Q2 2023 Renasant Corp Earnings Call
Participants
C. Mitchell Waycaster; CEO & Executive Vice Chairman; Renasant Corporation
James C. Mabry; Executive VP & CFO; Renasant Corporation
Kelly W. Hutcheson; Executive VP & CAO; Renasant Corporation
Kevin D. Chapman; President & COO; Renasant Corporation
Michael Edward Rose; MD of Equity Research; Raymond James & Associates, Inc., Research Division
Stephen Kendall Scouten; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Thomas Alexander Wendler; Senior Research Associate; Stephens Inc., Research Division
William Bradford Jones; Research Analyst; Keefe, Bruyette, & Woods, Inc., Research Division
Presentation
Operator
Good morning, and welcome to the Renasant Corporation 2023 Second Quarter Earnings Conference Call.
(Operator Instructions)
Please note, this event is being recorded. I would now like to turn the conference over to Kelly Hutcheson, Chief Accounting Officer with Renasant Corporation. Please go ahead.
Kelly W. Hutcheson
Thank you for joining us for Renasant Corporation's 2023 Quarterly Webcast and Conference Call. Participating in this call today are members of Renasant's executive management team. Before we begin, please note that many of our comments during this call will be forward-looking statements, which involve risk and uncertainty.
There are many factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Such factors include, but are not limited to, changes in the mix and cost of our funding sources, interest rate fluctuation, regulatory changes, portfolio performance and other factors discussed in our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has been posted to our corporate site, www.renasant.com at the Press Releases link under the News and Market Data tab.
We undertake no obligation and we specifically disclaim any obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. In addition, some of the financial measures that we may discuss this morning are non-GAAP financial measures. A reconciliation of the non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. And now I will turn the call over to our Executive Vice Chairman and Chief Executive Officer, Mitch Waycaster.
C. Mitchell Waycaster
Thank you, Kelly. Good morning. We appreciate you joining the call today and your interest in Renasant. Although the current operating environment continues to be volatile and uncertain at times, our focus on basic banking principles and the safety and soundness of our institution has not wavered. Our second quarter results are highlighted by solid core earnings, strong asset quality metrics and a well diversified and granular core funding base.
In the second quarter, we took steps to delever the balance sheet. These actions enhance the strength and optionality of our financial condition and will aid earnings in future quarters. Loan growth was solid and reflects the vibrancy of markets in which we operate. Our financial outlook will continue to benefit from the economic growth throughout our footprint. I will now turn the call over to Kevin.
Kevin D. Chapman
Thanks, Mitch. Our second quarter earnings were $28.6 million or $0.51 per diluted share. Included in our results is an after-tax loss of $18.1 million or $0.32 from the sale of a portion of our securities portfolio. Excluding this loss, our core EPS was $0.83, which represents a $0.01 increase from the first quarter. The securities had an amortized cost of just over $500 million, and the proceeds from the sale were used to shrink the balance sheet by paying down wholesale borrowings.
As Mitch mentioned in his comments, the actions we took during the quarter improved our capital and liquidity position and enhance future earnings and optionality. Breaking down net interest income, we experienced an increase in loan interest income of over $11 million on a linked quarter basis, driven by another quarter of solid loan growth, coupled with a 25 basis point increase to our loan yields. However, while loan yields increased, competitive pressures on deposit pricing impacted both our deposit mix and deposit costs this quarter, leading to an $18.5 million increase in deposit interest expense on a linked quarter basis. The balance sheet repositioning transaction was executed late in the quarter and had a nominal impact on net interest income during the second quarter.
The earnings benefit will be realized beginning in the third quarter. Considering the operating environment, our deposit portfolio performed well during the quarter, and our overall liquidity remains strong. Total deposits increased slightly during the quarter and our loan-to-deposit ratio held constant at 85%. Our team was successful in defending our core funding base as deposits, excluding brokered deposits, were up slightly late in the quarter after a seasonal decline in April.
We are still operating in a volatile environment following the developments in the industry during the first quarter but we continue to focus heavily on growing core deposits and managing our funding costs. Excluding the loss on the sale of securities, noninterest income increased modestly quarter-over-quarter. Our capital markets, treasury solutions, wealth management, and insurance lines of businesses continued to deliver solid results.
Our mortgage division had a strong quarter as income from the division increased $1.3 million on a linked quarter basis. Interest rate lock volume was flat quarter-over-quarter, while our gain on sale margin increased 51 basis points. Noninterest expense increased $1.5 million from the fourth quarter, driven primarily by the impact from our annual merit increases which was offset slightly by savings in other areas.
Our efficiency ratio, excluding the loss on the sale of securities was 63% for the quarter. Margin compression continues to put pressure on our efficiency but managing this ratio down continues to be a goal of ours. Improving operating leverage across all lines of businesses will help us meet this goal. I will now turn the call over to Jim.
James C. Mabry
Thank you, Kevin. As we walk through the quarter's results, I will reference slides from the earnings deck. Our balance sheet contracted $215 million from March 31. The sale of securities was offset by another quarter of solid loan growth. Loan growth in the second quarter was $165 million and represents an annualized growth rate of 5.6%. We continue to carry excess liquidity and our cash balances grew about $100 million on a linked quarter basis.
Slide 8 and additional slides in the appendix illustrate that we have a diverse loan portfolio with no significant concentrations in loan type or industry. And specific to our construction and non-owner-occupied commercial real estate portfolios, our exposure to individual sectors is granular and the portfolios are performing well.
Turning to Slide 9. Competition for deposits accelerated further this quarter and impacted both the mix and cost of deposits. Noninterest-bearing deposits represent 27% of total deposits compared to 31% at March 31. And our cost of deposits increased to 1.5%, which represents a cumulative beta of 27.
As you can see on Slides 10 through 12, the company's core deposit base and overall liquidity position remains strong. Similar to the loan portfolio, the deposit base is diverse and granular. The average deposit account is $29,000, and there are no material concentrations.
Slide 13 touches on the available sources of liquidity. And as you can see, our availability significantly exceeds the balance of uninsured and uncollateralized deposits.
Referencing Slide 15, all regulatory capital ratios are in excess of required minimums to be considered well capitalized and each of these ratios improved from the prior quarter.
Turning to asset quality. We recorded a credit loss provision of $3 million and a recovery of credit losses on unfunded commitments of $1 million, which is recognized in noninterest expenses. Net charge-offs were $3.9 million, which represents an annualized rate of 13 basis points. And the ACL as a percentage of total loans declined 3 basis points to 1.63%.
Credit metrics are presented on Pages 17 through 19. Our past dues and criticized loans each improved quarter-over-quarter. The increase in nonperforming loans is attributable to a single relationship which is well collateralized and therefore, we expect no loss. While pleased with the underlying strength of our portfolio, we remain cautious about credit in the current environment. Our commitment to high underwriting standards remains and we attempt to identify potential problems early in order to mitigate losses to the bank.
Moving on to profitability beginning on Slide 23. Net income declined $17.5 million on a linked quarter basis, driven by the after-tax loss of $18 million from the sale of securities. Excluding the loss on the sale of securities, our profitability metrics remain relatively stable. Core margin, which excludes purchase accounting accretion and interest recoveries, was 3.43%, down 20 basis points from Q1. Although loan yields were up 25 basis points, deposit pricing pressures more than offset the increase in yield.
Total cost of funding increased 47 basis points to 1.8% for the quarter, although we anticipate some relief in the short term from the balance sheet repositioning transaction, competitive pressures are likely to persist, and we believe funding costs will continue to increase in coming quarters. Kevin touched on the highlights within noninterest income and expense. We are encouraged by the results of our mortgage division. Although there was an uptick in our overall noninterest expenses this quarter, we remain committed to improving operating leverage and managing our expense base remains a priority. I will now turn the call back over to Mitch.
C. Mitchell Waycaster
Thank you, Jim. We continue to emphasize time-tested banking principles as we operate the bank. These fundamentals not only protect our customers and shareholders, but also position us to generate attractive shareholder returns. I will now turn the call over to the operator for questions.
Question and Answer Session
Operator
(Operator Instructions)
The first question comes from Thomas Wendler with Stephens.
Thomas Alexander Wendler
I just wanted to go back to the security sale. You said it happened late in the quarter. Can you just give us an idea of the impacts on 3Q from this then maybe like an earn back for the trade?
James C. Mabry
Thomas, this is Jim. So you're correct, a series of trades and they took place large in the first part of June. So the impact on Q2 was de minimis. Looking forward, I would say that our rationale and interest in that trade was really driven secondarily by earnings, but mainly by the impact that trade would have on our balance sheet. And what we liked about this trade was that we would delever the balance sheet, reduce indebtedness and give us more flexibility in the balance sheet side first and foremost.
And so that was the primary impetus for considering this trade. It did have the benefit, as you point out, benefiting future earnings. We essentially sold securities that were yielding about 2.9%, and we took those monies and paid down advances that were costing us roughly 5.5%. So the breakeven calculation roughly 2 years, plus or minus, but very pleased with the execution that we got and the impact that it had on the balance sheet.
Thomas Alexander Wendler
That's great color. And then just one more for me. You guys had an annual merit increase this quarter. Is there going to be any impact in 3Q from that merit increase?
Kevin D. Chapman
Tom, this is Kevin. There won't be. I mean, there may be some additional hires or at a cycle merit increases. But merit increase (inaudible) effect March 1. Some of that was recognized in Q1, but the full quarter impacted in Q2. If you know the salaries, employee benefit, it's up about $800,000. $600,000 of that is going to be related to mortgage commission increase. If you look, the mortgage income is up about $1.2 million, and there's going to be a corresponding increase on the expense side related to that. So as you back out mortgage, the increase in salaries was just a couple of hundred thousand dollars for the rest of the company.
Operator
The next question comes from Will Jones with KBW.
William Bradford Jones
I just wanted to go back to the bond sale for a minute. I mean, obviously, the math is very financially compelling, especially if you just look at that exchange in yield that you get in there. Is there any way to frame what kind of margin benefit will be moving -- obviously, the third quarter will see a nice benefit there and that run rate through the end of the year. But Jim, is there just any way or any kind of context you can give us on where you -- or maybe a range of where you think the margin could fall out in the back half of the year here?
James C. Mabry
It's a good question. And certainly, the trade benefits the earnings power of the company, there's two ways about that. But I would say this, as we look forward and think about the margin and impact on NII, I look at that trade at least from an earnings perspective, is helping to moderate the declines and the pressure that we're feeling on the margin industry-wide and certainly it [rent] us on. So I see it -- we're certainly better off having executed the trade in terms of what our performance will be in margin in the second half. But we still feel though that there are pressures on the margin, and we're likely to see some -- those pressures in the second half, so resulting in declines in the margin and in NII. But I will say those declines will be much more moderate than what we saw from Q1 to Q2, and that's the real benefit. So the pressures remain, but I would directionally say to you that margin and NII will be under pressure in the second half and down moderately from what we saw in Q2.
William Bradford Jones
Understood. That's very helpful. And then just separately on the margin, we saw a little bit of a catch-up beta this quarter. Just curious on the outlook where you see that trending for the year if you guys have any form of updated deposit beta expectations? And I know you brought on a little bit more broker deposits this quarter. Can you maybe just give us a sense of the tenor of those deposits and maybe rate or duration. That would be helpful.
Kevin D. Chapman
Sure. So I'll start with the broker deposits. And as you pointed out, we did see an increase in broker deposits. And I will go back to that bond right for a second because, again, what we like first and foremost about that trade was the delevering that allowed us to deal (inaudible) better home loan banking (inaudible). And if we think about alternative sources of funding, we paid down a lot of federal home loan bank outstanding and plan to pay down more of that debt in the quarter. And likewise, above, we sort of view it as a bridge. I mean, here we are in a period of time where traditional core deposits are tough to find and gather.
So we view that as a bridge, and it is up. But over the next few quarters, our goal, if we can accomplish it is to pay down of broker deposits. I mean we want to be a core-funded bank, and these alternative sources have benefited us and certainly, we're open and have used them. But that's our goal as it relates to that [thinking] about the funding. As it relates to the betas, what I would say is this, that the last couple of quarters, we have upped that -- those assumptions on deposit betas. And currently for interest-bearing deposit beta, we're using about 50% -- deposit beta 50%.
William Bradford Jones
Okay. Very helpful. And then maybe for Mitch, just bigger picture on this bond sale. It feels like the rationale was clearly what we saw liquidity build in March, the weather storm and kind of wait for the dust to settle and 3 months down the road, we've kind of removed ourselves from the deposit crisis and then it's time to rightsize the balance sheet and get it to get funding in a more efficient place. I guess, first Mitch, is that just kind of how you frame this trade you guys made here? And then just in terms of timing, what gives you confidence that right now and right here was kind of like the time of repositioning the balance sheet and you kind of put yourself behind this deposit and liquidity crisis?
C. Mitchell Waycaster
Yes. So I think as I mentioned in the opening comments, just enhancing the strength and the optionality for us going forward. Something we give a lot of thought to and we thought it timely and we were in a position to execute this trade. And we thought, like I say, giving us optionality and as we look forward and just position us for strength and certainly, there's earning benefits from it. But as Jim mentioned, we're more focused on just the strength of the balance sheet and just maintaining that optionality.
Kevin D. Chapman
I would add this, Will, to Mitch's comments. We obviously think a lot about the balance sheet and protecting the strength of the balance sheet, enhancing the strength of the balance sheet, I think about it from a capital and liquidity point of view and how we fund it and so forth. And -- so there are a number of things that we think about that could improve the strength of it. And in this particular topic, we started to think about late last year. And I think to your question, some of it was just finding the right time for the financial pieces of this to line and make more good sense. And so we're sort of navigating through the industry issues in early March. So it has been on our mind and we were just -- we're waiting for the right window, but that came to us the end of the June and so that's what we put in place.
Operator
The next question comes from Michael Rose with Raymond James.
Michael Edward Rose
Hope all is well. Just wanted to get a sense for loan production here, Mitch, and what the outlook could be here in the near term, just the competitive dynamics and what you guys are kind of seeing across your footprint?
C. Mitchell Waycaster
Sure. Thank you, Michael. Well, another solid quarter of production. As we've seen in the last 2 or 3 quarters, of course, we see pipelines continue to moderate some. And I would say, again, that's driven by our discipline in pricing, funding, underwriting and demand to the point of your question. But as I mentioned, we operate in vibrant markets and we continue to service and grow relationships. Our production this past quarter was $413 million. That compares to $415 million in the prior quarter. So again, solid production good net result this quarter, $169 million or roughly 6%, and that compares to $188 million or just over 6%, between 6% and 7% the prior quarter.
As I've mentioned before, kind of the governor on that net result is what we see in payoffs, payoffs were up modestly this quarter. But overall, compared to the prior year, of course, they have moderated as well. So as far as looking forward, the good thing about our portfolio, as Jim and Kevin mentioned in opening remarks, we're granular on both sides of the balance sheet. And that's reflected in this quarter's production geographically, we continue to see all of our regions.
Our business lines contribute well to our results as well as the granularity of our loan types that we continue to have pointed to in the past. But again, it's reflective of our book with about 30% of that production coming from the consumer kind of 1:4 family, another 30% from small business credits, less than $2.5 million and then another 24% or so from commercial credits, those above $2.5 million representing C&I owner-occupied commercial real estate type credits.
And then our corporate commercial business lines continue to contribute well. That makes out the balance of this quarter's production. So we continue to hit on many different cylinders, cylinders relative to our ability to produce and all of that, along with our markets, gives us optimism about our ability going forward. And as to our markets, I would point again to immigration, economic development in sectors like manufacturing, distribution, medical, government education. All of those contribute to a very vibrant, strong marketplace that we do business. And with all that, I would expect this quarter to be generally reflective of what we've seen in Q1 and Q2 relative to our net. All of that depending somewhat on the level of payoffs and just the continued economic activity that I referred to.
Michael Edward Rose
Mitch, that's great color. And that actually kind of touches on my follow-up, which is if the Fed raises today and signal that, that's kind of it, I mean, you guys have an expectation for what payoffs could look like here over the next few quarters? And then how does the acquisition of Republic earlier this year in the ABL business contribute to this quarter's growth and expectations in the back half.
C. Mitchell Waycaster
Yes. Thank you. Yes. So I don't know that an additional move in the Fed would have a significant change in the payoffs likely at this point. But relative to Republic, we have been very pleased. The integration with that company into our was the strong both business development and underwriting discipline in that company. We have been very pleased with what we've seen so far and just merging them into our company, it's been received very well the referral of business, I would say, both ways within both companies. We have been very pleased and was a meaningful contributor in Q1 and Q2. And looking at the pipeline, we certainly expect that to continue.
Michael Edward Rose
Maybe just one more for me, switching to expenses and maybe how it ties in to mortgage this quarter a little bit stronger. I assume that with some of the expenses coming in a little bit higher than the guidance range you'd given. Can you just give us some thoughts on where the efficiency ratio was for the mortgage company and what the profitability looks like and what the expense range could look like for the third quarter.
Kevin D. Chapman
Sure. Thanks. Michael, Kevin again. So yes, as we look at mortgage, mortgage again, continues to be a very volatile and rough environment, particularly compared to 2 to 3 years ago. The great thing about our mortgage company is under their leadership, we continue to be profitable. And we know that's an anomaly compared to what's happening in the industry, but also would say it's not the accident. But more or less efficient. I think our efficiency ratio for the quarter is going to be in the mid-90s. If you back them out, they weigh on our efficiency ratio by 2 percentage points.
And as we look at the expense increase at the top of the house, the majority of that is going to be attributable to mortgage, we talked about earlier in the call, just a salary benefits. It was up growing so it was up $800,000, $600,000 of that was mortgage. If you look at some of the other expenses in the categories, particularly in other mortgage is going to be contributing to that just for some of the costs to close the loans. As we look at expense guidance, we're probably going to be a little bit volatile for the next couple of quarters. And as far as the headwinds that we have versus some of our internal expense initiatives. But we do think -- but as we look out at expenses for maybe the next couple of quarters are a little bit flattish.
Some of that's going to be driven by mortgage. We do expect mortgage to have another good Q3. So expenses could be -- remain elevated compared to what we've guided to in the past, just because of mortgage. But again, continue to focus on initiatives to bring expenses down, bring revenue up and ultimately get our efficiency ratio back down towards that 60% range, which is in the current environment of margin compression is probably going to take a few more quarters than we anticipated.
Operator
The next question comes from Stephen Scouten with Piper Sandler.
Stephen Kendall Scouten
I guess I wanted to just follow up briefly on deposits. You talked about, I think, Jim, maybe you said you wanted to look to replace a lot of those broker deposits over the coming quarters. Where do you think that would come from? Would that likely be customer CDs at this point in time? And then kind of how do you think about noninterest-bearing deposits and where those balances might trend from here potentially bottom?
James C. Mabry
Stephen. So yes, I mean our focus remains core deposit growth, and we have a number of initiatives. So we're not unusual in that category with other banks. But we've got a real focus there and our aspirations are to try to grow core deposits, and we appreciate the significant headwinds in the industry, but that's our target. And we -- and of course, loan (inaudible) plays a role in this -- funding it. But our goal is that over the next few quarters, try to reduce that brokered number. In terms of NIB, I think we're roughly around 27% or 28%. Don't know for sure where that goes, but a reasonable expectation maybe over the next 2 or 3 quarters as you see that get in the mid-20s. Of course, it's a real bow given where rates are and the higher -- the longer the made higher, the more difficult that challenge becomes on NIB balances. So a lot of (inaudible) through specials and promotions on the deposit side. But our goal is to return to close to 100% core funded bank as soon as we can.
Stephen Kendall Scouten
Got it. Helpful color, Jim. And I'm curious just kind of at a high level, how -- obviously, we had this turmoil in March and May. And now the market is telling us everything, okay, I guess, right? So I'm wondering how your business model might have changed, if in any ways? And kind of as you think out longer term, how you want to focus to take advantage of any dislocation or opportunities that may exist for the bank to continue to succeed.
C. Mitchell Waycaster
Yes, Stephen, certainly, we're focused today on the economic uncertainties, whatever those might be. I guess there's varying opinions relative to maybe where we would be in that cycle. But certainly, what we will do is remain very disciplined in evaluating opportunities. But certainly, as we have consistently done in the past, we will remain opportunistic. And whether that be new talent, new markets, strategic partners, either banks or nonbanks. We talked a minute ago about our success with Republic. I would also add relative to Southeast commercial, which we added earlier last year as well. We continue to evaluate opportunities that drive shareholder value that align with our culture in our business model and risk appetite. So as we go forward, we will continue to do that and be opportunistic.
Stephen Kendall Scouten
Makes sense. And do you think today your loan-to-deposit ratio giving you a little bit more room than maybe some of your peers could allow you to bring on talent. And would you want to do that today? Or are we still in a period of maybe we wait and see how this shakes out and get more aggressive as we get down the line a little bit?
C. Mitchell Waycaster
Yes. Well, I think for the right talent, that's something you always take the opportunity when those opportunities come along. We actually had two additions this past quarter, one in Nashville, one in Atlanta. So we're always mindful of that and try to stay positioned where that's always something that we would take that opportunity. So Kevin, a follow-up comment there?
Kevin D. Chapman
Yes. Steve, I think it's a great question. And we just simply add is as we look at how we positioned our balance sheet either from a liquidity or from a capital standpoint. We're still looking for business. And we recognize that there was a shock for the system in March, and there may be some shocks in the future. We don't know. But we manage -- I'm not sure we're really managing any different today than we were over the last couple of years. There's capacity on our balance sheet to grow, but it's got to be -- we got to have relationships. We told you that 3 years ago or 5 years ago, we want to develop relationships. There's very little capacity on our balance sheet, either for liquidity or capital for a transaction.
For that transaction, we're going to get really well compensated. So that tends to lead not that doing any transactions. So we'd just say that our focus is the same. There's a highly focus on deposits. But there is also a highly focus on deposits in 2021 when everybody was (inaudible) liquidity. So we think with how we're positioned, not only from a balance sheet from a liquidity, capital, but also from an openness to higher talent, if, A, quality talent is available, we're going to hire that -- we will hire them. If it's B and C talent, we may pass. B and C talent typically is always available. But if there's A caliber talent, we will hire them because they don't become available very often.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Mitch Waycaster, Renasant CEO, for any closing remarks.
C. Mitchell Waycaster
Very good. Thank you, Drew, and thank you to each of you for joining the call today. We plan to participate in the Raymond James Conference on September 6 and the Stephens Conference on September 19.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
