Synovus Financial Corp. (NYSE:SNV) Q2 2023 Earnings Call Transcript

Synovus Financial Corp. (NYSE:SNV) Q2 2023 Earnings Call Transcript July 20, 2023

Operator: Good morning. And welcome to the Synovus Second Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I will now turn the call over to Cal Evans, Head of Investor Relations. Please go ahead.

Cal Evans: Thank you and good morning. During today’s call, we will reference the slides and press release that are available within the Investor Relations section of our website synovus.com. Chairman, CEO and President, Kevin Blair will begin the call. He will be followed by Jamie Gregory, Chief Financial Officer and they will be available to answer your questions at the end of the call. Our comments include forward-looking statements. These statements are subject to risks and uncertainties and the actual results could vary materially. We list these factors that might cause results to differ materially in our press release and in our SEC filings, which are available on our website. We do not assume any obligation to update any forward-looking statements because of new information, early developments or otherwise, except as may be required by law.

During the call, we will reference non-GAAP financial measures related to the company’s performance. You may see the reconciliation of these measures in the appendix to our presentation. And now, Kevin Blair, will provide an overview of the quarter.

Kevin Blair: Thank you, Cal. Good morning, everyone. And thank you for joining us for our second quarter 2023 earnings call. Before we get into our results, I’d like to sincerely thank Cal for his tremendous contributions over the last two years serving in his Investor Relations role. Cal has been instrumental as we have all navigated through the economic highs and lows with his strong background in market analytics and credit. He’s guided us well, worked hard to strengthen relationships and build even greater trust with all of you cover us and the investors you stand for. We are thrilled to welcome Jennifer Demba to the team, bringing her vast industry knowledge and sell-side perspective into our strategy setting and shareholder activities.

Her extensive financial services background will be incredibly valuable as we move through the current cycle, as well as execute on our strategic plan. So, thank you, Cal, and officially welcome, Jennifer. We couldn’t be in better hands with the two of you in your new roles for our company. What you will see today is financial performance that remains quite strong with PPNR up 8% year-over-year and an adjusted return on tangible common equity of 18%, despite a slowing economic environment and tighter liquidity market, which led to another quarter of contraction in our net interest margin. We continue to see evidence that our relationship-based model serves as a strong platform to attract and retain talent, as well as clients. Our team member turnover is the lowest it’s been in many years, engagement levels are high and we continue to add talent in key revenue producing in corporate services areas.

From a client perspective, deposit production remained strong with second quarter levels over 130% higher compared to the same period last year. While loan production remains muted versus last year, commitment levels increased 4% versus last quarter and second quarter adjusted fee income is up 10% versus the previous year. And while you will see shifts in some of our expectations for the year to adjust to the trends we are seeing internally and externally, we also still strongly believe our success to-date, as well as our path-forward is the result of our intentional approach to expand our business, diversify our client base and gain share of wallet. All while increasing our investments in innovative solutions to further enhance the client experience and sources of revenue.

We have also quickly responded to the changing economic environment and the recent industry headwinds to better manage the emerging risk. Over the course of the year, we have increased our CET1 ratio by approximately 20 basis points, reduced the percentage of deposits that are uninsured, increased contingent funding sources to $26 billion and reduce the midpoint of our expense guidance for the year by 3 percentage points, excluding the impact of the Qualpay transaction. Our bank has made significant strides in recent years, paving a path-forward towards achieving our long-term financial goals. While pursuing growth opportunities and maximizing profitability in this environment, we remain committed to optimizing our overall risk profile. By implementing robust risk management practices, closely monitoring market trends and adapting to regulatory changes, we aim to ensure the stability and resilience of our operations.

Our dedicated teams strive to strike a balance between growth and risk management, fostering a culture of prudence and innovation that sets us on a trajectory of sustainable success. Now let’s move to slide three for the quarterly financial highlights. When looking at the same period in the previous year, revenue and PPNR grew at high single-digit rates supported by strong operating metrics, which linked-quarter saw revenue and PPNR headwinds as a result of increased deposit cost and NIB remixing leading to margin contraction. Loans increased $309 million or 1% quarter-over-quarter. As we saw in the first quarter, this growth rate declined from prior year levels as we continue to experience lower loan production due to client demand and our increased emphasis on returns and relationship-based lending.

After seasonal tax-related outflows in April, core deposits increased modestly and ended the quarter roughly flat with the first quarter. Much like the rest of the industry, we continue to see pressures from non-interest-bearing deposit remixing as clients have increased their use of their operating funds, thereby further reducing average balance per account. Our underlying credit performance remains solid and although our credit metrics are experiencing some expected increases as a result of the current environment, overall credit trends are healthy and we have not seen meaningful change in the underlying performance of our borrowing base or stress focused in any particular industry or asset class. Lastly, as I have stated previously, we continue to focus on maintaining a strong capital position as we navigate through the uncertain environment and with the CET1 position ending the quarter at 9.85%, we are well on side of achieving our objective of exceeding 10% CET1 by the end of the year.

Now I will turn it over to Jamie to cover the second quarter results in greater detail. Jamie?

Jamie Gregory: Thank you, Kevin. I might begin with loan growth as seen on slide four. Total loan balances ended the second quarter at $44 billion, reflecting growth of $309 million. As Kevin mentioned, new production and overall growth have slowed as new fundings are focused on customers with more broad-based relationships. Similar to previous quarters, CRE growth was a function of draws related to existing multifamily commitments and a low level of payoffs. On the C&I side, the slight decline in balances was driven by lower utilization an exit of certain syndicated loan-only relationships. Lower C&I utilization is a positive credit signal, reflective of the health of our overall borrowing base. In the current environment, we are rationalizing growth in areas that have a lower return profile or don’t meet our strategic relationship objectives.

On that note, in July, we signed an agreement to sell a $1.3 billion medical office CRE portfolio. This transaction is expected to result in a onetime negative net income impact of approximately $25 million in the third quarter and reflects the exit of a business that maintained pristine credit quality, despite not meeting our long-term strategic criteria. Turning to slide five. Deposit balances remained relatively flat for the quarter. Core deposits saw a modest increase after April seasonal declines, and despite a more tempered outlook, we continue to expect deposit growth through the remainder of the year. Supporting this growth are seasonal tailwinds along with targeted deposit efforts, including deposit, specialist hires and focused industry vertical initiatives.

Looking at the composition of the quarterly change in balances. Non-interest-bearing deposits were down $1 billion quarter-over-quarter, a byproduct of the aforementioned seasonality from tax payments, cash deployment of excess funds and continued pressures from the higher rate environment. As in the first quarter, the decline in MMA was largely impacted by a shift to other products, in particular to CDs within our consumer customer base. As we look at deposit rates, our average cost of deposits increased 51 basis points in the second quarter to 1.95%, which equates to a cycle to-date total deposit beta of 37% through Q2. Our deposit cost and betas were impacted by the anticipated pricing lags on core interest-bearing deposits, as well as the decline in non-interest-bearing deposits.

We expect those same dynamics to play out in Q3, with deposit pricing lags continuing, albeit at a slower pace given the FOMC’s slower pace of tightening and with some further decline in non-interest-bearing deposits as a percent of total deposits. The result is further pressure on our expectations for through-the-cycle total deposit betas, which we now approximate will end the year in the context of 46% to 48%. Last quarter, we included statistics on our liquidity position that detailed our level of insured deposits and contingent liquidity sources. These figures have been updated and are available in the appendix to this presentation. Now to slide six. Net interest income was $456 million in the second quarter, an increase of 7% versus the like quarter one year ago and a decline of 5% from the first quarter, in line with our previously disclosed expectations.

The asset side of our balance sheet continued to benefit from both higher balances and rates. Though as in the first quarter, higher deposit pricing and remixing within our NIB deposit portfolio offset those gains resulting in overall NIM compression. As we look forward, we expect Q3 NIM to continue to contract at a pace similar to that in Q2, followed by some relative stabilization thereafter as deposit pricing lags and NIB remixing slow. Against those diminishing headwinds would be the gradual benefit, which accrues to the margin from fixed rate repricing, which has a compounding effect and should support the margin through time, assuming this higher rate environment remains. Slide seven shows total adjusted non-interest revenue of $111 million, down $7 million from the previous quarter and up $10 million year-over-year.

The primary variance in quarter-on-quarter fee income was due to the extremely strong first quarter for Capital Markets, which normalized as expected. That said, despite lower overall industry-wide transaction volume, the current level of capital markets income reflects the benefit of strategic investments in our CIB and middle market banking platforms. As we step back and look at the overall levels of durable core client fee income, excluding mortgage, the investments across our franchise and products and services continue to bear fruit. Over the last four years, we have compounded core client fee income at nearly a double-digit pace as we continue to invest in valuable revenue streams such as treasury and payment solutions, capital markets and wealth management.

Also of note in the second quarter is the closing of our Qualpay investment, which we announced last year. The go-forward impact is expected to have an immaterial impact to consolidated net income and is reflected in our guidance for the full year. Moving to expenses, slide eight highlights total adjusted non-interest expense of $301 million, down $4 million from the prior quarter and up $17 million year-over-year, representing a 6% increase. We are very proud of the team for our prudent expense management in a challenging operating environment. Where production volumes have declined, we have implemented headcount reduction strategies and discretionary spend has been reduced across the organization. In addition, as we have said before, our incentive plan alignment allows for expense flexibility in times when revenues are under pressure.

We will continue to operate with heightened expense discipline in the near-term and adapt our expense base to maintain a competitive overall efficiency ratio. Moving to slide nine on credit quality. Overall, credit performance continues to perform in line with expectations, as evidenced by the relatively stable life-of-loan loss expectations in the allowance calculation. As we saw last quarter, the 2 basis points increase in the allowance was a result of modest deterioration in the forecasted economic outlook. The quality of our originations remains strong and the impact of a few credit downgrades were offset by improvements in the performance of the aggregate loan portfolio. As we look to the second half of 2023, we expect credit costs to remain manageable, with expected full year charge-offs of 25 basis points to 30 basis points, reflecting a second half charge-off range of 30 basis points to 40 basis points.

We continue to have confidence in the strength and quality of our portfolio. We do not see any specific industry or sector stress within our loan book and we will continue to apply our conservative underwriting practices and advanced market analytics to both new loan originations and portfolio monitoring and management. As seen on slide 10, our capital position continued to grow in the second quarter, with the common equity Tier 1 ratio reaching 9.85% and with total risk based capital now at 12.79%. Our organic earnings profile supported capital accretion in Q2, which along with a somewhat slower pace of loan growth, was more than sufficient to offset marginal headwinds in the consolidation of our Qualpay investment. As we look ahead, we remain focused on eclipsing the 10% CET1 threshold.

At which time we intend to reassess the broader macroeconomic environment and consider what actions, if any, may be prudent as we diligently manage our capital position to the interest of all stakeholders. I will now turn it back to Kevin to discuss our guidance.

Kevin Blair: Thank you, Jamie. Now I will continue with our updated guidance for the quarter. Before we review the details, it’s worth noting that outside of loan growth, the ranges provided do not reflect the impact of the impending FDIC special assessment nor the impact of the medical office CRE sale as the transaction is yet to be settled. As you can see on slide 11, the changes in the operating environment that have impacted the industry over the last 90 days are reflected in our revised guidance. Loan growth is now expected to be 0% to 2% for the year. This reduced guidance is due to lower anticipated production volume, as well as the impact of the expected medical office CRE sale. Despite lower demand and a higher hurdle rate for new business, we continue to have growth oriented lines of business such as middle market and CIB, which we expect to produce strong second half growth.

We expect core deposit growth to increase 1% to 4% driven by the previously mentioned seasonal tailwinds and new growth initiatives. The adjusted revenue growth outlook of 0% to 3% aligns with an FOMC that reaches a target rate of 5.5% and holds through the end of the year. Changes to the revenue guidance are the result of lower loan growth expectations and overall deposit betas, which are now expected to reach 46% to 48% by year end. We expect 4% to 6% expense growth in 2023, while the environment has resulted in some strategic shifts and priorities, we remain confident in our growth strategies, including Maast and CIB, but have applied additional discipline across the entire expense base to better manage levels of growth. Over the course of the year, we have significantly reduced our guidance range and when adjusting for new growth initiatives, as well as uncontrollable environmental costs such as FDIC and healthcare, our core expense base is expected to be flat to up 1% year-over-year.

Moving to capital, as we previously communicated, we are targeting a CET1 ratio above 10%. At this time, we continue to believe it is prudent to build a larger capital buffer and we intend to continue to build capital levels through year end through the retention of organic capital generation and slowing balance sheet growth. Lastly, we expect our full year tax rate to be near the midpoint of our previous guidance range of 21% to 23%, supported by new federal tax investments, which will go into effect in the second half of the year. Our commitment to agility and responsiveness will be instrumental in navigating the ever evolving landscape. As we continue to focus on growing tangible book value, we also recognize an opportunity to right-size our balance sheet for sustainable profitable growth.

Our medical office transaction announced this quarter is an example of diligent balance sheet management optimization efforts, where we free up capital and liquidity to pursue higher returning, more expandable relationships. As we move forward, we remain steadfast in our dedication to managing expenses and leveraging other strategic measures to perform optimally in the current environment. By staying adaptable and resilient, we are confident in our ability to achieve sustainable growth and to deliver value to our shareholders, customers and communities alike. And now, Operator, let’s open up the call for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question is from the line of Steven Alexopoulos with J.P. Morgan. Please go ahead. Your line is open.

Steven Alexopoulos: Hey. Good morning, everybody.

Kevin Blair: Good morning.

Jamie Gregory: Good morning, Steve.

Steven Alexopoulos: Start on the updated revenue guide — hi. So the environment is tough. I don’t know if it’s that much tougher than we thought it was a quarter ago. What’s really changed to drive the revenue outlook moving down to the 0% to 3% range?

Jamie Gregory: Yeah. Steven, this is Jamie. Thanks for the question. As we look at the revenue outlook for 2023 compared to what we said in April. It’s really two different components. On the asset side, you have a couple composites. We expect spread revenue to remain high and that going on spreads to remain at these elevated levels. But we do have the impact of lower loan growth and some of that is environmental due to the economy and part of it is due to the sale of that medical office CRE portfolio. On the liability side of the balance sheet, you have the impact of further deposit mix headwinds and that’s really due to the decline in non-interest-bearing deposits that’s above prior expectations.

Steven Alexopoulos: Got it. Okay. And then, Jamie, to follow-up on that. So basically indicating NIM down about the same amount of the third quarter but then leveling out. So should we think about this really the NIM should bottom in the third quarter then maybe be flat to up past that and what are you assuming for non-interest-bearing, is that mix shift basically done once we get past the third quarter also? Thanks.

Jamie Gregory: We do expect, as you said, the margin to decline in the third quarter a little less than what we saw here in the second quarter and that does include continued remixing of the deposit base with further declines in NIB to total deposits. We have tried to look at it in multiple ways. It’s a hard thing to model given everything that’s going on that’s kind of outside of our control. You think about the exogenous factors of the Fed balance sheet and rate tightening and trillions of dollars in stimulus in a GDP growth environment, and so we try to look at history and determine where it’s going to go. Unfortunately, the prior tightening cycles don’t give us a lot of insight. The mid-2000s is probably best, but it still wouldn’t imply declines like what we are seeing right now.

I think a lot of that has to do with diminishment. When we look at the cash flows of our clients and using the same analysis that we have spoken about in the past about credit, we see that our client spend is the growth and it is declining, and we think that our clients are being managing their cash flows and so we do expect to see some of that diminishment slow as we go through this year. But we do expect to see declines, heading into year-end, we expect about another 3% decline in NIB to total deposits, and perhaps, if rates stay high, a little more decline, maybe another percent in 2024. But that’s how we are thinking about that mix, but it’s probably one of the more uncertain pieces of the model as we look forward. But we are just trying to be conservative in how we look at it, make sure that the guide we gave is pretty clear in that regard.

Steven Alexopoulos: Got it. So even with a sustained remixing, there’s not a benefit coming from the fixed assets pricing that NIM should be relatively stable in 4Q is what you are saying right?

Jamie Gregory: Yeah. That’s right.

Steven Alexopoulos: Okay.