Trustmark Corporation (TRMK) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Trustmark Corporation’s 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. [Operator Instructions] As a reminder, today’s call is being recorded. It is now my pleasure to introduce Mr. Joey Rein, 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 the 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 would like to caution you that these forward-looking statements may differ materially from the 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 will turn the call over to Jerry Host, President and CEO of Trustmark.

Thank you, Joey, and good morning, everyone, and thanks for joining us. With me this morning are, Barry Harvey, our Chief Credit Officer; Louis Greer, our Chief Financial Officer, and Tom Owens, our Bank Treasurer; We had a very solid quarter in the second quarter. Although, I’ll tell you there was a little bit of noise and hopefully we can help clarify that as we go through this presentation. We reported net income of $24 million or $0.35 per share in the second quarter. There were several non-routine items, I’d like to call to your attention. First, we terminated our defined benefit pension plan during the quarter, which reduced after-tax income by about $11 million. Second, we had charges related to our merger with Reliance Bank in Huntsville, Alabama and that reduced our net income by about $2 million. And then in addition, we received non-taxable proceeds related to a life insurance policy we acquired as part of a previous acquisition that increased net income by about $5 million. Adjusting for these three items our net income in the second quarter was $32 million or $0.47 per diluted share. I’d like to briefly provide you with an update on our strategic priorities, which are on Page 3 of our presentation. We continue to make advancements regarding profitable revenue generation. Loans held for investments increased $291 million or 3.6% from the prior quarter and $891 million or 12% year-over-year. Revenue, excluding interest income on acquired loans and the life insurance proceeds totaled $141 million, up 1.9% from the prior quarters and 6.4% from the prior year. FTE Net interest income, excluding acquired loans totaled $100.7 million, up 3.5% from the prior quarter. We completed, as I mentioned earlier, our merger with Reliance Bank on April 7 and had a seamless operational conversion and integration process. The estimated fair values of loans and deposits acquired were $117 million and $166 million respectively. Our efforts to manage expenses and improve processes were clearly evidenced in the quarter as core deposits – core expenses, which exclude ORE expense and tangible amortization merger charges and pension plan termination expense remained well controlled. Core noninterest expense in the second quarter totaled $99.3 million and compares favorably to the $98.7 million in the prior quarter, particularly when you consider the additional ongoing operating expense from the Reliance merger that closed on April 7. We did experienced an increase in non-performing loans during the quarter. The increase was primarily the result of a single healthcare-related credit moving to non-accrual status. Other real estate however continued to decline and recoveries exceeded charge-offs. I’d now like to call on Barry Harvey to maybe discuss loan growth and credit quality in a little bit more detail.

Thank you, Jerry. Looking on Page 4, you can see that we had continued strong diversified loan growth during Q2, as well as you can see year-over-year, both from a type and a geographical standpoint. We are very excited about that and pleased. The year-over-year growth kind of breaks down along the lines of CRE is about 53% of that growth, C&I 19%, public finance, about 15% and then some owner occupied growth state was about 4%. So, as indicated, it’s well diversified as it relates to the various product types. Our energy book was pretty steady during the quarter. We had a reduction in the exposure. Couple of loans paid off and moved out the company. From an outstanding standpoint, it was fairly flat. It still remains a modest part of our overall book at around 3% of outstandings. Looking on to Page 5, as Jerry indicated, we did have one large new non-performing credit of roughly $14 million. So therefore, all of the increase of $12.8 million is attributable to that one credit. It is in the healthcare area. And specifically it’s in the long-term acute care hospital management and owner type of entity. We unexpect we had a Chapter 11 bankruptcy filing. Therefore, once we dug into that a little bit, we made the determination that the credit should be on non-accrual. Therefore we moved it there. From a reserving standpoint, we still have the pull reserves associated with that credit as a sub-standard credit and then we will go ahead and true that up as we get into the latter part of Q3 once we get some updated values. As it relates to ORE, that’s a very positive story that we had a reduction of $6 million during Q2. We sold $8 million worth of property and had a – and we had a gain on sale of roughly $1 million on those $8 million worth of properties we sold. We were very pleased with that. Gross charge-offs obviously are benign, had some nice recoveries. Therefore we wouldn’t have recovered for the quarter. Overall loan loss reserves remains adequate. Ticked up one basis point this quarter, but it just remains in line with what we believe to be the risk embedded in the portfolio today. If we look over on Page 6, you can see on our acquired loans, we had a yield of 7.96%. A little bit of that is reduced by a few recoveries we had of 1.2% of that 7.96%. We do expect to see our yields going forward into Q3, being at 5.5% to 6.5% range for our acquired book. During Q3, we also expected to return back to, maybe a $20 million to $30 million reduction in outstandings. We did obviously trend up this quarter by $97 million as a result of the Reliance acquisition, which added in $117 million at the time of the consolidation. But we also continue to see some pay downs or payoffs and that netted out to be $97 million increase for the quarter. Jerry?

Very thanks for the update on loans growth and credit quality. One of our greatest strengths is our low cost core deposit franchise. And I believe that, it will be a distinguishing factor in a rising rate environment and thought we would go into a little bit more detail about where we are with our deposit base. So I’d ask Tom Owens, if you could talk about our deposits and the net interest margins.

I’d be happy to Jerry. Turning to Page 7, total deposits increased $319 million or 3.2% during the quarter. Excluding the Reliance merger, deposits increased $153 million or 1.5% from the prior quarter. We continue to maintain a favorable mix of deposits with 30% non-interest bearing deposits and roughly 60% of deposits were in checking accounts. Our cost of deposits rose four basis points during the quarter to 20 basis points, which represents an effective deposit beta of about 16% relative to the Fed’s March rate hike. Let’s turn our attention to revenue on Page 8. FTE net interest income totaled $107 million in the second quarter, up $4.5 million or 4.4% from the prior quarter, which resulted in a net interest margin of 3.49%, unchanged from the prior quarter. Excluding acquired loans, the net interest margin was 3.37%, down one basis points from the prior quarter. Louis will provide an update on noninterest income.

Thanks, Tom. Let’s continue on Slide 8 in noninterest income. You can see our diversification in the chart there and I’ll tell you that total noninterest income equals $50.2 million in the quarter, but when you exclude the life insurance proceeds, we had $45.3 million in the second quarter, a slight decline from the previous quarter of about $700,000. The primary driver of the decline was decreased mortgage hedges backing this. Still our mortgage business posted a really strong quarter generating revenues of $9 million. The production in the quarter totaled about $373 million, up about 23% from the prior quarter. Now let’s turn to Page 9 and look at noninterest expenses. Noninterest expense remained, as Jerry mentioned earlier, remains very well controlled with routine noninterest expenses that exclude ORE and amortization of intangible and the one-time charges that Jerry mentioned of little over $99 million in the second quarter. We continue to prudently manage expenses along with revenue growth experienced during the quarter. We resulted in an efficiency ratio of slightly under 65%, while we are pleased with the progress we made, we will remain focused on expense management. We will continue to realign branches and delivery channels and make investments to enhance our customer experiences. And as you can see on Page 10, we have ample capital to explore growth and are focused on the most attractive methods of capital deployment whether that be through loan growth, dividends or repurchase of stock. So, Jerry, back to you.

Louis, thank you. At this time, because that the discussion we’ve had to go with the second quarter results has been helpful. But at this time, we’d like to open it up for any questions that you might have.

[Operator Instructions] And our first question today comes from Brad Milsaps from Sandler O’Neill. Please go ahead with your question.

Hey, good morning guys.

Good morning, Brad.

Louis, maybe I could just follow-up, maybe on some of the expense commentary. I know you’ve got a lot of moving parts heading into the third quarter. I know when you announced the Reliance acquisition, you said you are going to make some investments there. So there might not be a lot of cost savings, but I am sure you will get some and then you’ve got the pension piece. Just want to get a better sense of, if you feel like you can kind of hold expenses at this level or do you have the ability to take that lower over the back half of the year, the core number?

Brad, I will tell you that the core number for the quarter is little over $99 million. But I will tell you, we acquired Reliance Bank on 04/07. So we still have some additional expenses to occur related to fully loaded for the quarter of growth to last and I’ll tell you in the third quarter, we do have seasonal revenues in our insurance area because of particular line of business. We have a high watermark. So, we do expect commissions to rise in the third quarter and I will tell you, we expect to have a little bit higher salary benefit runrate, specifically because of few increases in a number of headcount, as well as some incentive accruals or benefit accruals. So, I expect that we are going to be able to keep that runrate around $100 million, maybe around $101 million as we move forward. Again, excluding ORE and amortization of intangibles. So, I expect that $100 million more for core expenses in the third quarter.

That’s great. That’s helpful. And then, maybe Tom, just, a little more color maybe on the margin. In this quarter were there any big impacts of loan fees or prepayment penalties or anything like that that would affected loan yields? And I appreciate the discussion around the total cost of deposits, but some of the – it looks like, some of the interest-bearing categories are maybe up a little bit more. Just, any color around kind of customer demand, customer behavior in terms of kind of what you are seeing on the interest-bearing side of things?

Yes, thanks, Brad. So, essentially what we experienced, well, let me back up. You think about the guidance we gave back in January for the year, where we are projecting very modest compression in core net interest margin, call it, mid single-digit basis points. And we talked about how there maybe some upside to that to the extent that our realized deposit betas came in at lower than modeled. That is essentially what you’ve seen year-to-date. And so, basically, whether you look at a year-over-year or on a linked-quarter basis, you see increases in loan yields basically being offset by increase in deposit costs. I would tell you that, as you would intuitively expect, as far as realized betas, personal, consumer, betas are very low. Commercial, larger account are somewhat higher and then the largest betas we are actually experiencing are in public fund deposit category, although that’s a relatively small portion of the deposit base. So, in terms of guidance going forward, not much has changed in terms of the composition of the balance sheet. So it continued to be the case. We are projecting it relatively flat to modest declines in core net interest margin. But again, because of earning asset growth of mid to high-single-digits, core earning asset growth year-over-year, you should expect to continue to see mid to high-single-digit core NII, net interest income growth year-over-year.

Great. That’s helpful. Thank you, guys.

Thank you, Brad.

Our next question comes from Michael Rose from Raymond James. Please go ahead with your question.

Hey, good morning guys. How are you?

Good morning, Michael.

Hey, I just wanted to dig in a little bit to the healthcare credit. I know you gave some color, but can you just remind us as to what the size of the healthcare portfolio was at this point and if you have any broader concerns about the healthcare space at this point? Thanks.

Michael, this is Barry. Let me give you a little bit more color on the credit itself. Here again, this is a private company who is in the business of managing and owning these long-term acute care hospitals. We are monitoring the credit obviously, like all the credits in the portfolio very carefully. This was very much something that came out of the blue for us. We know that – we are very familiar with the regulatory changes and the environment. The various areas within the healthcare industry are facing them and their challenges and benefits to changes are all different. But in this type of case, this was one where there was really no early indicators from a financial standpoint of any distress and therefore the filing was a little bit of a surprise to us. It is a participation. We’ve got four of the banks, three of the banks the size ourselves involved and when the filing occurs, we just got to the bottom of what we can find out about what why it happened. Now we are moving through the bankruptcy process. And there will be hearings as you can imagine starting up next month and we’ll be very actively involved in that and then we will just see where it goes from there. We will be getting updated values on all of our real estate as part of the impairment process that will formally be done in Q3. And as I mentioned earlier, we did retain all of our reserves that came to our pooling process as a substandard credit. So, we feel like that we are in pretty good shape from a valuation standpoint. But as we get the updated values, we will be able to determine for sure where we are and of course, either release reserves or use reserves as we rise – as we adjust the credit to the appropriate size. As it relates to our healthcare book, from an outstanding standpoint, we are about $547 million and that’s going to be about 41% of risk-based capital. Having said that, it’s very diverse in terms of the types of healthcare customers we have from nursing home facilities to physician offices, just the routine typical general medical and surgical hospitals, specialty and hospitals at similar to ones we just talked about there on that one particular credit. Then there is going to be a number of other type of emergency type centers that are involved in that mix. So, some of those have been held by changes that have occurred over the last several years. Some of them have been impacted more, but most all of our customers have done a really good job, just like in the energy space. Our healthcare customers have done a good job of adjusting their expense base relative to the changes in reimbursement and things of that nature. So, we are very comfortable. We took a little look into the portfolio, specifically after this one popped up, looked at about 55% of the exposure, about 58% of the outstandings on the higher larger credits. Didn’t see anything that concerned us, didn’t make any great changes, didn’t make any accrual status changes. So, we did look at it to see if there was something we were missing as it related to the one that popped up and we didn’t see anything to that effect. What we saw was companies who were running their business and taken the appropriate actions based upon changes in their industry just like we have in the banking industry, as well as the energy sector. So, we felt very comfortable with our healthcare book.

Hey, that’s great color. Maybe just one more for me. And I guess loan growth this quarter was pretty strong. Can you talk about, as we look forward, kind of where your pipeline stand at the end of the quarter versus where they were maybe at the end of the first quarter? And it also looks like ex Reliance, ex the addition of Reliance, you guys definitely added some FTEs this quarter. Just wanted to see if any of those revenue producers and how that would play into loan growth as we think about it in the back half of the year? Thanks.

Barry, once you comment on loan growth and I’ll comment on the additional FTE.

Sure, I’d be glad to Jerry. And as mentioned earlier, Michael, what we were very pleased about, especially this quarter, and even year-over-year and really since we started seeing some real uptick in growth back the very beginning of 2014 is the diversity in the portfolio. In Q2, we saw on the C&I side about $94 million worth of growth. That’s an area where, like all banks, we would love to see growth in that category and preferably well priced, but you can’t always have both. But nonetheless, we do see good solid growth on the C&I side. On the CRE side, we continue to see good opportunities. We continue to be very selective in – especially in certain categories. Obviously, multi-family is one, as well as hospitality that we are very selective and – but the quality of the deals remain very solid. The pricing is actually improving in the CRE book – CRE opportunities we are seeing. So we are very pleased with that and we are pleased with the diversity of the geographical make-up of the increases we saw in Q2, as well as year-over-year. We are seeing some opportunities and some public finance areas throughout Mississippi and Alabama. And then, we are continuing to see opportunities on the construction side, as well as the existing side of CRE.

And then, Michael, as far as the FTE adds, you are exactly right. The adds has been in revenue producing areas. Three areas primarily. First, the mortgage company, we have added new originators in some processors, but primarily originators in the Alabama and the Florida markets. Next on the insurance area, we’ve been adding new producers and existing producers in terms of bringing them into the company and as you know, in that business, most businesses, most insurance agencies are set up with non-competes. So it takes a couple of years to get through that. But as we look at pricing multiples for insurance agencies out there, they are relatively high when compared them on a historical basis. So we’ve chosen to grow through adding and hiring both existing and new brokers to that business. And then, now the third area is in the lending area where we just continued to add CRMs in certain markets where we see growth possibilities as we just don’t have the lenders in our existing areas. So, those are the three areas. On the other side of the fence we are continuing to try to find ways to improve productivity and improve our processes, but as we can reduce some of the operating expense areas. And then, also continue to look at our branch distribution network to see if there are opportunities to improve that yet continue to protect this customer, this customer and deposit base.

Thanks for the color. Maybe just one quick one. What do you guys expect the tax rate to be for the rest of the year? Thanks.

This is Louis, Brad. I think, we expect that to – oh, Michael, I am sorry, excuse me. I expect that tax rate to stay in the low 20s somewhere around 20%, 22%.

The anomaly was caused by the life insurance proceeds which was tax exempt and we had a revenue. So that’s what’s dropped in for the quarter.

Yes, in addition, Jerry, I think we reinvested in the tax credit that added to that reduction in the effective tax rate as well. I think we had a tax credit that’s benefited by a couple others out.

Going back up in the low 20s.

Low 20s. Okay, appreciate it.

[Operator Instructions] Our next question comes from [Indiscernible] Please go ahead with your question.

Thanks, good morning.

Good morning, Brian.

Just a question on the loan growth, again on the C&I growth in the quarter was, was it new credit contentions? Or you did see any pick up in line utilization?

And Brian, this is Barry. It was a combination. We did see some – we did see quite a bit of new opportunities that were fully funded as they came on the books and then we did see some funding up of some other credits that were already existing facilities. But it was well-diversified in terms of industries, industries that we do routine business then and very familiar with. So, it was pretty much Mississippi, Tennessee and Alabama on the C&I side that drove the growth that we experienced. But we were very pleased to see that pick up. First quarter, we didn’t see a lot of growth on the C&I side and that really was the same in the fourth quarter of 2016. So, to see it pick up, we were very pleased with that. Hope that trend will continue.

Great, great. All right. The other question on the other real estate owned, you had nice dispositions there in this quarter and I guess some gains. Barry, if you – can you apply the pricing that you saw this quarter? And does that imply maybe some future gains in the coming quarters?

And I guess, Brian, from that perspective, what we see and we’ve kind of always looked at is, is that net number being in that $5 million range. So far this year, we’ve seen about $2.2 million worth of net ORE expense or in this particular quarter, Q2, we saw a little reduction in expenses and we saw a little pick up in the gain on sale versus Q1. So, between the combination of the two, that resulted in the – basically the improvement about $1.3 million, $1.4 million, quarter-over-quarter. We would continue to expect to see some opportunities for some gains on sale as we go out through the rest of the year and we are very hopeful that the expense side as we began continue to lower the amount of ORE procuring the expense side will come down as well. So, I think we guided in the past around a net ORE expense of around $5 million. We are about $2.2 million, $2.3 million through the first six months. So, I think we still feel comfortable with that, but we obviously are going to work hard to see if we could pick up some additional gains on sale and keep reducing the expense side.

Great. That’s all I had. Thanks for taking my questions.

Thank you.

[Operator Instructions] And ladies and gentlemen, I am showing no additional questions, I now like to turn the conference call back over to the speakers for closing remarks.

Thank you. This is Jerry Host, and let me say thank you to everyone who joined us this morning. We appreciate your interest in Trustmark. And our opportunity to review our second quarter results. We look forward to discussing third quarter results in late October. So, until then, again thank you for your interest in Trustmark and we will see then.

And ladies and gentlemen that does conclude today’s conference call. We do thank you for attending today’s presentation. You may now disconnect your lines.