acquired. Metro production, that total would be around 16%, which was reflective of what they were contributing to the pipeline at the beginning of 3Q. And we do expect continued growth from the Metropolitan group naturally, so we go into fourth quarter as they make up about 30% of our current pipeline.

Okay, Mitch. So, just to follow-up on that, it seems like the core pipeline, ex Metropolitan might be down a little bit, but that's obviously in the fields of pretty decent growth in the quarter.

Yes, we -- I'm sorry.

Go ahead Mitch, I'm sorry.

Yes, we typically see as we go into 4Q, the pipeline pull back. That's fairly typical. But as you can see this year, going into the fourth quarter, we are continuing with a strong pipeline. And to your point, Metropolitan is very additive to that. But if you go back to the production of 3Q and if you look at the pipeline as I went through the percentages, we do continue to see good pipelines around all the geographies, particularly in the commercial business lines. There was strong contribution there in 3Q from that group and looking forward to 4Q, we see that as well.

Okay. And then maybe just one follow-up. I guess I was a little surprised with the magnitude of the drop in mortgage income. If you guys could just give us more color to what happened there and maybe what the outlook is as we move into next year, given the MDA's forecast. Thanks.

Sure, Michael. This is a Jim. Really most of the decline in our mortgage income can be attributed to locked volume. In the second quarter, our locked volume was $706 million. That was versus the $571 million in locked volume for the first quarter. So, for the second quarter, our pipeline built quite a bit and had an impact on our mark-to-market adjustment. In the third quarter, our locked volume slowed somewhat, particularly into September. Our locked volume for the third quarter was $649 million, still stronger than the first quarter, but down from the second quarter. And that did result in a downward non-cash adjustment to the mark-to-market on our pipeline. As far as our closed volume, it was really strong for the third quarter. Over closed volume was $559 million versus $526 million in the second quarter. Our margin was a 2.11% for the third quarter versus a 2.19% for the second quarter, but that can primarily be attributed to our third quarter closings; 44% were wholesale versus 40% in the second quarter and obviously, our margins on wholesale volume are lower. And so we believe that the decline in the margin was really more attributed, just a change in mix and the closed volume. But we also had a strong month in sold volume. We sold $507 million versus $384 million in the second quarter. So, really you can boil it down to -- that difference was the fact that we had a large positive adjustment to the pipeline in the second quarter and a large negative adjustment to the pipeline in the third quarter.

Any change in the retail versus -- the refi versus purchase mix?

Yes, good point. Pretty much this year -- for this year, our refi volume has been fairly consistent. It was 32% in the first quarter, down to 23% and 24% in the second and third quarter. That's compared latter part of 2016, we were around 40%. So, obviously, the increase in rates has had an impact on the refi volume. And of course, we were out recruiting the originators. We're primarily focused on recruiting those originators that big -- primarily purchased volume. So, -- we tried to address that by trying to load our staffing more with the purchase volume type originator. And kind of talking about is the third quarter, a good run rate going forward, I certainly hope not. I think the pipeline adjustment did have an impact on that. We shouldn't continue to see that. Our locks for the first half of October had been really strong. We've been pleased with that, they have been up. They did drop off in, like I mentioned, in September, but we have seen a resurgence in locks into October. We do have a pretty good stable of approach [ph] right now. We've brought a number of new originators on in the last 30 days or so. We probably have another 10 to 15 that are -- should be coming onboard. You never know until they actually come, but it made bearable commitments that they will be coming in the next 30 to 60 days. We don't, at this time, anticipate any attrition from our existing team, so we believe we will be able to continue to increase our originators by maybe 10 to 12 over this next quarter as we have been doing over the last few quarters.

That's great color. Thanks for taking my questions guys.

You bet.

Thank you, Michael.

Next question comes from Catherine Mealor with KBW. Please go ahead.

Thanks. Good morning.

Good morning Catherine.

Quick question on the margin. Your deposit data seems really still very low this quarter, but I mean I would assume it still was impacted by Metro. Is there -- can you give any color as to how much of the increase in your deposit cost was related to the Metropolitan deal? And so what's the kind of core deposit data might have been?

Hey Catherine, this is Kevin here.

Hey Kevin.

Looking at our deposit cost, also our cost of fund, let's talk about the deposit cost first. We -- our deposit cost increased five basis points, and there's really two primary drivers of that increase. One, Metropolitan, Metropolitan, their cost of funding or their cost of deposits were higher than our legacy cost. Really, you can chalk up two to three basis points of our cost of deposits increase, specifically to Metropolitan. The other two basis points will just come to movement in our own deposit cost. Beginning in late Q2, we started to see some aggressive pricing of deposits and we have to react to that to protect our core. And so that -- as well as we did see a rate increase at the end of Q2. So, we were expecting our cost to come up. They did go up two bps. The other two to three bps can be attributable to Metropolitan. And that holds true if you look at our cost of fund. If you look at our cost of fund, the -- our cost of funds were up six basis points. Again, two basis points for our legacy cost, two basis points for Metropolitan. And then also if you look at our mix of our funding, we did rely a little bit more on FHLB borrowings during the quarter. They are up about $350 million and that is at a market rate, which is going to be higher than our deposit cost. And so that contributed to about two basis points. So, mix, that six basis points on cost of funds, you can add in another two basis points just for the mix change on the borrowing side.

Okay. And so what's your outlook for the margin moving forward?

Yes. So, I will say, we're -- I think we're going to continue to have upward pressure on our funding cost. I think that's real now. I do think though that our deposit base will respond better than the average. I still think our deposit betas are responding better than most of our peers. Our deposits are being sticky. And we've been very proactive in focusing on changing mix as we have to combat rate. It's really getting more of our customers' deposits as well as continuing our focus on mix. If you look at our non-interest-bearing DDA, it's now over 23% of our total funding. That's up from Q1 and Q2. That's something we'll continue to focus on. How that translates in the margin? If we look at -- if we look at our margin, excluding the purchase accounting, it did drop about eight to nine basis points. So, core margin, it's down about eight to nine basis points. Really, that's all attributable to Metropolitan. Metropolitan margin was in the 3.20%, 3.25% range. And you add them to us, just simple math; it's going to bring the average down. It brought -- but they -- just adding their margin to ours, it dropped our margin seven to eight basis points. So, our core margin is flat to down maybe a basis point. And for Q4, I would expect a similar type result. It's in the flat, maybe some downward pressure, but flat if we don't see a rate movement. If we see a rate movement, there could be an opportunity for some expansion in the margin.

Okay, that's helpful. Thank you.

Our next question comes from John Rodis with FIG Partners. Please go ahead.

Good morning guys.

Good morning John.

Hey Kevin, just a follow-up. Your comment on the margin, that was -- you said the margin would be flat in the fourth quarter on a quarter basis, correct?

Quarter basis, correct.

Okay, so excluding purchase. Kevin, maybe just another question for you, just the operating expenses for the quarter came in better. If you strip out the M&A cost, it came in around $74 million. And I think on the second quarter call, you were talking around $78 million to $79 million. So, can you talk about the difference there?

Yes, so a couple of things. One, I would just continue to complement our team for their ability and their focus on expense containment and control. We've really -- since going back to Q3, Q4 of last year, we've had flat expenses and some pretty significant revenue growth, and that's what's leading to the downward trend and efficiency. But several things are -- several things have occurred based on events that started last year. One, contract renegotiations, we highlighted the data processing cost. If you look at data processing cost, we're trending downwards for Q2. They bumped up in Q3. That's really just duplicate data processing cost with Metropolitan. That's a cost save that we will realize in Q4 if that comes down. So, our data processing costs are relatively flat, even including Metropolitan. Our -- if we look at other operating expenses, if you'll see, they're down the most. And it's a lot of little -- not any one specific item, there's a lot of little pickups in that other operating expenses. Legal and professional fees are down $300,000 to $400,000. Mortgage with mortgage production being down, some of our mortgage expenses are down. Total mortgage expenses are down about $1 million. And other operating expenses, that would be about $500,000 to $600,000. Some of our communication and our public relation expense is down $0.5 million. So, it's a lot of little that adds up to that decrease. So, we think that our expense rate -- with our expense initiatives on the Renasant side, our growth initiatives on the revenue side and still the opportunity to receive more cost saves coming out of Metropolitan as we get into Q4 and Q1 of next year, really like the trend of our expenses over this year, particularly this quarter and are positive about their outlook as we look at Q4 and Q1.

So, this quarter was $74.4 million without the merger charges. So, are you saying you can go -- I mean, can you go -- is the trend lower? Is that a good number to work off of, assuming you get some more cost saves out of Metro? Or -- and then I guess, part of that offset is if mortgage is better, is that correct?

Yes, so if mortgage picks up, expenses will go up. If mortgage banking income goes up, that will go up. But I would expect with an uptick in mortgage and some of the cost saves that were realized that are expense rate in Q4 will be up slightly from its current levels.

Just moving -- the tax rate, Kevin that jumped up to effective rate was 35%. That was up from, I think, 32%, 33% in second quarter. Is 35% a better number to use going forward or how should we think about that?

For the year, it will be in the high 33s, low 34s, picking up the Metropolitan income that did move us up on the tax bracket. So, a little bit of catch-up there, a little bit higher effective tax rate, but we think that will normalize a little bit in Q4. And that was really to get our effective tax rate in the high 30 -- for the year and a high 33, low 34 frame.

Okay. And as we look to 2018, assuming nothing out of Washington; is 34% to 35% a better tax rate or--

Well, 34% to 35%, I would say it's a better tax rate. It will be -- it will be an excellent tax rate. I do think that 34% -- the 34% range is what I would anticipate our effective tax rate to be without any change in statutory tax rates at the federal level.

Okay. Fair enough. Okay, thanks guys.

Thank you, John.

Our next question comes from Matt Olney with Stephens Inc. Please go ahead.

Hey good morning guys. This is Matt Sealy on for Olney.

Hey Matt.

I want to circle back to mortgage. So, in the earnings release, I think it mentions a reduction in housing supply in a number of your markets. Can you elaborate on this, providing the other commentary?

Yes, Matt, this is Jim. And I don't have any numbers to share with you on that. That is anecdotal. Evidence we've received from our originators in different markets, particularly the metro markets, we did -- we have talked with some of our competitors in those markets and they said they have seen the same thing, just hard to find that we'll have a borrower. It's pre-approved, shopping for a house and are having difficulty finding a house of their choice. And that's basically where that came from; it's the feedback we're getting. And again, particularly in our metro markets, the land of Birmingham, National Memphis, those markets.

Okay, I appreciate that. And with $10.3 billion assets now, do you think that you guys can manage this below $10 billion on October -- or excuse me, December 31st? Would you consider maybe down throughout 4Q to stay below that $10 billion threshold? And if so, how much would the save in Durban in 2018?

Hey Matt, Kevin again. That's something that we're looking at. It's really something that we considered as we look at Metropolitan acquisition and the fact that it would put us above $10 billion. And what it come -- what really boils down to is what assets can we convert to cash, what yield would we give up, what spread would we give up and does that offset, is that -- what will be more beneficial, to give up the yield, to retain Durban for another year? And that's best analysis that we're going through. The impact of Durban for us is going to be in the $8 million to $8.5 million range of pretax annually. And so where we currently are being at $10.3 billion -- as we look at our -- as we look at assets that we could convert and possibly sell, there will be an income give up to do that. Another thing that we have to factor in is it's not just a matter of converting that asset to cash; we actually have to reduce the liability. We got to delever the balance sheet. And we have had an internal focus for several years of core deposit origination. And so really, if you look at our borrowings, we have about $300 million to $350 million of FHLB borrowings that we could possibly delever, that we could use to pay down as a deleveraging strategy. But I just say that only because we don't have much leverage on the liability side. So, something that we're looking at. It's something we would not rule out, but it has to make economic sense for us to do that. And if we look at selling $300 million in earning assets that have a 3% spread, that's $9 million of pretax income that we would give up to save $8 million of pretax income. So, it's just -- it's something we'll look at and continue to build and have -- build our balance sheet to have some optionality and flexibility, but it's really going to come down to the economics and what we give up versus what we retain. As it relates to other costs associated with going over $10 billion, I think we discussed this in the past. We've been preparing for that, whether a higher level of regulatory rigor or DFAST. We've already embedded some of those expenses in. We got processes in place to be prepared. We are in the process of doing a mock stress test, even though we would not be required to submit anything for another 18 months to two years. I don't think -- we're not going to try to do anything that would cause a delay in those expenses or those initiatives because we feel they'd be heading our way, whether we're over $10 billion or not. It's really just a matter of preserving that Durbin Amendment interchange income, which really comes down to give up in yield versus retaining the interchange fees.

Right. No, it's fair. And on the other DFAST-related cost, what's already been accrued for? How much is left? Would you guys say you're in the later innings or still kind of middle innings of building out that DFAST team?

I'd say we're in the later innings. I mean, we are -- there's still incremental cost that we incurred to complete, the actual DFAST. There's incremental cost that we will incur as we have higher levels of regulatory scrutiny. But for the most part, the majority of our expenses -- we've already incurred a significant amount of our expenses, whether it's on the IT build, whether it's on infrastructure build, whether it's databases, data warehouses that we build. Those expenses are already in our run rate. We may have a small amount with some consultative work that we're doing, some outside help that we're using, but we've already had those groups engaged in excess of a year now.

Okay, great. I appreciate it guys. That's it for me.

[Operator Instructions] Our next question comes from Andy Stapp with Hilliard Lyons. Please go ahead.

Good morning.

Good morning Andy.

Just have a follow-up question on other non-interest expense. How should we think about Q4's other non-interest expense? Is -- and just wondering if Q3 is good run rate for modeling purposes.

Yes, I would say that it's a good baseline. It may increase a little bit just as we have some volatility in mortgage. There are some mortgage expenses tied to mortgage originations that flow through that line item. So, they -- it could be higher than where it currently is, but I think that's a good baseline to work off of.

Okay. And did you have any cost savings related to Metropolitan in Q3?

We did. So, we've incurred -- we are on target with our total cost saving initiative. And what we targeted with, Metropolitan. I think we targeted 37.5%. With that, we would realize 75% of those in the current year in 2017 and then we'd realize [Indiscernible] as we get into next year. Right now, just through Q2, I think we're a little bit ahead of those realizations. Our total realizations were slightly ahead. We're more on the 38% side of that 37.5%, but our realization rate is a little bit ahead of schedule. Just through Q3, we're about 70% realized on those and we're realized -- and that's -- we did not convert Metropolitan until late September. So, we had a significant amount of duplicate cost in Q3 that we won't have in Q4 just being post-conversion.

Okay. All right. Thank you.

Thank you, Andy.

This concludes our question-and-answer session. I would like to turn the conference back over to Robin McGraw for any closing remarks.

Thank you, Bran. Thank you, everybody. We appreciate your time and your interest in Renasant Corporation and look forward to speaking with you again next quarter. Thank you.

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