Synovus Financial Corp. (NYSE:SNV) Q3 2023 Earnings Call Transcript

Synovus Financial Corp. (NYSE:SNV) Q3 2023 Earnings Call Transcript October 19, 2023

Operator: Good morning and welcome to the Synovus third quarter 2023 earnings call. All participants will be in a listen-only mode, and should you need assistance, please signal a conference specialist by pressing star, zero. After today’s presentation, there will be an opportunity to ask questions. If you would like to do so, please press star, then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded, and I will now turn the call over to Jennifer Demba, Head of Investor Relations. Please go ahead.

Jennifer Demba: 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 for our presentation. Now Kevin Blair will provide an overview of the quarter.

Kevin Blair: Thank you Jennifer. Good morning everyone and thank you for joining us for our third quarter 2023 earnings call. Over the past three months, Synovus has taken several actions to better position the bank for a more challenging, higher-for-longer interest rate environment, while continuing to build and expand our diversified business model in order to deliver long term sustainable growth. As previously announced, we completed two loan-sale transactions during the third quarter which strengthened the balance sheet and freed up capital for the bank to make more profitable relationship-oriented loans. The proceeds from the third party indirect auto and medical office building loan sales allowed us to reduce our level of wholesale funding while accelerating the path to our greater than 10% CET-1 target.

Also, on September 30 we further simplified our business mix by selling our asset management firm, Globalt, to its management team. The divestiture will be immaterial to earnings and allow the bank to reallocate capital to higher returning fee income lines of business while continuing to meet our wealth clients’ needs. We believe Globalt has a bright future as an independent investment advisor enabled to explore a wide range of additional partners and potential client relationships. To that end, we are in discussions to continue and expand our longstanding held-for-sale partnership with GreenSky. Given our ongoing discussions, any potential revenue benefits are not currently included in our 2023 guidance. There will be more details forthcoming over the next two to three months.

We are navigating the short term headwinds presented by higher interest rates by making the tough decisions around business mix, balance sheet optimization, and operating expenses, all of which will generate better financial performance in the quarters and years to come. Now let’s move to Slide 3 for the quarterly financial highlights. Synovus reported third quarter diluted EPS of $0.60 and adjusted EPS of $0.84. There were year-over-year and linked quarter revenue and PP&R headwinds as a result of continued higher deposit costs, leading to further but more moderate net interest margin contraction. As expected, loan growth outside the medical office building sale was less than 1% in the third quarter. This core loan growth was primarily attributable to multi-family construction draws while middle market commercial, corporate and investment banking, and specialty lines activity contributed to C&I loan growth.

There continues to be an increased emphasis on stronger returns and more deposit relationship-based lending, which has translated into higher yields on new production. Core deposits increased 1% or $432 million from the second quarter. Importantly, the shift from consumer money market accounts to higher rate time deposits slowed during the third quarter. Non-interest bearing deposits declined less than in the first and second quarter, but clients continued to use their excess operating and personal funds. Net interest margin contraction was not as significant as expected due to modestly better asset yields and funding costs; also, our deposit generation strategies are demonstrating continued success as production remains strong with third quarter levels approximately 70% higher compared to the same period in 2022.

Given the pressures on the margin, our operating expense discipline was quite evident as adjusted non-interest expense increased 2% from the second quarter and rose just 4% from the prior year. Cost containment remains a very high priority; in fact, we expect adjusted non-interest expense should be relatively flat year-over-year in 2024 as we implement more cost reduction initiatives in a variety of areas. As expected, credit costs increased as we continue to move off historically low levels; however, excluding the third quarter loan sales, net charge-offs remain manageable at 40 basis points, which includes a 21 basis point impact from a commercial industrial credit discussed in our recent 8-K filing. Along with other banks in the syndicate, we are in the process of evaluating and assessing all avenues of recovery to include legal recourse related to that specific transaction.

Finally, we continue to focus on maintaining a strong capital position as we navigate through a more volatile economic environment. With our CET-1 position ending the quarter at 10.13%, we are now slightly above our targeted capital levels. Over the near term, we expect to continue to preserve capital in excess of our target levels, given the continued amount of economic uncertainty. Now I’ll turn it over to Jamie to cover the third quarter results in greater detail. Jamie?

Jamie Gregory: Thank you Kevin. As you can see on Slide 4, total loan balances ended the third quarter at $44 billion, reflecting a sequential decline of $674 million or 2%. This includes the impact of the sale of the $1.2 billion medical office loan portfolio. Similar to recent quarters, CRE growth was a function of draws related to existing multi-family commitments and low levels of pay-offs. On the C&I side, middle market commercial lending and corporate investment banking contributed to growth. Our new loan fundings remain focused on customers with more broad-based deposit and fee income relationships. At the same time, we are rationalizing growth in credit-only lending areas that have a lower return profile or don’t meet our strategic relationship objectives.

Our balance sheet optimization efforts should continue over the near term and loan and core deposit growth should be relatively balanced. No further meaningful loan portfolio sales are being contemplated over the foreseeable future. Turning to Slide 5, core deposit balances grew $432 million or 1% sequentially during the third quarter, driven by a 23% increase in time deposits which was partially offset by a 4% decline in non-interest bearing deposits. Importantly, we leveraged our improved liquidity position to reduce wholesale funding by $1.6 billion, which improved our wholesale funding ratio by 240 basis points, while public funds declined $146 million or 2%. The non-interest bearing deposit decline is a by-product of deployment of excess funds and continued pressures from the higher rate environment.

This is a slower decline than we experienced during the first and second quarters. There was also a moderation in the decline in money market accounts during the quarter as the shift from money market accounts to CDs slowed. We expect to experience some core deposit growth during the remainder of the year. Supporting this growth are seasonal tailwinds along with our targeted deposit gathering efforts. As we look to deposit rates, our average cost of deposits increased 36 basis points in the third quarter to 2.31%, which was a slower rate of increase than in the second quarter and equates to a cycle-to-date total deposit beta of 42% through the third quarter. From the month of June to the month of September, total deposit costs were up 29 basis points.

Our deposit costs and betas were impacted by the pricing lags on core interest-bearing deposits as well as the decline in non-interest bearing deposits. Our expectations for through-the-cycle total deposit betas are now slightly reduced to 46% to 47% at year end. Now moving to Slides 6 and 7, net interest income was $443 million in the third quarter, down 7% versus a year ago and a decline of 3% from the second quarter, which was slightly better than our previously disclosed expectations. NIM compression moderated during the third quarter, down 9 basis points from the prior quarter versus a 23 basis point sequential decline in the second quarter. The asset side of our balance sheet continued to benefit from higher rates, though higher deposit pricing and further remixing within our NIB deposit portfolio offset those gains.

As we look forward, we expect the fourth quarter NIM to decline in a similar amount as the third quarter, followed by a relatively stable margin in the first quarter. That is expected to be followed by expansion as fixed rate asset re-pricing is more than enough to overcome the gradually reducing headwinds of deposit re-pricing and negative deposit mix shift. The graph on Slide 7 outlines the estimated marginal benefit to our NIM relative to our 3.11% NIM in the third quarter of 2023, attributable to fixed rate re-pricing for the asset and liability categories listed there. This assumes rates remain constant with the September 30 levels at a 5.5% Fed fund and around 4.5% on the 10-year. Slide 8 shows total reported non-interest revenue of $107 million.

Adjusted non-interest revenue was $106 million, down $4 million from the previous quarter and up $1 million year-over-year. The variance in quarter-on-quarter fee income was due to a combination of factors. There was a change to the NSF/OD program in July which impacted non-interest income by approximately $1.5 million and is now almost fully reflected in fee income as of quarter end. Core fee income has also been impacted by a soft mortgage lending market and more muted capital markets activity; however, the relative stability of fee income over time highlights the diversity of our revenue streams, many of which are insulated from the impacts of the volatile rate environment. We continue to invest in core non-interest revenue streams that deepen client relationships, such as treasury and payment solutions, capital markets and wealth management, which have demonstrated healthy growth over the past few years.

We also continued to simplify and optimize our business during the third quarter. The sale of asset management firm, Globalt to its management team on September 30 led to a $1.9 million non-recurring gain during the third quarter and should result in an approximately $10 million reduction in fee income and $8 million reduction in non-interest expense. Moving to expenses, Slide 9 highlights our operating cost discipline. Reported non-interest expense was $354 million. Adjusted non-interest expense of $306 million was up $5 million or 2% from the prior quarter and $12 million from the previous year, representing a 4% increase. Personnel expenses were flat sequentially, benefited by our headcount reductions during the second and third quarters.

Reported non-interest expenses were impacted by an $18 million voluntary early retirement charge and a $31 million loss from loan sales during the quarter. A $47 million special FDIC assessment should be incurred in the fourth quarter. Importantly, we will remain quite proactive with disciplined expense management in this revenue-challenged environment. We implemented reductions and a voluntary early retirement program in the second and third quarters which supported a nearly 4% company-wide reduction in headcount. In addition, as Kevin mentioned, we have several expense rationalization initiatives in various areas underway, which should keep our adjusted non-interest expenses relatively flat year-over-year in 2024. There will be more underlying details of these initiatives discussed at forthcoming industry conferences during the fourth quarter.

Moving to Slides 11 and 12 on credit quality, as expected, credit losses have risen over the past two quarters, primarily from idiosyncratic charge-offs. The 3 basis point increase and $6 million growth in our allowance for credit losses primarily reflects loan migration trends and an uncertain economic environment. Excluding the medical office building loan sale, net charge-offs were 40 basis points compared to our 30 to 40 basis point guidance for the second half of this year. Approximately 50% of third quarter charge-offs, excluding the medical office building loan sale, were attributable to a previously disclosed shared national C&I credit totaling $23 million. Non-performing loans increased modestly to 0.64% as credit metrics migrate from historically low levels.

Total criticized and classified credits rose slightly but are still a manageable 3.4% of total loans. We expect net charge-offs to average loans to be 30 to 40 basis points in the fourth quarter. We continue to have a high degree of confidence in the strength and quality of our loan portfolio. We will continue to apply our conservative underwriting practices and advanced marketing analytics to new loan originations and portfolio monitoring and management. As seen on Slide 13, our capital position continued to increase in the third quarter with the common equity Tier 1 ratio reaching 10.13% and with total risk-based capital now at 13.12%. Retained earnings and strategic transactions supported 27 basis points of capital accretion in the third quarter.

In addition, the proceeds from the third quarter third party and direct auto and medical office building loan sale allowed us to reduce our level of wholesale funding and total commercial real estate exposure. Even though Synovus has achieved its greater than 10% CET-1 target, we will continue to preserve our capital over the near term given there is still a fair amount of macroeconomic uncertainty. Moreover, there should be more limited capital accretion in the fourth quarter as a result of the expected $47 million FDIC special assessment. Of course, we will regularly re-assess the economic environment and consider if any opportunistic capital management may be appropriate in the future. I’ll now turn it back to Kevin to discuss our guidance.

Kevin Blair: Thank you Jamie. I’ll now continue with our updated fundamental guidance for the remainder of 2023. Loan growth is still expected to be zero to 2% for the 2023 year. We expect fourth quarter loan production to be at similar levels to third quarter, which remains muted versus 2022. Growth in the current quarter should be fueled by continued success in middle market and corporate and investment banking, as well as draws on construction lines. We maintain our expectations for core deposit growth of 1% to 3% as the company strives to balance loan and core deposit growth and will be aided by the previously mentioned seasonal tailwinds and new funding growth initiatives. The revenue growth outlook for 2023 is 1% to 2%, which assumes a Fed funds rate of 5.5% that holds through the end of the year.

Deposit betas are now expected to reach 46% to 47% by year end versus 42% in the third quarter. We have lowered our adjusted expense growth expectations to approximately 4% to 5% in 2023 versus previous expectations of 4% to 6%. Please note that the non-interest expense guidance does not reflect the impact of the upcoming $47 million FDIC special assessment expected to be incurred in the fourth quarter. While the environment has resulted in strategic shifts in priorities, we remain confident in our growth strategies and we continue to remain diligent in expense management. Over the course of the year, we have reduced our guidance range as we have implemented various expense initiatives. Moving to capital, we are now at our target CET-1 level.

At this time, we think it is prudent to maintain that target and continue to build capital over the near term, given there is still a fair amount of uncertainty in the macroeconomic environment. We still anticipate the tax rate should approximate 22% in 2023, supported by recent federal tax investments. At Synovus, we are focused on execution and closing out 2023 in a strong fashion. We remain optimistic that through the actions we have taken, we are better positioned to overcome the short term headwinds and to strengthen the bank’s foundation for a return to growth as we proceed through 2024. Now Operator, let’s open the call for Q&A.

Operator: Thank you. We will now begin the question and answer session. [Operator instructions] The first question we have comes from Ebrahim Poonawala of Bank of America.

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Q&A Session

Ebrahim Poonawala: Good morning.

Kevin Blair: Good morning Ebrahim.

Ebrahim Poonawala: Maybe a question, Kevin, on credit quality. Appreciate that there is a hit from one credit in the third quarter, but just looking at criticized loans and the 3.4 – I’m not sure if that’s impacted by that or not, but just talk to us around your sense of where credit is headed. You’ve spent a decade talking about just the clean-up has happened under [indiscernible] and then under you on the credit quality side post-GFC. Give us a sense of one day you think credit is headed from a macro perspective over the next 12 months, and then within your loan book, where are you seeing stress, like what should we expect from the outside in terms of potential [indiscernible] on credit costs over the coming quarters? Thank you.

Kevin Blair: Ebrahim, there’s a lot of questions in that one question, but let me take it from the start, and I’ll let Bob add in some comments around credit. You know, we’ve been talking for some time about normalization and moderation of credit cost, and that comes off, as you know, some of the lowest levels of credit cost and metrics that we’ve seen in many, many years. What you’re seeing this quarter was we’d talk a lot about and publicly disclosed is one large credit that charged off, which was a syndicated credit, and even with that credit, we’re still within the guidance that we provided during the second quarter, where we noted 30 to 40 basis points in the second half of the year. So although credit is moderating, we believe that it’s still very manageable.

It’s within the ranges that we had anticipated, and I’ll be honest with you, that large transaction, the loss content in that was not fully considered when we gave that guidance, so that tells you that in general, our credit costs came in a little less than what we would have anticipated, so it’s manageable. We still believe that the second half of the year will be 30 to 40 basis points, excluding the loan sales. Yes, there has been some increases in NPLs and criticized and classified, but I think that comes with the territory. As you see in this environment, many of our clients are having their margins compressed by the recessionary and inflationary efforts or numbers that are happening, and that results in things being downgraded; but again, it’s all within a manageable range, and when you look at it for the full year, we still think we’re going to come in between that 25 and 30 basis points, so for all the discussions that we’re talking about net charge-offs, there is really just a modest increase over what we’ve seen in previous years.

Bob, what would you add to that?

Bob Derrick: Yes Ebrahim, it’s Bob. I wouldn’t add much, other than to say it’s just general normalization, particularly in our corporate businesses that recall that we have about 60% of our balance sheet is made up of wholesale corporate businesses. For years, those numbers were extremely low, so as they move back into sort of normal territory as it relates to credit costs, you kind of–it kind of pushes your number in that 30 to 40 point range, as Kevin said. I think that’s a reasonable expectation for us. Overall, stress is in some of these portfolios, but nothing that we don’t feel like is manageable.

Ebrahim Poonawala: Noted, and I guess maybe one for you, Jamie, around give us a sense of deposit pricing as we move into next year, just competitively. What are you seeing in the market, are things getting easier or are they as competitive as they were earlier in the summer? Maybe if you can talk to just the appetite of the balance sheet around potential offsets with some of the fixed rate assets re-pricing. Thank you.

Jamie Gregory: Ebrahim, I think you’re the champion of multiple questions in one! Let me make sure–I hope I’ll answer them all, but I’ll start with deposit production and what are we seeing there. If you look at the rate of deposits, the ongoing–the going on production quarter-on-quarter, we were up 12 basis points quarter-on-quarter, right around 370 was the cost of deposit production in third quarter. What’s included in that is a little more than 20 basis points increase in the cost of CD production, so that’s around 4.7%. But the rate pressure on CDs has been a little bit reduced recently in the month of September, so we feel good about that, and then on other interest-bearing deposits, we saw MMA production come down about 11 basis points quarter-on-quarter, we saw now production down almost approximately 75 basis points quarter-on-quarter, so we feel good about the trends of deposit production within our interest-bearing products.

Mix will be an impact going forward, so all-in, I would say that deposit production cost increases in the fourth quarter will probably be similar to what we saw in the third quarter, but for overall deposit cost, you know we gave our guidance of 46% to 47% through-the-cycle beta, so we expect continued increases in the fourth quarter, and that actually has a little bit less to do with production than it has to do with re-pricing in the existing book. I would point to the table we put on Page 7 of the earnings deck with the fixed re-pricing. What you see below the line there is the impact of CD re-pricing, and the fourth quarter has a decent sized impact of CD maturities, so we have a little more than $2 billion in CDs that mature in the fourth quarter.

The rate on those today is about 3.75, and so we will have a headwind to deposit costs in the fourth quarter as those re-price to kind of the normal going-on production rate. We do expect further declines in non-interest bearing deposits in the fourth quarter, and so we think that the net result of all that is you get to that 46% to 47% through-the-cycle beta for the month of December, and deposit costs end the year in the mid to upper 2.50s. You asked about the asset side of the balance sheet. Will you remind me – was that the rate on the asset side?

Ebrahim Poonawala: Yes, I was just wondering in terms of the churn, the re-pricing that we’re going to see and the magnitude of that next year. That could be [indiscernible] growth.

Jamie Gregory: Yes, so as we look at–looking forward next year, so we’ll have a few things happen. First, going back to the liability side, we think that deposit costs, total deposit costs will peak or flat line starting in early 2024, but then you start to see the benefit of the fixed rate asset re-pricing, and you can see that on that same chart with the fixed rate assets, and you see how that impact just grows as you go through the year. We expect the margin to decline in the fourth quarter, be relatively stable in the first quarter, and then because the impact of CD re-pricing is a couple million dollars incrementally each quarter when you go through 2024, that will be easily overwhelmed by the benefits of the commercial–fixed rate commercial loan re-pricing, securities portfolio hedge run-off, and residential mortgage re-pricing, and you can see that in the chart that it’s pretty powerful as you go through 2024.

It’s a nice tailwind to both NII and the margins.

Ebrahim Poonawala: Thank you so much.

Operator: Thank you. We now have Steven Alexopoulos. You may proceed with your question when you’re ready.

Steven Alexopoulos: Hey, good morning everybody.

Kevin Blair: Good morning.