Trustmark Corp (NASDAQ:TRMK) Q2 2020 Earnings Conference Call July 29, 2020 9:30 AM ET
Joseph Rein – SVP & Assistant Secretary
Gerard Host – President, CEO & Chairman
Robert Harvey – EVP & Chief Credit Officer
Thomas Owens – EVP & Bank Treasurer
Duane Dewey – President, COO & Director
Louis Greer – Treasurer & Principal Financial Officer
Conference Call Participants
Graham Dick – Piper Sandler & Co.
Jennifer Demba – SunTrust Robinson Humphrey
Catherine Mealor – KBW
Good morning, ladies and gentlemen, and welcome to Trustmark Corporation’s second quarter earnings conference call. [Operator Instructions].
It is now my pleasure to introduce Mr. Joey Rein, Director of Investor Relations at Trustmark.
Morning. I’d like to remind everyone that a copy of our second quarter earnings release, as well as the slide presentation that we’ll discuss on our call this morning, is available on the Investor Relations section of our website at trustmark.com.
During the course of our call, we may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and we’d like to caution you that these forward-looking statements may differ materially from our 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 Jerry Host, Chairman and CEO of Trustmark Corporation.
Thank you, Joey, and good morning, everyone, and thanks for being with us. Joining me this morning are Duane Dewey, President and Chief Operating Officer; Louis Greer, our CFO; Barry Harvey, our Chief Credit Officer; and Tom Owens, our Bank Treasurer.
During the second quarter, we remained focused on ensuring the safety of our customers and associates and supporting our local communities. We continued serving customers both remotely and through our branches, actively promoting digital touch points, including our ATM and ITM networks, as well as digital and mobile banking applications.
We continue to offer customers flexibility by providing waivers of certain fees and charges, granting extensions, deferrals and forbearance as appropriate, and pausing all foreclosures and repossessions. Through the SBA’s Paycheck Protection Program, we provided over 9,700 loans totaling $970 million to local businesses. I’m especially proud of our associates and the incredible dedication they showed working tirelessly to implement this program and help small businesses secure much-needed funding.
We are following better practices for the health and safety of our associates, including social distancing, required temperature checks, and face masks in common areas. Approximately 45% of our associates continue to work remotely, while some larger departments are working on rotating schedules. We limited vendor and public access to our corporate buildings and extended our employee travel policy. Additional actions are detailed on Page 3 of our investor presentation.
Moving to Page 4, let’s review some highlights from the quarter. Our results reflect the value of our diversified financial services business, as the strong performance in our fee income businesses more than offset interest rate headwinds. Noninterest income increased 6.5% linked quarter, driven by strong mortgage performance.
Our provision and expense for credit losses totaled $24.4 million in the second quarter due to macroeconomic uncertainties related to the COVID-19 pandemic. PPP loans totaled $970 million at June 30, 2020, before deferred fees and costs of almost $30 million.
Loans held for investments excluding PPP loans increased $92 million, or 1%, from the prior quarter and $450 million, or 6%, year-over-year. Our pre-tax, pre-provision income totaled $62.1 million, up 9.8% linked quarter and 21.1% year-over-year.
We maintained disciplined expense management, as core non-interest expense, including COVID-19 related costs, totaled $111 million in the second quarter, up less than 1% from the prior quarter.
Our credit quality remains solid, as nonperforming assets declined 12.3% linked quarter, reflecting declines in both non-accrual loans and other real estate. We maintained strong capital levels with a common equity Tier 1 capital ratio of 11.42% and a total risk-based capital of 13%.
The board of directors declared a quarterly cash dividend of $0.23 per share, payable September 15 to shareholders of record on September 1.
At this time, I’d like to ask Barry to provide some additional detail on PPP loans, loan growth and credit quality. Barry?
Thank you, Jerry. Turning to Page 5, you can see the bank has continued to actively participate in the Paycheck Protection Program and has been able to successfully assist a significant number of our local businesses who have been negatively impacted by the COVID-19 pandemic. Our PPP loans totaled $940 million as of June 30, and that’s net of the deferred loan fees and costs of $30 million. During round 1 and round 2 of the program, we originated 9,750 loans totaling $991 million worth of balances. Most of our PPP loans have been in the $350,000-and-less category, with our average size being roughly $100,000. We look forward to processing our borrowers’ forgiveness requests as we begin to take applications for forgiveness, hopefully sometime later next month.
Turning to Page 6, loans held for investment excluding the PPP loans totaled $9.7 billion as of June 30. That’s up $92 million, or 1% linked quarter. The growth was driven by fundings in our commercial construction loans. The loan portfolios remain well-diversified, both from a type and a geography. Looking over to Page 7, Trustmark’s CRE portfolio is approximately 2/3 existing projects and 1/3 construction land development. Of the construction land development book, 81% is construction. The bank’s owner-occupied portfolio has a nice mix between real estate types as well as industries.
Looking on over to Page 8, the bank’s commercial portfolio is well-diversified across industry segments. Typically, these loans are well-secured, governed by formulaic borrowing bases. They’re coveted to protect both the income statement and the balance sheet. On Page 9, you can see we have a minimum exposure to both restaurants and energy. Trustmark has never been in the higher-risk C&I lending business. Currently, we have 1 customer with $3 million in balances. The bank has always underwritten both its hotel and the retail CRE loans in a conservative manner. Recently, we’ve surveyed our material borrowers that are in the at-risk categories and, so far, have largely found them performing better than we anticipated.
Looking at Page 10, Trustmark continues to offer payment deferrals for all product types as requested by customers. We’ve been extremely successful in converting requests for full P&I deferrals to interest only. Those P&I deferrals that are required to be made have been limited to 90 days, giving us an opportunity to continue to update our information with the borrowers by keeping it on a shorter duration. At this point, the borrowers requesting a second round of payment concessions have not materialized at the level we anticipated, which we’re very encouraged by. July concessions are on track to be roughly half of what we saw in June.
Looking to Page 11, we continue to post positive asset-quality metrics. Nonperforming loans decreased 5.7% from the prior quarter and 5.5% year-over-year. Other real estate declined 26% from the previous quarter and 42% for the same quarter in the previous year. At July 30, our allowance for loan losses represented 1.23% of loans held for investment. Our reserve increases reflect the deterioration in the macroeconomic factors resulting from the COVID-19 pandemic.
Thank you, Barry. Now, as we turn to the liability side of the balance sheet, I’d like to ask Tom to comment on deposits and the net interest margin. Tom?
Thanks, Jerry. So turning to Page 12, deposits totaled $13.5 billion at June 30, up $1.9 billion from the prior quarter, primarily reflecting additional customer liquidity associated with the PPP loan program and government stimulus payments. By segment, growth was comprised of 48% in commercial, 40% in public funds, and 12% in consumer balances.
Our cost of interest-bearing deposits declined 34 basis points from the prior quarter to total 37 basis points as we continue to proactively reprice deposits in response to the Fed’s mid-March rate cuts. We continue making change a favorable deposit mix, as noninterest-bearing deposits rose to 28% of deposits at June 30, with 63% of deposits in checking accounts.
Our liquidity remains strong with a loan-to-deposit ratio of 78% at June 30 and reliance on wholesale funding of less than 2% of assets. Turning our attention to revenue, on Page 13, net interest income FTE totaled $108 million in the second quarter, representing a linked quarter increase of $947,000. Interest and fees on PPP loans totaled $5 million, while $103 million was core, which was a decline of $4.1 million from the prior quarter, as a reduction of $10.9 million in core interest income more than offset a decline of $6.8 million in interest expense.
Net interest margin in the second quarter of 3.12 declined by 40 basis points from the first quarter, while core NIM ex-PPP loans declined by 38 basis points. Approximately 20 basis points of the decline reflects the impact of lower interest rates, while 18 basis points is due to an increase in other earning asset balances, representing excess reserves held with the Fed driven primarily by an increase in public fund deposit balances, which is anticipated to be transitory.
And now Duane will provide an update on noninterest income.
Thank you, Tom. As shown on Page 14, our fee businesses posted strong performance in the second quarter. Noninterest income totaled $69.5 million, up 6.5% linked quarter and 40% year-over-year. For the quarter, noninterest income represented 39.8% of Trustmark’s revenue, demonstrating a solid diversified revenue stream. Our mortgage banking group led the way for the quarter, and we will discuss that in detail in a moment.
Service charges on deposit accounts decreased $3.6 million linked quarter due to lower NSF/OD fees. This reflects the impact of stimulus actions and a slowdown in economic activity due to COVID-19. Insurance revenues increased 2.8% linked quarter, driven by growth in property and casualty commissions. Also, in the second quarter, we completed the acquisition of Boyles Moak Insurance Services in Richland, Mississippi.
Our wealth management business was impacted by the equity market decline in the second quarter, as revenue was off 11.3% for the quarter, reflecting lower income from fee-based businesses. Turning to Page 15, our mortgage banking group had an outstanding quarter, as loan production totaled $853.3 million, an increase of 86.7% from the prior quarter and $106.1% year-over-year. Retail production represented 70.5% of volume, or $602 million, in the second quarter. The gain on sale of loans for the quarter totaled $34.1 million, which is an increase of $19.7 million on a linked quarter basis.
Overall, mortgage banking revenue in the quarter totaled $33.7 million, up $6.3 million from the prior quarter, a very nice quarter for mortgage. Louis will now cover noninterest expense and capital management.
Thank you, Duane. Let’s turn to Page 16. You can see that the detail of our noninterest expense is broken out between core and non-core. Core noninterest expenses, which included COVID-19 related costs of about $2.5 million, totaled $111 million in the second quarter, an increase of approximately $860,000, about [indiscernible] in the prior quarter, which was in line with our guides in the first quarter. The increase is principally related to higher mortgage commissions generated by significant increases in mortgage deductions of $853 million in the second quarter, as Duane just mentioned.
Non-core expenses totaled $7.6 million, reflecting $6.2 million in credit losses for off-balance sheet credit exposure as well as $1.4 million for amortization of intangibles, overall RE expenses and a few other non-core expenses of about $400,000. In the third quarter, we expect core expenses should remain fairly flat, depending on the continuation of COVID-19 and the continuation of strong mortgage deduction volumes in the third quarter.
Trustmark remains well positioned from a capital perspective, as noted on Page 17. Our capital ratios remain solid with a common Tier 1 ratio of 11.42 and a total risk-based ratio of 13% as of June 30, as previously mentioned by Jerry. The board of directors declared a quarterly dividend of $0.23 per share, payable on September 15 to shareholders of record as of September 1.
Now, Jerry, I’ll turn it back over to you.
Thank you, Louis. I trust that the discussion of our second quarter financials has been helpful. In closing, I’d just like to point out that Trustmark remains focused on providing support, advice and solutions to meet our customers’ unique needs during these unprecedented circumstances brought about by the COVID-19 pandemic.
Over our 131-year history, we have weathered many storms, and we remain well positioned to continue serving customers and creating long-term value for our shareholders.
At this time, we would be glad to address any questions that you might have.
[Operator Instructions]. And the first question comes from Graham Dick with Piper Sandler.
So starting off with PPP loans, you guys gave pretty good detail in the earnings release, but I was just wondering if you could provide a breakdown on what portion of that $5 million in PPP income came from fees versus what came from the 1% interest rate. I’m basically just trying to get an idea of how much of that $30 million in fees you have remaining.
Well, I’ll start. This is Tom Owens. So if I understand the question correctly, you’re trying to get a feel for the $5 million in interest income associated with the PPP loans in the second quarter. Again, as you indicated, it is a 1% coupon, but then we’re also recognizing over the life of the loans the net fees associated with the loans, so you end up with a higher yield, which is how you arrive at the $5 million in interest income for the quarter.
I guess just moving in towards expenses, did you all see an impact from deferred loan origination costs related to the PPP loans this quarter?
I’m sorry, would you repeat that question? I didn’t quite hear it.
In moving towards expenses, did you guys see any FAS 91 impact on personnel expenses from deferred loan origination costs related to PPP production?
Yes, I can answer that. I will tell you that we had a lot of costs associated that we have not capitalized immediate-term costs, because we expect that most of that would be amortized within the year, by the end of the year, so we have not recognized any internal costs associated with FAS 91 on these PPP loans because we expect to recognize almost all of the fees net of the hard expenses that we’ve paid out to folks by December 31. So it would be an inter-period expense by deferring costs and recognizing it in a very short period of time. And not only that, it would probably be an immaterial number as well.
And then just kind of sticking with expenses, it was obviously another really strong quarter for mortgage banking. Do you mind kind of outlining what kind of impact this had on compensation expenses this quarter, like what this kind of production had on those.
Well, certainly it was increased because of those volumes, and I would say it increased a couple of million dollars as a result of that production volume in the quarter.
And then, I guess lastly from me, what do guys kind of expect to see on the loan growth front for the rest of the year, excluding that PPP runoff? Have borrowers grown any more cautious recently with the recent headlines of an uptick in COVID cases, or has it kind of leveled off, I guess?
This is Barry. I think what we’ve guided to previously at the beginning of the year — of course, a lot has changed since then, but we were looking towards mid-single digit loan growth. I think we’re still on track for that. Q2 was a little bit slower than we would have anticipated, but obviously there’s a lot that went on during Q2 in terms of the pandemic and its impact on our borrowers. I do think that’s still a good barometer for us, is mid-single digit loan growth for the full year 2020.
Yes, excluding PPP. Right. From the standpoint of PPP, we’re really not — from a ratio standpoint, from any measurement standpoint, obviously, from loan growth, we’re not including the PPP in the denominator.
And the next question comes from Jennifer Demba with SunTrust.
Two questions. First, just curious about your pipeline in terms of the mortgage business for the third quarter. And then my second question, can you just give us some details about your trends in criticized and classified loans from first quarter to second quarter?
This is Duane Dewey. The pipeline in mortgage remains solid, fairly consistent with the second quarter to date, maybe down slightly. We’re expecting the third quarter in the maybe 90% range of the second quarter, but we’ve not seen a decline yet at this point in the pipeline, and it remains solid moving through the quarter.
And Jennifer, this is Barry. I would mention to you, as it relates to criticized loans, we were probably about 7 basis points up in the quarter-over-quarter, and on classifieds, we were probably down 16 basis points, so I would just call that flat, little to no movement in criticized and classifieds. We are actively reviewing our at-risk portfolios. We are, of course, having round 1 of the payment deferrals. We’re into round 2. We’re pleased with the level of round 2 we’ve seen thus far, and of course it’s early, relative to what we expected to maybe roll to round 2 from round 1.
And we’re monitoring that round 2 and all of the active portfolios to ensure that we’re getting the trades correct and keep them correct at all times, looking at that cash flow burn, seeing how long these customers can survive before hopefully we return to some level of normalcy in 2021. So we are very conscious about making sure those grades are accurate at all times. Thus far, between 331 and 630, we’ve seen no change in criticized and classifieds to speak of.
Would you envision there being a round 3 of loan deferrals for your customers?
I think there will be a round three, Jennifer. Under the CARES Act, as you know, we have the ability to go all the way to 12/31 as it relates to how TDRs are viewed. Obviously, the way we view TDRs and how we view risk rate changes and accrual status and things of that nature are unrelated. We’ll be grading the credits through the process of the year and making sure the grades are appropriate, the accrual status is appropriate.
Whether we get a little bit of relief from the CARES Act as it relates to what we classify as a TDR is important to us, but the main thing we want to do is work with our customers, so we had a round 1. We limited our customers typically to 90 days, and we did a very good job of avoiding as many full P&I deferrals as we could. About 42% of what we had requested in P&I full deferrals, we were able to turn into interest-only payments for 90 days. We feel very positive about the fact that they were able to continue to pay interest as opposed to needing the full deferral.
We had round one, which began in the very end of March. We’re into round 2 now. We will have round three in the fall and early winter and all the way through 12/31. Our focus is to continue to work with our customers where needed in order to give them an opportunity to kind of re-establish their businesses as we move through this pandemic and hopefully move towards some form of vaccine either later this year or sometime next year. But our focus is going to be to continue to work with our customers through this process.
[Operator Instructions]. And the next question comes from Catherine Mealor with KBW.
I just wanted to ask about the margin. If you kind of strip out the impact of the excess liquidity this quarter, how are you viewing your forecast for the margin? It seems like you made some really nice progress in lowering deposit costs, but at 37 bps you’re probably at, let’s say, on the low end. So I guess question 1 is how much room do you have on the funding side, and then 2, on your loan yields, what kind of downside do you see from where you sit today?
This is Tom. So I think there are a few questions there. I’ll start with how much room do we have to continue to lower deposit costs. So I would say that with respect to interest-bearing non-maturity, we’ve done a lot. That’s obviously the big driver of the linked quarter decline in our deposit costs.
From this point forward, most of it would come from the ongoing repricing of the timed deposit book, which ended at about 90 basis points or so as a weighted average coupon at June 30. We’re projecting that that will continue to go lower. Say 10 to 15 basis points per quarter over the next 4 quarters, would get you down into the neighborhood of, say, 40 basis points or so. And so as a result, that would take our interest-bearing deposit costs, say from the 37 basis points — it would cut it approximately in half.
Now, we’ll still continue to get some continued moderate pressure in our core net interest margin, because obviously you have the asset side of the balance sheet continuing to reprice with respect to securities, with respect to fixed-rate loans. I’m going to say that looking 4 quarters ahead, we’re projecting the decline in the securities yield to go from, say, 210 or so, where we were in the second quarter, down to about 180.
So you add all that up, and what you get is earning asset yields on a linked quarter basis over the next 4 quarters or so, assuming that market interest rates don’t change — you’d have earning asset yields decline in mid-single basis points, you’d have our interest-bearing deposit cost declining low-single digit basis points, and so linked quarter, you’d be looking at low to mid linked quarter single digit basis point declines. That would be the run rate.
So I’ll also say it’s obviously very noisy. When we’re talking about core net interest income and core net interest margin, we’re excluding the PPP loans, but obviously we have tremendous excess liquidity on the balance sheet right now, and so you have to think about how is that deployed over time. There’s not a lot of visibility on that, but I would say if you look past the excess liquidity for full year ’20, say, compared to full year ’19 on a core basis, you’re probably looking at a mid-single digit decline in — percentage decline in net interest income. And the way you get there is high-single digit percentage decline in net interest margin offset by mid-single digit percentage increase in average earning assets.
And then kind of thinking about the loan growth, how much of your growth outlook, which I would say is actually pretty good compared to what I’ve heard from other banks this quarter — but how much of that would you say is coming just from the fundings of the commercial construction loans that you already have versus new pipeline, new originations that you’re making today?
Catherine, this is Barry. I would say virtually all of it, of the CRE growth that you’ll see for us, definitely in the second half of the year, is going to be based upon fundings of projects that are on the books today that are beginning to fund up. So as of the second quarter, all of the $92 million worth of loan growth that you saw was based upon fundings on existing projects, and those were in various categories, whether it be apartments, student housing, office, and it’s going to be geographically diverse as well.
We’re obviously in Dallas, Houston, Atlanta — being some of the markets that we had fundings in for Q2, and we would anticipate that geographical diversity and as well as the — as far as the category diversity being the same. But I do expect the growth in the second half of the year to come from existing projects that are funding up.
And my last question is just on capital. You had a lot of capital, but I think if you look at some of [indiscernible] issues versus some of your peers that have raised preferred and sub-debt over the past quarter, now that you’ve seen some active capital raising, now I’d say you’re a little bit below your average on that. So just curious how you’re thinking about your capital versus your risk today and any thoughts on considering some preferred or sub-debt to boost those capital ratios.
So Catherine, this is Tom. We continue to maintain a rigorous capital stress testing framework here at Trustmark. We continue to proactively assess our capital adequacy, and we are very comfortable with our capital levels. When you look at total risk-based capital, for example, we’re at the high end of our operating target range there, so we do not currently anticipate issuing any type of sub-debt, tier 2 capital.
[Operator Instructions]. As there isn’t anything else at the present time, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Jerry Host for any closing remarks.
Thank you, operator, and thank you all for joining us for the second quarter call. We’re very pleased with our results. I want to assure you that our board of directors and our management team is staying very focused on not only the short-term impacts of COVID-19, but also on the longer term and planning for the potential impacts as this continues. And we look forward to meeting with you again sometime in the October timeframe for the third quarter announcement. Thank you again, and please stay safe.
Thank you. The conference call has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.