Cadence Bank (NYSE:CADE) Q1 2023 Earnings Call Transcript

Cadence Bank (NYSE:CADE) Q1 2023 Earnings Call Transcript April 25, 2023

Cadence Bank misses on earnings expectations. Reported EPS is $0.4 EPS, expectations were $0.66.

Operator: Good morning, and welcome to the Cadence Bank First Quarter 2023 Conference Call. All participants will be in a listen-only mode for the duration of the call. I would now like to turn the conference over to Will Fisackerly, Director of Corporate Finance. Please go ahead, sir.

Will Fisackerly: Good morning, and thank you for joining the Cadence Bank first quarter 2023 earnings conference call. We have our executive management team here with us this morning Dan Rollins, Chris Bagley, Valerie Toalson, Hank Holmes. Our speakers will be referring to prepared slides during the discussion. You can find the slides by going to our Investor Relations page at ir.cadencebank.com where you’ll find them on the link to our webcast or you can view them at the exhibit today 8-K that we filed yesterday afternoon. These slides are also in the Presentations section of our Investor Relations website. I would remind you that the presentation along with our earnings release contains our customary disclosures around forward-looking statements and any non-GAAP metrics that might be discussed. The disclosures regarding forward-looking statements contained in those documents apply to our presentation today. And now I’ll turn to Dan for his opening comments.

James Rollins: Good morning, everyone. Thank you for joining us today to discuss Cadence Bank’s first quarter 2023 financial results. I will start with a few general comments and highlights, and Valerie will review financials in more detail. Following our prepared remarks our full executive management team is available for questions. While it was clearly a very unique quarter for the industry, I believe our customer base and our company’s first quarter results generally reflect a business as usual operating environment, while we added some additional on balance sheet liquidity including borrowings and broker deposits simply out of an abundance of caution customer behavior including deposit flows were actually pretty normal during the first quarter.

We reported total deposit growth of $450 million, or 4.7% annualized for the quarter. If you excluded the routine seasonal flows of public funds as well as the brokered funds deposits declined approximately $400 million, which we view as reasonable given the industry pressure on deposits. We actually saw a modest increase in our deposits within our community bank offset by some normal first quarter outflows from some of our corporate customers, which is not unusual given the annual bonus and tax payments during the quarter. The sticky granular nature of our largely rural deposit base has been and will continue to be a tremendous value to our franchise. We have an average consumer account size of less than $20,000 while our average commercial account balance is approximately $135,000.

Additionally as of the end of the first quarter, approximately 98% of our total accounts had balances less than $250,000 and 70% of our deposit dollars are either fully FDIC insured or collateralized. From a loan growth standpoint, we had another solid quarter reporting net loan growth of $933 million, or 12.5% annualized. While the largest portion of our growth this quarter came from our Corporate Banking team that continues to be very diverse both geographically and by category. A portion of this growth is funding on existing CRE credits originated in prior quarters. As we look forward, our pipelines have declined, but we are still seeing good activity. Having said that, the overall credit tightening is very apparent in the industry as almost all banks are requiring deposits.

I anticipate pipelines will continue to decline over the next quarter or two. However, we continue to have a large unfunded CRE book of existing lines that we’ll fund throughout this year and will be somewhat of an annuity for us on loan growth in the coming quarters. Stepping back and looking at some of our other financial metrics. We reported net income available to common shareholders of $74.3 million, or $0.40 per diluted common share and adjusted net income available to common shareholders of $124.4 million or $0.68 per share on an adjusted basis. The primary difference between the two was a loss on sale of investment securities which I will discuss further in just a moment. From a credit quality perspective, net charge-offs continue to remain very low, totaling just $1.9 million or 2 basis points annualized.

We recorded a provision for the quarter of $10 million, which accounted for our net loan growth as well as some increases in non-performing and classified assets. We have said for quite some time that we expected to see our credit metrics return to a more normal level from historically low levels we have reported now for many quarters. We like the rest of our industry expect to see a negative impact of increasing rates on our clients’ year-end financial reporting which has driven some grade migration. This has been especially true in the C&I space for us. Before I turn it over to Valerie to review the financial statements, I would like to briefly discuss the ongoing efforts to improve profitability and operating efficiency. During February, we sold $1.5 billion in available for sale securities that had a weighted average yield of 70 basis points, which resulted in an after-tax loss of approximately $39.5 million.

This trade is expected to have an earn-back of around 7.5 months and be accretive to earnings and early fourth quarter, ultimately improving net interest income by approximately $10.5 million this year. The strategy was strictly an effort to improve our financial performance and was unrelated to and well in advance of the industry liquidity concerns that occurred later in the quarter. In addition, branch optimization is one of the many efficiency initiatives we are focused on. We plan to close an additional 35 branch locations during the third quarter of this year as part of our ongoing effort to optimize our branch network structure and to improve our efficiency. These closures are in addition to the 17 branches closed in the fourth quarter of last year.

This branch optimization in addition to our other efficiency initiatives underway is expected to result in expense savings of approximately $15 million to $20 million annually. As we are now past our system conversions we are continuing to actively identify and execute on additional efficiencies as we look forward through the coming quarters. I would be remiss if I didn’t acknowledge Paul Murphy’s transition this month from Executive Vice Chairman to a key consultant for both me and the management team. As you know, Paul was the force behind building legacy Cadence and coined the phrase for same day service call by 8:00 PM which exemplified the company’s service oriented culture. While he is no longer engaged in day-to-day management, his continued commitment to customer engagement and service insight will be invaluable to all of us as we continue to grow as the new Cadence Bank.

Valerie, let me turn it to you for a few minutes on financials.

Valerie Toalson: Thank you, Dan. I wanted to first point out a few — a bit of new information that we added this quarter to further illustrate some of the points Dan made on our deposit base and liquidity position. Specifically, included in our slide deck on Pages 4, 5, and 6 — slides 4, 5, and 6. Dan mentioned 70% of our deposit base being either fully insured or collateralized. The top left graph on Slide 4 shows the components of this calculation. One of the points of confusion that we saw in some of the early screens they were published on this topic was the lack of adjustment for collateralized public funds, which in our case is a fairly meaningful number at approximately $6 billion as of the end of the first quarter.

When you take this into account, we compare very favorably with peers with over 70% of our deposits being either insured or collateralized. Further our contingent funding availability which is shown in the slides as well is over 50% greater than our uninsured and collateralized deposit total. Slide 5 speaks to the diversity and granularity of our core deposit base. Over 75% of our deposit balances are within our Community Bank structure and over 85% of our deposit accounts are consumer accounts. Additionally, the nature of our deposits are tenured, with over 70% having been with the bank over five years including over 50% that have been with us for over 10 years. We are very proud of our granular deposit base and a longstanding relationships that exists between all of our customers and bankers.

Regarding our $10.9 billion securities portfolio it continues to be, as it has been historically fully categorized is available for sale, but any fair value adjustments transparently reflected on the balance sheet. We have always believed balance sheet flexibility is important and that flexibility allowed us to execute on the accretive security sale in the first quarter without any negative implications to the rest of the portfolio. A securities book representing just over 20% of our assets is made up of highly liquid largely government backed securities with an effective duration of just over four years. Given the nature of the investments, it provides solid cash flows on an ongoing basis and we anticipate approximately $1.5 billion in cash flows to come off the portfolio for the rest of 2023.

This can be used to support higher yielding loan growth or other investments. Moving on to the components of our net income for the quarter. And looking at Slides 12 and Slide 13, we reported net interest income of $354 million for the first quarter, a decline of $5 million compared to the fourth quarter of 2022. First quarter has two fewer days in the fourth quarter and each day is worth about $4 million in net interest income. So excluding the day count, we would have increased around $3 million linked quarter due to the strong loan growth and positive impact of higher rates on our earning assets. Our net interest margin was 3.29% for the first quarter, down just 4 basis points from the linked quarter. On a net basis the decline in the margin was simply due to the excess liquidity that we added to the balance sheet in March.

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With the impact of what I would call routine higher funding costs offset by the improvement in earning asset yields. Our total cost of deposits increased to 1.28% from 76 basis points in the quarter. As expected, we continue to see migration from non-interest bearing products to interest bearing which is reflected in a linked quarter decline in our percentage of non-interest bearing deposits from 32.7% at year-end 29.2% at the end of the first quarter. Although this quarter’s ratio was somewhat impacted by the late quarter addition of $1.6 billion of brokered CDs. Our total deposit beta was 59% for the first quarter and now stands at 25% cycle-to-date on a cumulative basis. This compares to the first quarter’s loan beta, excluding accretion at 53% and 41% cycle-to-date.

Our yield on net loans excluding accretion was 5.87%, up 47 basis points from the prior quarter. That’s a lot of information, but when you step back we are very pleased with our ability to continue to grow net interest income on a per day basis, continuing to grow loans and improve our earning asset yields to offset funding pressure. Looking out over the rest of this year, we currently anticipate our margin to trend pretty stable to potentially upward, if our deposit assumptions hold including a cumulative deposit beta of 30%. Non-interest revenue highlighted in Slide 15 was $74.1 million, which includes the security loss that Dan mentioned earlier. Excluding this item, non-interest revenue was $125.3 million for the quarter, which is a $9.9 million increase comparable to the fourth quarter.

Insurance commission revenue is responsible for approximately $5 million of the increase as fourth quarter is the lowest quarter each year from a seasonality standpoint. Insurance continues to perform very well for us from both retention and pricing perspective, which is reflected in the year-over-year quarter growth rate of 11%. Mortgage revenue was also up $3 million and it increased due to increased origination revenue and a decrease in payoffs and paydowns. Card and merchant fee revenue declined this quarter due both to the seasonality of transaction volumes as well as the impact of the fourth quarter additional $2.5 million benefit related to annual vendor incentives. Finally, we had a $6.4 million linked quarter increase in other non-interest revenue.

This increase was really driven by various items in the blend of $2 million range including Federal Home Loan Bank dividend income, SBA volume and credit-related fees. Moving on to expenses, which are highlighted on Slides 16 and 17. Total adjusted non-interest expense increased from $279.3 million for the fourth quarter of 2022 to $305.2 million for the first quarter of 2023. If you recall, our fourth quarter conference call, we indicated that the run rate was closer to $290 million when you factored out various year end accrual adjustments. Approximately $7.3 million of which was related to employee benefits. In addition to this variance, approximately $5 million of the change in salaries and benefits this quarter was related to seasonal increases in payroll taxes, primarily from the FICA resets with the majority of the rest of the increase driven by increases in insurance commissions linked to strong revenue this quarter.

The linked quarter increase of $2.4 million in FDIC insurance is, of course, largely driven by the 2 basis point increase in the assessment rate effective in the first quarter. Well, there are several other puts and takes, the increase in other miscellaneous expense is a result of a number of items including the impact of a fourth quarter benefit of $1.6 million related to franchise taxes and regarding first quarter items we had an increase in fraud losses of $2.4 million, which is in the process of collection over the coming quarters. In addition, the portion of pension expense that is recorded in other expense increased $1.7 million as a result of higher interest rates impacting the discount rate. SBA expense also increased about $1.6 million on increased volume which also positively impacted the revenue as I mentioned earlier.

The remainder of the increases were driven by various smaller items, several of which we detailed in the slide deck. Going forward, we expect second quarter adjusted expenses to be below $300 million and closer to that $290 million base level we discussed last quarter and trend downward from there, the latter half of the year as the impact of the branch optimization and other efficiencies realized, partially offset by the third quarter of merit cycle. Our longer term efficiency ratio target remains below 54%. Regarding the non-routine adjusted items merger and merger-related costs were $14 million, which is a significant decline from the $53 million in the fourth quarter period that included our franchise rebranding and core system conversion.

The largest component of the first quarter total is related to one-time employee compensation agreements and certain trailing system decommissioning costs. We expect these merger and merger-related costs to decline by more than half in the second quarter and continue to dwindle when they complete later this year. Finally, some additional color on the credit picture which is shown on Slides 10 and 11. We are pleased to see net charge-offs continue to hold at low levels, totaling just $1.9 million or 2 basis points annualized for the first quarter. As Dan mentioned, we had a provision of $10 million for the quarter, which was necessary to support the loan growth we reported for the quarter resulting in a stable ACL coverage of 1.45% of loans.

NPAs as a percent of assets ticked up compared to the fourth quarter, but it’s relatively flat with the first quarter of 2022 and continue to compare favorably to historical levels. From a non-performing perspective the increase was driven by two larger C&I credits and additionally, approximately $12 million of the increase was the repurchase of government guaranteed loans primarily SBA that we previously sold in order to fulfill our collection obligations. It is important to note that $43 million of our total NPAs are government guaranteed SBA and FHA loans that were required to repurchase while working through the collection process. These do have a longer resolution cycle, but a significant portion of these dollars in excess of 75% are guaranteed from a loss perspective.

So, given our active participation in these markets that does elevate our non-performing numbers somewhat. From a credit-sized loan perspective, we are seeing some impact in grade migration as we collect year-end financial information and incorporated into our credit models. We have referenced in past calls that our expectation is that interest rates may have some impact on credit and while we are seeing it in some of the grade migration we are also seeing stable past dues across all geographies and business lines. In short, we have not experienced any systemic trends or themes and types of loans geographies, et cetera and results to-date align with expected grade migration for a credit cycle with increased rates. So looking back at what was an interesting quarter for the industry, our performance highlighted the broad strength of our balance sheet, our resilient net interest margin and fee revenue streams and the clear differentiating value of our customer relationships having both a rural and metro footprint and a community plus corporate business mix.

We also demonstrated our commitment to refining our branch footprint and driving ongoing operating efficiency, a theme that is a key focus for us, particularly through the rest of this year and into next. Operator, we would like to now open the call for questions.

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Q&A Session

Operator: And our first question here will come from Brad Milsaps from Piper Sandler. Please go ahead with your question.

Brad Milsaps: Hi, good morning.

James Rollins: Hi Brad.

Brad Milsaps: Thanks for taking my questions. Valerie thanks for all the color around the margin and other details. I was curious, if you might be willing to provide sort of spot loan and deposit rates at the end of the quarter. Obviously, a lot of moving parts like every bank, but just kind of wanted to get a sense of maybe where some of those deposit rates were at the end of the quarter?

Valerie Toalson: Yes absolutely, Brad. So at the end of the quarter, I’d say new loans for the month of March were coming in around the 7% level, and that varied a little bit depending on the type of loans, obviously. New CDs, if you back out what was brokered, we’re actually renewing at about a 1.5% rate. There have been a number of CDs that were part of the growth this quarter that were actually between 4% and 5% as part of some promotional activity. And then Chris, I don’t know if you want to add a little color on some of the money markets and so forth.

James Rollins: I’ve got the loan numbers pulled up, Chris. You can jump back in here. The production in the fourth quarter came on at an average rate of 6.25% loan production, and the first quarter came on at an average yield of 7.04%. Chris?

Chris Bagley: Nothing to add, that – you guys covered it.

Brad Milsaps: Okay. And Valerie – and then just to kind of delve into your guidance around the margin staying flat or moving up a few basis points. Should we assume that you plan to take some of the cash that you had at the end of the quarter, which I think was above $4 billion in paydown, some of those advances that you brought at the end of the quarter, how – is that kind of a bit of mix change that we should see there to kind of keep the margin flat?

Valerie Toalson: Yes exactly. I do think that we’ll probably continue to have a little bit of excess liquidity, at least in the near term. And that could swing a little bit depending on volatility in the industry. But absent any of that, then yes, we would use those dollars to paydown the borrowings.

Brad Milsaps: Okay great. And then final question for me, just kind of bigger picture on credit. I know some of these numbers are moving from very small numbers, but just wanted to get a sense, were the loans that you are seeing migrate? Are these loans that would have been originated since the merger happened or would these be legacy BancorpSouth loans or more legacy Cadence credits or maybe a mix, just trying to get a sense of kind of the key drivers there? Thanks.

James Rollins: I’ll take that – I think the easy answer is all of the above. But go ahead, Chris.

Chris Bagley: The vintage is not since the merger. They go back two and three years, one the legacy BXS that we lead, one is a legacy CADE that we’re a participant in. Color there is there’s – they’re not related to each other in anyway, different industries, no really tied to any kind of trend that we can think of and from a credit perspective.

Brad Milsaps: Great, thanks Chris. I appreciate it.

James Rollins: Thanks Brad.

Operator: Our next question will come from Manan Gosalia with Morgan Stanley. Please go ahead with your question.

Manan Gosalia: Hi good morning.

James Rollins: Hi good morning.

Manan Gosalia: Good morning, appreciate all the color on the expense side. I was wondering if you would help us with how we should think about expenses exiting the year given you mentioned that the run rate expenses should be about $290 million next quarter, heading lower from there given the branch cuts and the other actions you’re taking? I think you also noted that will identify and execute on additional efficiencies. So I was wondering what the exit expenses would look like as we go into the fourth quarter of ’23. And then as we think about ’24, does that mean that we should see expenses actually decline on a year-on-year basis or are there upward pressures coming through from inflation as we think about ’24?

James Rollins: Yes. Let me take a stab at that a little bit, Valerie, and you can jump back in on some of your comments that you made. But I think it’s a great question. And we continue – we’re less than six months past the consolidation of our two banks through the merger and consolidation of all of our systems. We continue to look for and find and harvest efficiency initiatives. I don’t have a number of what some of that turns out to be as we work through the rest of the year. We certainly wanted to let you know what we were doing down. So you’ve seen those numbers. We continue to try and push down on expenses. Valerie, you need to go through the details behind what you were putting out there for what you think will look like in dollars going forward.

Valerie Toalson: Yes. And then I would just circle back around to your question on some of the exit expenses regarding the branch closures. I don’t have an estimate for you now. Those are generally not significant. We actually own about two-thirds of the locations and lease the others. And so there won’t be a huge amount of exit costs associated with that. However, we will be sure and isolate that as a separate line item in the earnings releases going forward, so that will be very clearly definable. And then like I said in the release, the first quarter always has a number of unique items. And the payroll taxes and all those kind of things, they dwindle throughout the year. We are expecting closer to – between the $300 million and $290 million level for the second quarter and then layering in for the third and fourth quarter the savings from the efficiencies of the branch closures of $15 million to $20 million on an annualized basis so obviously, getting closer to half a year impact on that for 2023.

Manan Gosalia: Got it. And looks like you’re absorbing some of the upward pressure from inflation there as well within the number?

Valerie Toalson: Yes. Those numbers include inflation impact it includes merit increases and of course, the increases that we saw in the first quarter of FDIC assessments and pension costs and so forth.

Manan Gosalia: Got it, all right perfect. And then separately, you made the comment earlier on the call that the credit tightening is very apparent in the industry. Can you talk about what you’re doing on lending standards? And just generally, how much you think loan growth is going to be impacted from both tightening lending standards as well as weaker demand?