Cadence Bank (NYSE:CADE) Q3 2023 Earnings Call Transcript

Cadence Bank (NYSE:CADE) Q3 2023 Earnings Call Transcript October 24, 2023

Operator: Good day and welcome to the Cadence Bank Third Quarter 2023 Webcast and Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Will Fisackerly, Director of Finance. Please go ahead.

Will Fisackerly: Good morning and thank you for joining the Cadence Bank third quarter 2023 earnings conference call. We have members from our Executive Management team here with us this morning, Dan Rollins; Chris Bagley, Valerie Toalson, Hank Holmes and Billy Bradd. 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 to the 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 contain our customary disclosures around forward-looking statements and any non-GAAP metrics that may be discussed.

The disclosures regarding these forward-looking statements contained in those documents apply to our presentation today. And now, I’ll turn it to Dan for his opening comments.

Dan Rollins: Good morning, everyone. Thank you for joining us. We would like to take some time this morning during our third quarter 2023 earnings conference call to also discuss the announcement of our agreement to sell Cadence Insurance to Arthur J. Gallagher & Company. Following our prepared remarks, our executive management team will be available for questions. The first several slides in our deck today provide some detail regarding the sale of our insurance agency. The total deal value of nearly $1 billion represents a multiple of 5.4x the last 12 months revenue. The achievement of this multiple is a tremendous testament to the growth and accomplishments of Cadence Insurance under the leadership of Markham McKnight, Chris Boone, Aimee Kilpatrick and their entire executive team.

While we’ve repeatedly said, we like the insurance business; the opportunity to monetize this business at historically high valuation levels is a huge win for our shareholders. It’s also a tremendous win for our insurance teammates and clients with access to additional resources and product offerings of an agency with the size and scale of Gallagher. We value the relationships we’ve built with these teammates and we look forward to continuing to work with them in their new roles as Gallagher will be the preferred insurance partner of Cadence Bank. From a shareholder perspective, we are able to significantly enhance our capital metrics and tangible book value per share while focusing our efforts on supporting and growing our core banking business.

Valerie will provide some more color on the pro forma impact of the transaction as well as planned uses of the proceeds in just a moment. As we move to financial results for the quarter, we reported quarterly net income available to common shareholders of $90.2 million or $0.49 per diluted share and adjusted net income available to common shareholders of $103.9 million or $0.56 per diluted common share, with the primary difference being non-routine expenses largely associated with our efficiency initiatives that we’ve discussed on our second quarter call. Our balance sheet was relatively stable for the quarter. Loans were essentially flat for the quarter at $32.5 billion, while reported deposits declined $357 million. The deposit decline included our intentional reduction in brokered CD balances as well as a seasonal decline in public funds.

Before the impact of those, total core customer deposits actually increased just over $500 million or 5% annualized. This growth reflected success in both our Corporate and Community Banking segments, particularly given the ongoing competitive environment for deposits. Deposit trends also reflected a slower pace of deposit mix shift compared to the most recent quarters as noninterest-bearing deposits represented 25.2% of total deposits at the end of the third quarter compared to 26.4% 3 months ago. These balance sheet trends contributed to stability in our net interest margin which was 2.98% for the third quarter. The third quarter increase in deposit costs slowed considerably, representing roughly half of the increase we experienced during each of the first 2 quarters this year.

We anticipate this margin stability to continue in the fourth quarter as well. From a credit quality standpoint, net charge-offs were elevated as a result of the charge-off of 2 C&I credits that were previously identified as impaired. These 2 credits have been on our radar and reflected in our credit metrics for several quarters now. Otherwise, both of our non-performing as well as our criticized and classified asset totals were stable compared to the second quarter of 2023. We reported a provision for credit losses of $17 million for the quarter, driven by slower loan repayment expectations and credit outlook. Overall, despite the volatility in the macro environment, our risk identification process is working well and credit quality expectations remain stable.

Finally, we continue to make progress on our efficiency initiatives. This progress is evidenced in our head count decline. Total FTEs have declined over 300 during the third quarter and over 400 since the end of last year. We expect a decline of additional 80 head count prior to the end of this year. We expect the fruits of these efforts to be more visible in our numbers during the fourth quarter and the first part of 2024. Before factoring in the insurance sale impact, we are working hard toward holding our 2024 expenses flat through these and other efforts. I’ll now turn the call over to Valerie for her comments. Valerie?

A businesswoman in a suit carrying a briefcase and walking through a busy banking hall.

Valerie Toalson: Thank you, Dan. I would like to start by making a few brief comments on the pro forma financial impact and expected uses of proceeds on the Cadence Insurance transaction which is highlighted on Slides 5 through 7. The financial metrics of this transaction are extremely attractive. We estimate that the transaction will result in additional capital of approximately $620 million, including a net book gain of approximately $520 million which represents approximately 160 basis points of additional CET1 and 24% tangible book value accretion. Further, we estimate the transaction to be net neutral to earnings by simply applying the cash proceeds towards the paydown of wholesale funds before any use of the generated capital.

Referencing Slide 7, upon completion of the sale, in addition to the paydown of borrowings, we anticipate executing on a securities repositioning of at least $1.5 billion of the securities portfolio, whereby we would use a portion of the generated capital to sell securities yielding under 1.2% and use the proceeds to reinvest in earning assets at market value rates likely with higher building securities. The pro forma earnings and margin impact of these actions are impressive. Using consensus estimates for 2024, we estimate EPS accretion of 11% and incremental net interest margin pickup of over 20 basis points and an improvement in the efficiency ratio of 530 basis points. After factoring in an estimate of the related loss associated with the sold securities, the pro forma net impact to our CET1 is still nearly 120 basis points.

We also anticipate both the gain from the insurance transaction and a subsequent loss from the securities sales to occur in the same reporting period in support of efficient tax management. On the remaining generated capital, we ultimately aim to maintain capital strength and flexibility, whether it be in additional securities, portfolio restructuring, share buyback or various other forms of future growth. If I sound excited, I am. This is a unique opportunity that we believe has meaningful shareholder value. Moving on to our financial results for the quarter. Looking at our balance sheet and margin highlights beginning on Slide 18. We reported net interest income of $329 million for the third quarter, a decline of $4.5 million compared to the second quarter of 2023.

Our net interest margin was 2.98% for the third quarter, down 5 basis points from our second quarter margin of 3.3%. Our total cost of deposits increased to 2.14%, up 27 basis points from the second quarter which is roughly half of the increase we experienced in each of the first 2 quarters of the year. While it’s clearly still very competitive, pressure on deposit balances and pricing seems to have moderated over the last several months. We also saw a reduction in the pace of migration from noninterest-bearing products to interest-bearing products. Noninterest-bearing balances represented 25.2% of total deposits at the end of the third quarter compared to 26.4% at the end of the second quarter. Our yield on net loans, excluding accretion, was 6.31% for the third quarter, up 13 basis points from the prior quarter as slowing in new originations contributed to a reduction in the pace of loan yield increases compared to prior quarters.

Noninterest revenue highlighted on Slide 21 was $119 million on a reported basis. Excluding $6.7 million in facility and signage write-downs associated with the branch closures during the third quarter which is reflected in the other income line item. Total adjusted noninterest revenue was $125.6 million, a $6.6 million decline in the prior quarter. About half of this decline was driven by mortgage banking income, with the remainder being driven by a combination of other revenue sources, including credit-related fees and brokerage income. Mortgage banking production and servicing declined by $1 million, primarily as a result of slowed purchase activity. Additionally, the MSR asset adjustment was a negative $0.2 million for the third quarter compared with a positive $1.6 million for the second quarter.

Moving on to expenses which are highlighted on Slides 22 and 23. Total adjusted noninterest expense was $301 million for the quarter, reflecting stability across most of the major expense categories. Salaries and employee benefits increased $1.3 million compared to the second quarter as the headcount declines that Dan mentioned earlier, allowed us to stay relatively flat on compensation expense despite the July 1st effective date for annual merit increases. We reported a $2.7 million increase in deposit insurance assessment expense which was driven by an increase in uninsured deposits, higher second quarter loan balances and changes in certain of the credit quality metrics that impact the assessment. Dan spoke to the progress on our efficiency initiatives but to briefly recap, we expect our total FTE to be down by over 480 since the end of last year or an 8% reduction excluding insurance.

We also closed 35 branches in the third quarter, reducing our total branch count by 12% since merger. And of course, all of this is before factoring in the impact of the pending sale of the insurance company. We believe the combination of these and other efforts will provide a meaningful positive impact on our performance and efficiency. Finally, speaking to credit quality on Slide 16. Dan addressed most of this provision for the quarter was $17 million, up slightly from the $15 million provision in the second quarter of this year. Net charge-offs increased to $34.2 million in the third quarter or 0.42% of average loans on an annualized basis, primarily due to 2 credits that were identified as impaired and reserved for in prior quarters, as Dan mentioned.

Our nonperforming loans and nonperforming asset totals were stable linked quarter at 0.49% of loans and 0.33% of assets, respectively. Our criticized loan totals were also stable compared to the second quarter, while our classified loans increased slightly to 2.10% of total loans. We saw some migration from special mention to substandard, primarily the result of higher interest rates and inflationary pressures on loan rates. We continue to monitor credit quality very closely while higher rates and other macro factors have clearly impacted certain borrowers, our near-term outlook on credit remains stable. Our allowance coverage is solid at 1.37% and we continue to appreciate the diversification of our loan book, both in type and geography. In closing, I can’t help but use the word excited again because we simply are.

It has been nice to see the stabilization in our balance sheet and margin this quarter, highlighting the value of our core deposit franchise and our efficiency initiatives are progressing as planned. Finally and importantly, the pending insurance sale transaction is a transformative step in our efforts to improve our performance and enhance shareholder value. Operator, we would now like to open the call to questions.

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Q&A Session

Operator: We will now being the question-and-answer session. [Operator Instructions] The first question today comes from Manan Gosalia with Morgan Stanley.

Manan Gosalia: I was wondering can you talk through the rationale for the insurance sale? Why now? Was it a function of rates rising further and reaching a breakeven point for you? Or are the economics of the deal much better than you would have originally got, say, at the start of the year? Maybe help us think through that?

Dan Rollins: Sure. I think we’ve talked about it on this call for the last couple of quarters that we like the insurance business. We’ve always liked the insurance business. We knew we had what we thought was the premier bank-owned agency as we continue to talk to potential partners that were out there. The valuation just continued to be a big number. And when we look at the multiples that we received, I think it proves the process out that we did have the premier bank-owned insurance agency out there and the numbers that we’re publishing out here can show that. The value of the agency represents about 25% of our total market cap and the agency produced 5%, give or take, of our net income. So the disconnect there was just too big and the benefit that it brings to our shareholders, we work for our shareholders.

We’ve got to be shareholder focused. As we look at our performance, we know we’ve got to continue to improve our performance. We’re not pleased with where we are and this is an opportunity for us to benefit our shareholders.

Manan Gosalia: And in terms of the capital benefits, you’re generating a pretty meaningful 160 basis points of capital through the deal. You’re using about a quarter of that and I think you’re suggesting that there’s some upside to that as you use more of that gap freed up over time. But can you help us think to any constraints that you might have there? So for instance, if there is a high level of CET1 that you want to hold over time? Or is there a certain level of liquidity you want to hold, how you’re thinking about the asset sensitivity and doing more of the securities yield resets, et cetera. So maybe help us think through that as well.

Dan Rollins: Yes. We’ve got some examples in the deck that we published this morning and I think that the securities repositioning is something that we’re going to do. That gives us lots of options. I think today, we don’t have a number that we need to hit. We don’t have a capital number that we’re worried about. This is a tremendous benefit to us and it puts all the options in front of us.

Manan Gosalia: But are there any constraints like why not do is it more?

Dan Rollins: We certainly can. As far as I know, there are no constraints. We want to make sure that we take all the information that we have before that make good decisions.

Operator: The next question comes from Michael Rose with Raymond James.

Michael Rose: Maybe, Valerie, I just haven’t had a chance to run through all the numbers yet but what were the expenses, the annual expenses associated or expected for the insurance business? Next year obviously, we forecast the revenues but maybe not explicitly break out in. I just wanted to get a sense for what that is. And then just separately, if you could discuss the appetite for potentially using some of the proceeds for a buyback? Or is it just a better use to maybe look at investing in lenders or the franchise in other ways?