Truist Financial Corporation (NYSE:TFC) Q2 2023 Earnings Call Transcript

Truist Financial Corporation (NYSE:TFC) Q2 2023 Earnings Call Transcript July 20, 2023

Truist Financial Corporation misses on earnings expectations. Reported EPS is $0.95 EPS, expectations were $1.01.

Operator: Greetings, ladies and gentlemen, and welcome to the Truist Financial Corporation’s Second Quarter Earnings Call. Currently, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this event is being recorded. It is now my pleasure to introduce your host Mr. Brad Milsaps, Head of Investor Relations, Truist Financial Corporation.

Brad Milsaps: Thank you, Tarren, and good morning, everyone. Welcome to Truist’s second quarter 2023 earnings call. With us today are our Chairman and CEO, Bill Rogers; and our CFO, Mike Maguire. During this morning’s call, they will discuss Truist’s second quarter results, share their perspectives on current business conditions and provide an updated outlook for 2023. Clarke Starnes, our Vice Chair and Chief Risk Officer; Beau Cummins, our Vice Chair; and John Howard, Truist Insurance Holdings ‘ Chairman and CEO are also in attendance and are available to participate in the Q&A portion of our call. The accompanying presentation as well as our earnings release and supplemental financial information are available on the Truist Investor Relations website ir.truist.com.

Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on slides two and three of the presentation regarding these statements and measures as well as the appendix for appropriate reconciliations to GAAP. With that, I’ll now turn it over to Bill.

Bill Rogers: Thanks, Brad, and welcome to the team. Good morning, everybody, and thank you for joining our call today. I don’t think it’s a surprise to anybody on this call that the increasing levels of uncertainty in our economy, the impact of interest rates on funding cost, and a new sort of post-March operating environment for our industry are impacting our results and plans. Truist was specifically built to increase our flexibility to respond to any condition to fulfill our purpose and commitment to all stakeholders. Capital and liquidity have taken on an increased focus and although Truist is currently well-positioned. We’re also intensely building future flexibility. This environment also challenges us to move faster with greater intensity to tighten our strategic focus and rightsize our expense chassis to reflect the new realities.

We also have flexibility in strengthening our balance sheet to support our focus on our unique core client base and market opportunity. These decisions are less incremental and more time-bound than the ones previously made during our shift from integrating to operating. Mike will highlight some of these decisions in his comments and I’ll close with some of the underlying momentum. While these changes will be manifested over time, this is not business as usual and reflects an important and significant pivot for Truist and for our leadership team. We’ll provide more details about these topics and our second quarter results throughout the presentation. Before we do that, let me start where I always do on slide four on purpose mission and values.

Truist is a purpose-driven company dedicated to inspiring and building better lives and communities. I’d like to share some of the ways we brought that purpose to life last quarter. In May, we announced the launch of Truist Long Game, our mobile app that leverages behavioral economics to reward clients for building financial wellness at a high-level user set goals, save money and earn rewards that are deposited into a Truist account as they make progress towards their savings goals. Based on early data, users tend to play four to five times a week with strong retention and we’ve seen positive trends towards new client acquisition. This is also the first product from our Truist Foundry, our very own start-up tasked with creating digital solutions to help meet clients where they are.

Truist has also highlighting small-business owners through a small-business Community Heroes initiative which is all about focusing on the small-business owners who worked tirelessly to serve our neighbors, create jobs and build our communities and help drive our economy. Our branch teammates are visiting and connecting with tens of thousands of small business clients to say thank you and have a carrying conversation to assist with their unique needs. The response so far has really been excellent and our outreach efforts have helped drive a 31% increase in net new small business checking accounts during the second quarter alone. Lastly, I want to thank our teammates, who dedicated more than 16,000 hours during the second quarter to volunteer in their communities.

I’m really proud of the good work our company and our teammates are doing to live out our purpose and to make a difference in the lives of their clients, teammates and communities. So let’s turn to the second quarter performance highlights on slide six. Second quarter results were mixed overall. Net income available to common in the second quarter was $1.2 billion or $0.92 a share. EPS decreased 16% relative to the year-ago quarter, primarily due to a higher loan loss provision and noninterest expense partially offset by higher net interest income. EPS decreased 12% sequentially as higher funding costs pressure net interest income. Total revenue decreased 2.9% sequentially, consistent with our revised guidance, and a 6.1% decrease in net interest income was partially offset by 2.6% increase in fee income led by record results at Truist Insurance Holdings.

Adjusted expenses were within our existing guidance range although we are actively working to manage cost even more intensely. Loan balances were relatively stable and we’re pleased with the initial progress we’ve made to reposition the balance sheet for higher return core assets, especially in consumer, though there’s always additional work to do. Average deposits were down 2% largely due to client activity in March, the overall deposit trends have stabilized significantly since that time frame and our conversations with our clients and our pipelines have improved. We’re also prudently increasing our provision and allowance due to increased economic uncertainty. At the same time, our CET1 capital ratio increased 50 basis points driven by organic capital generation and the sale of a 20% stake in our insurance business.

These same factors drove a 5% increase in tangible book value per share for March 31st. Our stress capital buffer increased from 250 basis points to 290 basis points higher than we think our steady state business model warrants, but still a good performance as Truist had the fourth lowest loan loss rates among traditional banks that participate in the stress test reflecting again our conservative credit culture and diverse loan portfolio. We also announced plans to maintain our strong quarterly common stock dividend at $0.52 a share subject to Board approval. Strategically, we continue to optimize our franchise and focus our resources on our core clients and businesses, which is why we made the strategic decision to sell a $5 billion non-core student loan portfolio at net carrying value which has no upfront P&L impact.

We’re also making solid progress toward shifting our loan mix towards higher return core assets. As we adapt to the current environment, we’re highly focused on doubling down on our core franchise, simplifying where it makes sense, rationalizing our expenses, and building capital, all of which will address later in the presentation. So moving to the digital and technology update on slide seven. Digital engagement trends remain positive, reinforcing the importance of continued investment in digital due to its close association with relationship primacy client experience and account growth. As a proof point, we recently enhanced our digital on-boarding experience through a series of platform enhancements resulting in higher conversion rates for new applications, faster funding and higher average digital account balances.

Our growing mobile app user base is also driving increased transaction volumes. Digital transactions grew 5% sequentially and now account for 61% of total bank transactions. Zelle transactions increased 12% compared to the first quarter and now account for one-third of all-digital transactions at Truist, which underscores the importance our clients place on our payments and money movement capabilities. Retail digital client satisfaction scores have also returned to their pre-merger highs. We are proud of our third-place ranking in the Javelin 2023 Mobile Banking Scorecard. From an overall client experience and technology perspective, we continue to enhance our capability set that includes recent improvements to our cloud-based self-service digital assistant Truist Assist since implementing these enhancements several months ago, Truist Assist has hosted over 500,000 conversations with more than 380,000 clients and is connected clients to live agents to support more than 100,000 complex needs via LiveChat.

Over time, increased utilization of Truist Assist should lead to lower volumes in our call centers. We’re also delivering on our commitment to T3, through the launch of our Truist Insights to our small business heroes earlier this month. Truist Insights on power small businesses by providing actionable insights about financial activities, including cash flows, income and expense and proactive balanced monitoring. We first piloted Truist Insights in 2021 and this year alone have generated over 200 million financial insights for more than 4.5 million clients, who are now delivering the best valuable tool to small businesses. This is just one more way we’re bringing touch and technology together to build trust and to help our small business clients bank with confidence, where and how they want.

Overall, I’m highly optimistic that our investments in innovation and digital and technology will enhance performance and further improve the client experience. Let me turn to loans and leases on slide eight. Loan growth continues to be correlated with the solid progress we’ve made to shift our loan mix towards more profitable portfolios and core clients while intentionally pulling back from lower-yielding and certain single-product relationships. Average loan balances were stable sequentially as growth in our commercial portfolio was largely offset by lower consumer balances. Commercial loan growth was driven by seasonality and mortgage warehouse lending and continued growth in traditional C&I which is a core area for us. The decline in average consumer balances was primarily due to indirect auto where we’ve intentionally reduced production, home equity, residential mortgage and student loan balances also declined and I’ll provide more details about the sale of the student loan portfolio in a few moments.

At the same time, we’re seeing strong results from our Service Finance and Sheffield businesses where second quarter production grew 34% and 21% respectively from the year ago quarter. Service Finance continues to perform very well and take market share and consistent with our balance sheet optimization we’ll increase our loan sale opportunities to help support its growth. As I mentioned, we made the strategic decision to sell our $5 billion non-core student loan portfolio, which had been running off at a pace of approximately $400 million per quarter. We sold the student loan book in late June and net carrying value with no upfront P&L impact. Proceeds from the sale were used to reduce other wholesale funding. The transaction will modestly hurt NII, but boost NIM and balance sheet efficiency, exactly what we should be doing in an environment where cost of capital and funding has increased meaningfully.

Moving forward, we’ll continue to better focus our balance sheet on Truist clients who have broader relationships while limiting our exposure to single product and indirect clients as well as evaluate ways to increase the velocity overall of our balance sheet. Now let me provide some perspective on overall deposit trends on slide nine. Average deposits decreased $8.7 billion or 2.1% primarily due to seasonal tax payments and outflows that occurred late in the first quarter and were consistent with industry impacts of quantitative tightening. We continue to experience remixing within our deposit portfolio as noninterest-bearing deposits decreased to 31% of total deposits from 32% in the first quarter and 34% in the fourth quarter of 2022. Interest-bearing deposit costs increased 55 basis points sequentially and our cumulative interest-bearing deposit beta was 44%, up from 36% in the first quarter due to the continued presence of higher rate alternatives and the ongoing shift from noninterest-bearing accounts to higher-yielding products.

We continue to remain a balanced approach in the current environment being attentive to client needs and relationships while also striving to maximize value outside of rate paid. Our continued rollout of Truist One and ongoing investments in treasury and payments are the bullseye of our sharpened strategic focus and will remain critical as we look to acquire new relationships, deepen existing ones and maximize high quality deposit growth. Now let me turn it over to Mike to discuss our financial results in a little more detail.

Mike Maguire: Great. Thank you, Bill, and good morning, everybody. I’ll begin with net interest income on slide 10. For the quarter, taxable equivalent net interest income decreased 6.1% sequentially as higher funding costs more than offset the benefits of higher rates on earning assets. Reported net interest margin decreased 26 basis points to 2.91% due primarily to an acceleration of interest-bearing deposit betas and mix-shift out of DDA into other high cost alternatives. The lower net interest margin also reflected our liquidity build late in the first quarter, while liquidity remained elevated throughout April and May, it has normalized by June and will provide some modest boost in NIM going forward. On a year-over-year basis, net interest income is still up 7.1%, and core net interest margin is up 13 basis points.

This reflects the cumulative benefit we’ve seen from the rising rates during the cycle, particularly throughout 2022, but now we are losing some of that benefit in 2023. Moving to fee income on slide 11. Fee income rebounded 2.6% relative to the first quarter. Insurance income increased $122 million sequentially to a record $935 million, demonstrating the strength of Truist Insurance Holdings. Year-over-year organic revenue grew by 9.1%, the highest in four quarters, driven by strong new business growth, improved retention and a favorable pricing backdrop. Other income increased $65 million primarily due to higher income from our non-qualified plan and higher other investment income. In contrast, investment banking and trading income decreased $50 million, reflecting lower bond originations, loan syndications and asset securitizations as well as lower core trading income from derivatives and credit trading.

Finally, mortgage banking income increased or may decreased $43 million, with most of the decrease related to prior quarter gain on sale of a servicing portfolio. Turning to non-interest expense on slide 12. Adjusted noninterest expense increased $67 million or 1.9% sequentially. The increase in adjusted expenses reflected a $75 million increase in personnel costs due to higher variable compensation and non-qualified plan expense and a $38 million increase in professional fees associated with enterprise technology and other investments. These increases were partially offset by a $41 million reduction and other expenses due to lower operational losses during the quarter. As a company, we have substantial opportunities to operate more efficiently and are committed to generating expense reductions.

On the April earnings call, we discussed a strategic realignment within our fixed-income sales and trading business in which we discontinued certain market making activities and services provided by middle-market fixed-income platforms that had an unattractive ROE. We also identified various expense reduction activities that had already been underway, including realigning our LightStream platform to our broader consumer business and ongoing capacity adjustments to market-sensitive businesses such as mortgage. We’re actively working to identify and accelerate additional actions that could be implemented over the course of the next 12 to 18 months to generate cost reductions to reflect efficiency opportunities and changing conditions. These actions include taking a much more aggressive approach towards FTE management, realigning and consolidating businesses to advance our long-term strategy, rationalizing our tech spend to drive more efficient and effective delivery and optimizing our operations and contact centers, which will help us transform Truist into a more effective and efficient company.

Taken together, we believe these actions will increase our focus, double down on our core, simplify our business, bend the expense curve, and enhance returns for our shareholders. Moving to slide 13, asset quality metrics reflected continued normalization during the second quarter. Nonperforming loans rose 11 basis points primarily due to increases in our CRE and C&I portfolios, though they remain manageable at 47 basis points. While the increase in CRE, nonperforming loans, include some office, these loans are generally paying as agreed. Our net charge-off ratio was 54 basis points inclusive of a 12 basis point impact from the sale of the student loan portfolio, excluding the student loan sale, net charge-offs were 42 basis points up 5 basis points sequentially.

We’d also note that the student loan sale had no impact on our provision expense this quarter as the charge-offs taken in conjunction with the sale was essentially equal to the allowance on the portfolio. During the quarter, we also increased our ALLL ratio 6 basis points to 1.43% due to greater economic uncertainty. Consistent with our commentary last quarter, we have tightened credit and reduced our risk appetite in select areas though we maintain our through-the-cycle approach for high-quality long-term clients. Next, I’ll provide more details on our CRE portfolio, which takes us to slide 14. On June 30th, CRE, including commercial construction represented 8.9% of loans held for investment, while the office segment comprised only 1.6%. We maintain a high-quality CRE portfolio through disciplined risk management and prudent client selection.

We typically work with developers and sponsors we know well and have observed their performance through multiple cycles. Our larger exposures tend to be associated with sponsors that have strong institutional ownership and we have actively managed less strategic exposures out of the portfolio since the close of the merger. Looking at office in particular, the chart at the lower right provides a breakdown of our office portfolio by tenant and Class. Our office exposure tends to be weighted towards multi-tenant Class A properties that are situated within our footprint. All factors that we believe will drive outperformance. In addition, we have a strong CRE team that is highly proactive in working with clients to get ahead of the problems. During the second quarter, we completed a thorough review of the majority of our CRE office exposure.

We considered current conditions and client support in our risk rating approach. As a result, a handful of loans were moved to non-accrual, though the preponderance of the clients in exposure are paying as agreed. We believe our actions are prudent in light of current market dynamics and demonstrate our commitment to proactive and early identification and resolution of credit risk. While problem loans have increased in recent months, we believe overall issues will be manageable in light of our laddered maturity profile, conservative LTVs, and reserves which for office totaled 6.2% of loans held for investment. Turning to capital on slide 15. As you can see from the capital waterfall, Truist is well-capitalized and has significant flexibility to respond to potential changes in the risk and regulatory environment.

Beginning on the left, CET1 capital increased 50 basis points to 9.6% at June 30th. This was driven by organic capital generation and the completion of the sale of the 20% stake in Truist Insurance Holdings. I would also point out that at 9.6%, we’re well above our new regulatory minimum of 7.4% which takes effect on October 1st. We expect to achieve an approximate 10% CET1 ratio by year-end through a combination of organic capital generation and disciplined management of RWA growth. This view does contemplate the headwind from the pending FDIC assessment. On top of this, Truist has more than 200 basis points of additional flexibility given the residual 80% ownership stake in Truist Insurance Holdings. As we look beyond ’23, we do expect regulatory and capital requirements to become more stringent and potentially require us to deduct AOCI from our CET1 ratio, while the final form of any regulatory changes remains to be seen Truist is well-positioned to respond due to our strong organic capital generation and the likely phasing periods of any potential new requirement.

Specifically, and as shown on the right-hand side of the slide, based on estimated cash flows and assuming today’s forward curve, we would expect Truist AOCI to decline by 36% by the end of 2026. Assuming our current rate of organic capital generation remains constant, Truist should generate sufficient capital to offset the estimated remaining impact of AOCI on CET1 over this time period while maintaining the strategic capital flexibility with Truist Insurance Holdings. And now I will review our updated guidance on slide 16. Looking into the third quarter of 2023, we expect revenues to be down 4% due to seasonally lower insurance revenue and slightly lower loan balances, which will lead to continued pressure on net interest income, albeit at a slower pace relative to the decline we experienced in the second quarter.

Adjusted expenses are anticipated to decline zero to 1% as seasonally lower insurance commissions and our efforts to bend the expense curve will offset several seasonal headwinds like marketing and employee benefits that should change the tailwinds in the fourth quarter. For the full year 2023, we now expect revenues to increase 1% to 2% compared to 2022. The decline from our previous outlook for 3% growth is primarily driven by lower net interest income due to higher deposit betas, slower loan growth and lower investment banking revenue. Adjusted expenses are expected to increase 7%, which is at the upper end of our previously guided range due to continued investments in enterprise technology and other areas. This excludes the anticipated FDIC surcharge.

This is a number that is higher than where we’ve been targeting, but as we’ve discussed, we are pursuing a number of actions to reduce costs. In terms of asset quality, our expectation is for the net charge-off ratio to be between 40 and 50 basis points, which includes the impact of the student loan sale. Finally, we expect an effective tax rate of 19% or 21% on a taxable equivalent basis. Now Bill, I’ll hand it back to you for some final remarks.

Bill Rogers: Great. Thanks, Mike. So let’s conclude on slide 17. We’re on the right path and I’m highly optimistic about our ability to realize our significant post-integration potential as summarized in our investment thesis. Our goal financially is to provide strong growth and profitability and to do so with less volatility than our peers. Our strategic pivot from integrating to operating is well underway. And while the financial benefits of our pivot have been masked by the rapid increase in funding costs and related revenue pressure, we’ve made significant strategic progress over the past year and showing up in a number of operating metrics across our business. In our Consumer Banking and Wealth segments, Retail and Small Business Banking net new checking production has been positive during four last five quarters, reflecting the success of Truist One and improved retention associated with our increasing client service metrics.

Truist One also has many features that appeal to millennials and Gen Z represent 70% of the new client applications. Our Wealth Trust and Brokerage business continues to build momentum as net organic asset flows, which exclude the impact of market value changes have been positive eight of the last nine quarters. We’ve also steadily improved client satisfaction through the distinctive service provided by our branches and care agents as well as improvements to our digital processes and procedures that originated in our client journey rooms. As a result, our client satisfaction scores were stable to improving across most of our channels during the second quarter, but have been consistently rising over the past year since the integration. In Corporate and Commercial, we continue to focus on left lead loan transactions and the synergies between our CIB and CCB businesses.

During the first half of the year, 25% of the left lead transactions closed by Truist were with our CCB clients. We’re also making inroads with new CCB clients as 65% of the CCB left leads I just mentioned were new relationships. In equity capital markets, transaction economics have improved approximately 300 basis points on average since the merger. And in wholesale payments, our pipeline is the highest it’s been since the merger. Each of these data points reflects our increasing strategic relevance with our clients. In addition, our IRM program, integrated relationship management is off to a great start this year as we’ve already delivered nearly 50% more IRM solutions year-to-date than during the same period a year ago. Our strong progress demonstrates what is possible post-integration when our teammates can focus their undivided attention on caring for their clients and deepening those relationships.

However, just as we’re shifting our focus from integrate to operate, the economic landscape shifted from favorable to more challenging. As a result, we too much shift and make tough decisions to fit the realities of today’s economic environment and tomorrow’s regulatory requirements. This means being more disciplined about where we choose to compete and deploy our capital, whether businesses, clients or products and looking deeper and more — more structural cost opportunities that exist at Truist. These opportunities exist, but not the primary focus during the integration period where the focus was on creating the best transition possible for clients and teammates. Mike highlighted many of the specifics earlier while the details are critically important, what will ultimately matter to stakeholders is our absolute expense base and growth, and our teams are aligned internally on changing that trajectory.

I’m really truly optimistic about the future of Truist as our unwavering foundation of purpose, our talented teammates, leadership in growth markets and diverse business model will continue to drive our momentum and fulfill our potential. So Brad, let me turn it back over to you for Q&A.

Brad Milsaps: Thank you, Bill. Tarren, at this time, will you please explain how our listeners can participate in the Q&A session, as you do that, I’d like to ask the participants to please limit yourselves to one primary question and one follow-up in order that we may accommodate as many of you as possible today.

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Q&A Session

Operator: [Operator Instructions] We’ll take our first question from Ken Usdin with Jefferies. Please go ahead.

Ken Usdin: Thanks. Good morning, everyone. So I just wanted to follow-up, of course, it makes sense that the funding cost and slower loan growth is part of the change in the revenue outlook. I’m just wondering as you look forward and you think about that deposit mix and deposit cost trajectory as far as funding cost looking past the second quarter, how do you see that affecting the NII trajectory within that new revenue guide for the third and fourth? Thanks, guys.

Mike Maguire: Hey, good morning, Ken. It’s Mike. I’d say as we think about the rest of the year, the same factors that have been driving, I’d say just Average Balance QT primarily in the second quarter, we had a little bit more of an impact from tax payments will continue. The mixing has been pretty consistent too from a noninterest-bearing demand perspective into higher-cost alternatives. We saw a little bit of an acceleration in the first quarter as you’ll recall, but this quarter that stabilized a bit. We were down about 5.5% on those balances and remix from I guess 32% to 31%. We would expect that trend to continue as well. I think really the factor as we think about NII trajectory for the third and the fourth quarter has much more to do with sort of the Fed policy track, right, where we had about call it close to 50 basis points average increase in the Fed funds rate in the second quarter which really did have an impact on our betas, in our funding costs, we would expect that to be about half that in the third quarter and further moderating from there.

Ken Usdin: And just on the follow-up, what do you think that means for kind of the view of where you think terminal interest-bearing beta might land?

Mike Maguire: It’s tough. We’re at 44% today, that’s higher than where we expect it to be. I think we — as recently as a month or so ago expressed an expectation that maybe mid-to-high 40s would be the case. I think certainly piercing 50%, but really hard to pick a number at this point, Ken, to be honest with you, a lot of it I think has to do with how long we’re higher for longer.

Ken Usdin: Yeah. That makes sense. Okay, thank you.

Operator: We will take our next question from Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala: Good morning. I guess maybe the first question, Mike, just following up on what — your response to Ken around just the change in deposit beta expectations even relative to last month. Are they — like when we think about what you said on deposit beta outlook, are there any real signs that are suggesting that deposit trends are in fact slowing down and the likelihood of the beta — deposit beta update you provided today is more likely to play-out versus having to change this again next month. I’m just wondering are you seeing any tangible signs on the ground that suggest things are getting better?

Mike Maguire: You know it’s — we look at it on a weekly, monthly basis, Ebrahim. And so, I think, yeah. I mean I think history would say that as we approach and reach this terminal policy rate, we should start to see some moderation in the beta creep. We’re starting to see that a little bit, but a month or a few weeks the trend does not make, and so, just being very cautious on the outlook there. I mean at 5.25 going to 5.50, the degree of rate awareness across our client set is very, very high across the industry is very, very high. And so, look I — and I think that’s probably as much as anything driven the miss on betas for the sector so far.