Synovus Financial Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 18, 2024

There are 13 speakers on the call.

Operator

Good morning, and welcome to the Synovus Second Quarter 2024 Earnings Call. All participants will be in listen only mode. Please note this event is being recorded.

Operator

I will now turn the call over to Jennifer Demba, Head of Investor Relations. Jennifer, please go ahead.

Speaker 1

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, cenovus.com. Kevin Blair, Chairman, President and Chief Executive Officer, will begin the call. He will be followed by Jamie Gregory, Chief Financial Officer, and we will be available to answer your questions at the end of the call. Our comments include forward looking statements.

Speaker 1

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 site. 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.

Speaker 1

And now Kevin Blair will provide an overview of the quarter.

Speaker 2

Thank you, Jennifer. Good morning, everyone, and thank you for joining us for our Q2 2024 earnings call. Synovus reported a loss of $0.16 in the Q2 of 2024, which included a previously announced $257,000,000 loss from the recent securities repositioning that was executed as a result of the capital benefits derived from our risk weighted asset optimization exercise. However, adjusted earnings per share were $1.16 compared to $0.79 in the Q1, while adjusted pre provision net revenue rose 20% from the prior quarter to $262,000,000 Adjusted revenue and earnings inflected higher in the 2nd quarter. Net interest income increased 4% from the prior quarter on 16 basis points of sequential NIM expansion.

Speaker 2

Also adjusted non interest revenue jumped 9% sequentially while adjusted non interest expense declined 5%. Moreover, our net charge offs and non performing loans declined meaningfully this quarter and our liquidity and capital positions remain as strong as they've been in several years. Our success and positive momentum are a direct result of the work of our talented team members. We are also making progress in key initiatives and in further strengthening our value proposition for our clients. We continue to attract talent in the expansion of our commercial and wealth lines of business.

Speaker 2

Our retail analytics platform has translated into a better client experience and is delivering 60% increase in new revenue resulting from the insights and leads generated. Our focus on the business owner wealth strategy is delivering a 52% conversion rate on qualified referrals. Our growth in the current pipelines remain robust in treasury and payment solutions. Our efforts to reduce fraud and operating losses have proven fruitful with year to date expenses down 11%. And lastly, we saw a significant improvement in credit quarter.

Speaker 2

In fact, our Community Bank line of business ended the quarter year to date in a net recovery position. So our progress is broad based and truly a team effort. In addition, as we've discussed in recent quarters, our focus remains firmly on execution, while reducing uncertainty and performance associated with the net interest margin and credit cost. The 2nd quarter results reflect our progress towards these goals. Now let's turn to Slide 3 for the highlights.

Speaker 2

As previously noted, net interest income increased 4% from the Q1 as a result of 16 basis points of sequential net interest margin expansion. Despite funded production increasing almost $500,000,000 this quarter, period end loans were down just over $200,000,000 from the Q1. We continue to generate healthy and consistent loan growth in the middle market, CIB and specialty commercial units, but payoff activity in senior housing as well as lower C and I utilization drove the overall decline in outstandings for the quarter. Core deposits declined slightly in the 2nd quarter driven by a drop in non interest bearing deposits offset by growth in time deposits. Furthermore, we reduced broker deposits for the 4th consecutive quarter.

Speaker 2

Our team remains highly focused on accelerating core funding generation through sales activities and product expansion. Adjusted non interest revenue increased 9% from the prior quarter, primarily from significant growth in capital markets income. On a year over year basis, there was strong growth in commercial sponsorship income from the expansion of card sponsorship business as well as our partnership with GreenSky. Capital Markets and Treasury and Payment Solutions fees also contributed to healthy year over year growth. Adjusted non interest expense was down 5% sequentially and relatively flat on a year over year basis.

Speaker 2

Our 2023 cost initiatives as well as ongoing diligence have led to a modest core operating expense growth from a year ago, while maintaining a level of strategic investments that position Cenovus well from a competitive standpoint in order to drive long term shareholder value. On the asset quality front, net charge offs of 32 basis points were 9 basis points lower than the 1st quarter levels, while non performing loans declined by 22 basis points. Lastly, we further bolstered our common equity Tier 1 ratio in the 2nd quarter through solid earnings accretion and balance sheet management, while still completing about $91,000,000 of opportunistic share repurchases. Common Equity Tier 1 levels are the highest in over 8 years at 10.62% and currently set modestly above our stated range of 10% to 10.5%. Now I'll turn it over to Jamie to cover the 2nd quarter results in greater detail.

Speaker 2

Jamie?

Speaker 3

Thank you, Kevin. Moving to Slide 4, period end loans were down $216,000,000 from the prior quarter. Loan production actually rose significantly from the Q1, but was offset by payoffs, paydowns and continued portfolio rationalization as well as lower utilization from our larger corporate and specialty line clients. We continue to maintain pricing discipline as evidenced by loan spreads on new production, which remain elevated relative to the prior year. Consistent with our focus on core client relationships, despite utilization headwinds, growth in middle market commercial, CIB and specialty lines was $157,000,000 or 5% annualized during the second quarter.

Speaker 3

During the first half of twenty twenty four, we produced 8% annualized growth in these core commercial business lines, which we believe should continue throughout the remainder of the year. Senior housing loans declined $196,000,000 from the prior quarter. There has been increased strength in the markets as evidenced by higher levels of transaction and refinancing activity over the last few quarters. That said, we anticipate more stable senior housing balances throughout the remainder of 2024. We also continue to strategically reduce lending within our national accounts portfolio as well as our 3rd party consumer loans, further positioning our balance sheet for core client growth.

Speaker 3

These balances were down $223,000,000 in the second quarter. In the second half of this year, 3rd party consumer loans should continue to decline estimated $60,000,000 per quarter, while national account balances should be more stable. We estimate we should see stable to higher total loans in the second half of twenty twenty four with continued growth in our key commercial segments. Turning to Slide 5. Period end core deposit balances were relatively flat on a linked quarter basis with somewhat more stable mix shifts within the quarter.

Speaker 3

Non interest bearing deposit balances were down $387,000,000 from the prior quarter. However, average balances were more stable in the 2nd quarter relative to the Q1. We still see some further pressure on non interest bearing deposits, though the trends continue to suggest notable slowing in the pace of decline in those balances. Finally, broker deposits declined $317,000,000 or 6% from the Q1, which was the 4th consecutive quarter of contraction. Deposit costs were stable in the 2nd quarter, up just one basis point from the prior quarter.

Speaker 3

This equates to a cycle to date total deposit cost beta of approximately 49%, which was unchanged compared to the Q1. As we look at the back half of the year, we expect deposit cost to remain relatively stable and are looking for broad based deposit growth across our business segments, which should be supported by seasonal tailwinds into the end of the year. Moving to Slide 6. Net interest income was $435,000,000 in the 2nd quarter, which was an increase of 4% from the 1st quarter. The Q2 benefited from various drivers, including improving loan yields, the residual impact of 1st quarter hedge maturities and the securities repositioning in May.

Speaker 3

As we alluded to in the Q1, we also witnessed relative stabilization in deposit cost and mix trends, which resulted in a much more modest headwind to interest expense. As we translate that to the margin, NIM expanded 16 basis points sequentially to 3.2%. This was primarily driven by the same factors which supported net interest income along with a one time positive impact from our securities held to maturity reclassification which served to reduce earning assets. As we look forward to the 3rd and 4th quarters of 2024, we continue to expect net interest margin expansion, driven by fixed rate asset repricing and 4th quarter hedge maturities as well as a full quarter impact of the securities repositioning, which was completed in May. Kevin will provide further detail on our guidance momentarily, which is based on an FOMC rate cut of 25 basis points in December.

Speaker 3

Slide 7 shows total reported non interest revenue was impacted by the $257,000,000 securities loss related to our securities repositioning in the 2nd quarter. However, adjusted non interest revenue was $127,000,000 which is a 9% jump from the previous quarter. Adjusted non interest revenue was up $17,000,000 or 15% year over year. The majority of the sequential growth was attributable to higher capital markets fees, which surged 128% from the Q1 and are expected to remain elevated in the second half of the year. The growth was driven by syndication finance, arranger fees and debt capital markets income.

Speaker 3

Also commercial analysis, treasury and payments solutions fees increased 4%, while core wealth management income increased 2% outside of an expected decline in repo income due to client asset allocation changes. When looking at the year ago quarter, core banking fees increased 4% supported by growth in treasury and payment solutions, while capital markets fees increased 59% and commercial sponsorship income jumped 188%. We continue to invest in core non interest revenue streams that deepen client relationships and provide further healthy fee growth in areas such as Treasury and Payment Solutions, Capital Markets and Wealth Management. Moving to expense. Slide 8 highlights our operating cost discipline.

Speaker 3

Reported and adjusted non interest expense were both $302,000,000 Adjusted non interest expense declined 5% from the 1st quarter and was flat compared to the year ago quarter. Employment expense fell 4% from the Q1, largely due to seasonality, partially offset by a full quarter impact of the 2024 merit increases and higher employee incentives. Turning to other expenses. FDIC premiums declined as a result of the $13,000,000 FDIC special assessment that was accrued in the 1st quarter and a partial special assessment reversal of $4,000,000 in the 2nd quarter. Legal expenses increased from the prior quarter, primarily due to expenses associated with previously resolved problem loans.

Speaker 3

Employment expense declined 1% year over year, benefited by our 7% year over year decline in headcount. Occupancy and equipment expense increased 8% as a result of ongoing technology investments as well as increased property expense. Importantly, we will remain proactive with disciplined expense management in this growth constrained environment. Moving to Slides 9 and 10 on credit quality. Provision for credit losses declined 51% from the Q1 to $26,000,000 Our allowance for credit losses ended the 2nd quarter at 5 $38,000,000 or 1.25 percent, which is relatively unchanged from the Q1.

Speaker 3

Net charge offs in the 2nd quarter were $34,000,000 or 32 basis points compared to 41 basis points in the 1st quarter and 38 basis points in the 4th quarter. Non performing loans declined 27% and are now 0.59% of loans, down from 0.81% in the 1st quarter, primarily from the resolution of a previously charged off credit and slower inflows. The criticized and classified credit ratio declined slightly to 3.7% and remains at very manageable levels. We have a high degree of confidence in the strength and quality of our loan portfolio and we will continue to reduce our non relationship credits and manage the portfolio with a heightened level of diligence in this more uncertain macroeconomic environment. As seen on Slide 11, our capital position continued to build in the 2nd quarter with the preliminary common equity Tier 1 ratio reaching 10.62% and total risk based capital now at 13.59%.

Speaker 3

A strong quarter of core earnings coupled with the completion of our previously announced risk weighted asset optimization exercise helped to support over 80 basis points of capital accretion within the quarter. Against that, we completed the anticipated available for sale securities repositioning and we executed approximately $91,000,000 in share repurchase. These actions serve to diligently deploy our capital while still ending the quarter near the top end of our targeted CET1 range. More details on the securities repositioning can be found in the appendix of our presentation deck. As we look to the remainder of the year, we will maintain a disciplined approach to capital management, which balances the uncertain economic environment with prudently managing near the top end of our 10% to 10.5% CET1 range.

Speaker 3

As a reminder, our focus remains on prioritizing the deployment of our balance sheet and capital position for core client growth. However, we expect to complement that with share repurchases to effectively manage within our capital management framework. I'll now turn it back to Kevin to discuss our 2024 guidance.

Speaker 2

Thank you, Jamie. I'll continue with our updated guidance for the remainder of 2024. Based on the first half results and our existing pipelines, period end loan growth is expected to be 0% to 2% in 2024. Growth should be supported by continued success in middle market, corporate and investment banking and specialty lines. Year to date headwinds with senior housing and national accounts syndicated lending are expected to subside, but broader commercial real estate payoff activity should increase in the second half of the year.

Speaker 2

Our forecast for core deposits now supports growth within the 2% to 4% range aided by seasonal tailwinds as the year progresses and new core funding growth initiatives. Stable deposit costs should result in a peak total deposit cost made up for this cycle near current levels of approximately 49%. Our outlook now points to adjusted revenue growth in the negative 3% to 0% range. Importantly, our adjusted revenue guidance now assumes there is 1 25 basis point rate cut in December 2024 compared to our prior assumption of stable rates as well as the realization of our robust capital markets pipeline in the second half of twenty twenty four. We expect more net interest income improvement in the second half of this year as deposit cost stability combined with fixed rate asset repricing, our hedge maturities and the full impact of the securities repositioning benefit, our net interest margin.

Speaker 2

Adjusted non interest revenue is now forecasted to grow in the mid single digit percentage range this year versus our previous guidance of low to mid single digit growth. The previously mentioned capital markets fee pipeline remains strong. We continue to execute on core growth in treasury and payment solutions and the GreenSky Forward Flow program continues to build commercial sponsorship fees. We remain very focused on disciplined expense control. Excluding the FDIC special assessments, we anticipate our adjusted non interest expense will be up 1% to 3% this year.

Speaker 2

This modest increase in expense guidance is due to incremental expenses and infrastructure spend and investments, legal costs primarily associated with resolve credits and higher team member incentives. We continue to closely monitor and manage our loan portfolio for any credit deterioration or systemic themes across industry and markets. Given current credit migration trends, assuming a relatively stable economic environment and considering the impact of certain large individual losses in late 2023 and early 2024, we expect net charge offs to be flat to down in the second half of this year compared to 36 basis points in the first half of twenty twenty four. Moving to the tax rate, our current forecast points to an approximately 21% level as compared to 21% to 22% previously. Finally, our common equity Tier 1 ratio is above our target range of 10% to 10 point percent.

Speaker 2

Therefore, we will remain opportunistic with share repurchases to manage overall capital levels at or near the top end of this range. Prudent capital management remains our top priority to ensure we have a strong and liquid balance sheet, which is prioritized towards serving the growth needs of our clients regardless of the economic environment. And now operator, this concludes our prepared remarks. Let's open the call for questions.

Operator

Thank you very much. We will now begin the question and answer The first question is from the line of Ebrahim Poonawala with Bank of America. Ebrahim, your line is now open. Please go ahead.

Speaker 4

Thank you. Good morning.

Speaker 5

Good morning.

Speaker 6

Maybe I

Speaker 4

guess just around the comments on net interest margin expansion in the back half. If you could unpack that in terms of the drivers of margin expansion, obviously, the full quarter impact from the bond book restructuring should help. But beyond that, just remind us in terms of the back book repricing and how NII evolves in the face of potential for rate cuts starting in September? Maybe if you could start there.

Speaker 3

Thanks Ebrahim. When you look at the margin and the trajectory in the second half of the year, there are a few different moving parts. First, as you mentioned, the securities repositioning, we experienced about half of that benefit in the second quarter and we'll experience another the other half here in the third quarter. And so that's a tailwind to the margin this quarter. There is, as you know, a little bit of fixed rate asset repricing as well in the Q3.

Speaker 3

That's a positive. But then there's a headwind due to average DDA balances. You can see that in the appendix. We put average balances and then the period balances. And there will be a decline in average balances just given the Q2, where that landed.

Speaker 3

And so that'll be a headwind to the margin in Q3. But we expect margin expansion in the 3rd quarter. We expect margin expansion again in the 4th quarter and we expect to end the year at or approaching a 3.30 margin given with the assumption of a rate cut in December.

Speaker 4

Understood. And just incrementally, if we get a series of rate cuts, Jamie, is that a drag to the name at least short term?

Speaker 3

It does. It does. So for our guidance, we used the Fed dot plot from June. But if you were to pivot to a September rate cut, which is more consistent with the forward curve today, there would be pressure on the margin in the months of September October. And so let me just kind of unpack that a little bit because this is an important question as we head into an easing cycle.

Speaker 3

In the period of time leading up to these, there is NIM pressure, which is minor due to short rates declining in the expectation of these. And so asset yields will decline and there's really not an offsetting benefit to funding costs. Then once the ease happens, the margin will be pressured further as the majority of floating rate loans repriced down. The full impact of these will flow through on the loans almost immediately as the majority of our floating rate loans are 1 month rates or shorter. But that will be partially mitigated by the 13% of floating rate loans that are hedged.

Speaker 3

And then when you're post easing, then you will start to see the benefit of reduced liability costs. And so you have the asset repricing, but then the reduced deposit costs, reduced funding costs will come through. And we believe that that will neutralize the reduction in asset yields over the course of 1 to 2 months. And so kind of to be more specific around that, if you were to just compare a September December ease, the forward curve relative to the Fed dot plot, which is a December ease. There's about a $5,000,000 to $7,000,000 margin, I mean, NII impact between those two scenarios and is split between the 2nd and the 3rd quarter, I mean the 3rd and the 4th quarter because it's a September October impact.

Speaker 4

That's extremely helpful. And just the only other follow-up, Jamie, you mentioned stable deposit costs second half. One, if you don't mind, give us an update on the pricing sort of competition in your markets. We had a peer of yours talk about intensity picking up. So would love any color there?

Speaker 3

The deposit pricing is playing out like we said in April. As we look at the outlook from here, we expect stable deposit calls through the remainder of the year. We feel good about our positioning here. We feel good about our production pipelines, pricing. What we've seen in the marketplace is not necessarily an increase in competition, but we've seen more coalescing around rates and less volatility between highs and lows.

Speaker 3

And it feels to us like on the promotional rate that there's a concentration around if you look at CD, the concentration around 5% and you're not seeing a lot of the outliers that we were seeing earlier in the year that were much higher. And it appears that the banking industry, it appears everybody is preparing for an easing cycle by shortening the duration, which is appropriate. And that's you've seen that with us as well where we have 2 thirds of our CDs that will mature in 6 months. And so I feel like the industry is preparing for easing. The industry is shorting the duration of time deposits and kind of coalescing around market rates.

Speaker 3

So it feels competitive but stable to us. And Ebrahim, just to

Speaker 2

put a data point behind Jamie's comments, our production rates for the quarter were 3.77 and we achieved kind of peak rates back in the Q4 of 2023@382. So we've seen stable production yields quarter on quarter and actually a reduction versus where we ended last year.

Speaker 4

Extremely helpful. Thank you for taking my questions.

Operator

Thank you. Our next question is from Steven Alexopoulos with JPMorgan. Steven, your line is now open. Please go ahead.

Speaker 7

Hi, good morning, everyone.

Speaker 5

Good morning, Steve and Steve. I

Speaker 7

want to start on the loan growth headwinds. Maybe could you help us better understand what's left in terms of the remaining headwind from rationalization efforts? And then Kevin, I thought you said that the CRE payoffs would increase in the back half of the year. Maybe you could quantify that for us. And how far away do you think we are to what these cumulative headwinds are really behind the company and that strategic growth and other areas of growth we're seeing start becoming the total low growth?

Speaker 2

Yes, Stephen, it's a great question because I think there to your point, when you assess the growth of loan outstanding, there's multiple components. And we've talked a lot about our ability to grow predicated on increasing production. But as you mentioned, there's a couple of things that are driving outstanding lower in the current environment. 1st and foremost, we've been rationalizing some of our portfolios that either we think have lower returns or have a lower funding profile. And that specifically is senior housing, 3rd party consumer, national accounts.

Speaker 2

Thank you. And when you look at those portfolios and we've run off about $2,300,000,000 in the last 12 months in those portfolios. That is just reduced their total percentage of outstandings from 18% to 13% and that's largely been accomplished. And so as we look forward for senior housing national accounts, those balances will stay roughly flat. And when you look at 3rd party consumer, those are going to continue to decline just because we're not putting on a lot of new production.

Speaker 2

So I would say that the headwinds around rationalization, and any loan sales, which as you recall, we did the MOB sale, the medical office sale last year, that's largely done. So as you look into the future, our production levels are actually increasing. When you look at this quarter alone, we are at $1,300,000,000 in funded production. That was up 37% quarter on quarter and almost back to the levels we saw back in 2023. So production is picking up.

Speaker 2

Our pipelines are up 8% quarter on quarter. So then the other question mark is the payoff and pay down activity. This quarter as Jamie referenced, the payoff activity occurred more on the C and I side. It was the national accounts and senior housing and we saw about $250,000,000 of lower utilization on C and I. From a CRE perspective, we don't expect the payoffs to really pick up this quarter, but rather in Q4.

Speaker 2

And that's just based on some of the maturities that we have. And to put it in context, we had about $370,000,000 of payoff and pay down activity this quarter. That number could get as high as $800,000,000 to $900,000,000 So we're talking about $400,000,000 ish increase in payoff activity And those are the headwinds. Now again, that's predicated on some of the renewals. As we look into 2025, as we've shared in the past, we think a lot of those headwinds are completely abated and we return to more of a normalized growth rate pending what the underlying economic environment looks like.

Speaker 7

Okay. That's terrific color. Maybe just for my follow-up question. Thank you for that. In terms of the non interest bearing deposits, right, there was a bit of excitement last quarter when you guys talked about seeing a trough maybe and stability in February, March, April.

Speaker 7

And then this quarter, the period in non interest bearing came down quite a bit again. Could you walk us through what you ended up seeing there? Because it seems like they trended a bit down.

Speaker 2

Yes. We had a good start to the quarter and we saw some declines as the quarter progressed. And it was really relegated to our commercial operating accounts. And when you look at the average balance there, we're still running about 20% higher than what the average balances were prior to the pandemic. So it still suggests that there's some sort of excess cash sitting on our commercial client balance sheets and they're using it as maybe correlated to the reduction in utilization.

Speaker 2

We continue to see our commercial clients use cash as rates decline, as we achieve kind of pre pandemic levels, which we're getting closer to that. We think that diminishment will continue to decline. And ultimately, the production and some augmentation that we're starting to see will offset that. So still expect to see some DDA remixing in the second half of the year, but the pace at which it's diminishing continues to decline. And Stephen,

Speaker 3

one thing I would add to that is, when you break it down, we have to Kevin's point on commercial, we've seen stability in retail DDAs since the beginning of the year. Commercial, like the smaller commercial clients that is down, but just only down slightly. And so it's I feel like the stability is increasing, but it's going up market as we go through this. And so that's what we're seeing and we both that's one thing that helps us believe that it will diminish in the second half of the year as well.

Speaker 7

Got it. Terrific. Thanks for taking my questions.

Speaker 2

Thank you.

Operator

Our next question from Jared Shaw with Barclays Capital. Jared, your line is now open. Please go ahead.

Speaker 8

Hi, good morning, everybody.

Speaker 3

Good morning.

Speaker 8

Maybe just quickly just following up on the margin discussion and you mentioned that we have half the benefit of the securities repositioning. What's the spot yield on the securities book at the end of the quarter going into 3rd quarter?

Speaker 3

Jared, I don't have that handy. I mean, we were at 304 for the quarter itself. It's about a 40 basis point impact just due to the repositioning. But I don't have the spot yield at quarter end.

Speaker 8

Okay. Okay. That's fine. And then looking at credit, if you could give just a little more discussion around that. It's great seeing sort of the confidence there in the longer the bigger trends.

Speaker 8

When you look at the driver of the lower ACL, is that really loan level performance that you're feeling more comfortable with? Or was there some change to the broader macro model assumptions driving that? And then should we assume that we're sort of stable here at these levels given the broader economic outlook?

Speaker 3

Yes. Jared, this is Jamie again. And by the way, there was 3.32 in June for the securities yield. The allowance, when you look at that, the change quarter on quarter, it really was due to the macro drivers. You can see the waterfall in the appendix of the change.

Speaker 3

Forward looking, we feel good about the level where we are right now. And when you look at the components of the allowance quarter on quarter, the performance in CRE continues to be very strong. And the allowance loan ratio for the quarter, life of loan loss estimate was down in CRE and it was up a little bit in C and I. So you see a little bit of shifts within the portfolios. But altogether, we would expect stability from here given the economic outlook, as we continue to look at how the portfolio migrates going into the second half of the year.

Speaker 3

And I

Speaker 2

think Jared, just to your broader question on credit, I think it was a solid quarter on all fronts. When you look at the data, net charge offs down 9 basis points, NPLs declined 22 basis points, our FDMs declined $93,000,000 We only had 60 $2,000,000 of NPL inflows. And to Jamie's point, only $1,000,000 of that was in CRE. And when you talk about the ACL, it came down a bit, but our coverage to NPLs increased back to 2 10%. So all in all, I think it was a storyline that was broad based.

Speaker 2

And as we've been talking about, as we look at the data and the underlying credit metrics, we're not seeing any additional deterioration. In many ways, we're starting to see some improvement in some of the metrics. And so as we look into the next couple of quarters that's why we feel very comfortable about guiding flat to down in overall charge offs.

Speaker 8

Great. Thanks very much for the color.

Operator

Our next question from Manan Gosalia with Morgan Stanley. Manan, your line is now open.

Speaker 9

Hi, good morning. I wanted to ask on the expenses front. Can you expand a little bit on the drivers of the higher expense guide? And the number implies, I think, about $315,000,000 or so of expenses a quarter in the back half. So how do you think about that as a jumping off point into 2025?

Speaker 3

Thanks for the question, Manan. I would just start and say the baseline for the Q2, I would use $306,000,000 which is adjusted expenses excluding the FDIC reversal. And we are expecting the 3rd quarter to be in the $310,000,000 area, so not the $315,000,000 you mentioned. We expect that to be driven by increased personnel costs and that's largely a day count issue. We do have some infrastructure project spend, some of that's fraud detection, fraud prevention, pricing analytics.

Speaker 3

And then there are just simply some other inflationary impacts. And so it's about a 1% increase from the 2nd quarter getting to the 310 area, and we expect that to hold in the 4th quarter as well.

Speaker 9

Got it. And that's a good run rate for 2025?

Speaker 3

As we look at 2025, we do think that expense rate will be a little more normalized. We will give an update on 2025 more at the end of the year, but we do expect expenses to be more normalized in 2025. And so 2024 benefited from a lot of the efforts we did in 2023 with Synovus Ford. In the second half of the year in 2023, we had a lot of efficiency efforts that were very successful in reducing cost, improving efficiency, reducing headcount and those benefited this year. I mean, when you think about the full year 2024, we're talking about up 2%, if you do use the midpoint of the guide excluding FDIC.

Speaker 3

And there are some large drivers in there of expense increases. We have about a 1% impact of simply of merit, about a 1% impact of the consolidation of Qualpay, about a 1% impact of credit related expenses is from the first half of the year. And with all of that and every other inflationary impact, we're still guiding to a 2%, 1% to 3% number. That feels pretty good. But we do expect 2025 to likely be higher than that.

Speaker 9

Got it. I appreciate the color. And then maybe separately on capital, your target CET1 is 10% to 10.5%. You're slightly above that. I think you're saying you want to manage to the higher end.

Speaker 9

What keeps you at the higher end of that 10% to 10.5% target? Is it the current uncertainty in the economy? Is it credit? What would drive you to move to the lower end or even below that 10% number?

Speaker 3

In isolation, we would drive to be there today. It's just when you look at capital management, stress testing, scenario analysis, there's nothing quantitative that would drive you to the levels where we are now or even to 10% to 10.5%. You would actually likely run below that when we think about capital deterioration in severe adverse scenario. But we believe it's prudent to operate with higher capital than the models would suggest just given, 1, there is uncertainty in the environment. But again, that wouldn't point you to the levels where we are today and 2, where peers are.

Speaker 3

And so if we've seen one thing we've seen over the past few years and economic uncertainty and market uncertainty, we do believe that relative capital ratios to peers in uncertain times can lead to higher betas. And we think it's prudent to stay closer to peer levels. And so while it's not quantitative, it's not due to uncertainty in the income statement, it's not due to uncertainty in the balance sheet. We do think it's prudent to run at these higher levels in the current environment.

Speaker 9

Great. Thank you.

Operator

Thank you. Our next question is from Brandon King with Truist Securities. Brandon, your line is now open.

Speaker 10

Hey, good morning.

Speaker 2

Good morning, Brandon.

Speaker 5

Good

Speaker 10

morning. So capital markets was pretty strong in the quarter. And Jamie, you mentioned how you expect it to stay elevated going forward, I guess, for the rest of the year. So does that mean we'll still see, I guess, close to that $50,000,000 run rate in the back half of the year?

Speaker 3

We do expect to see that continue. However, I would just qualify it with it is uncertain how it will play out quarter to quarter. So I feel more confident in the total number in the second half of the year than being able to say it's a stable number quarter to quarter. Because with our client base, with the uncertainty with the economy, with the uncertainty with the election, we do believe that it's likely that there are deals that will wait until the Q4. And so that could back end load the capital markets fee revenue.

Speaker 3

So again, we feel good about the total number. I'm just not certain how much will come through in Q3 and how much will come through in Q4.

Speaker 2

And Brandon, to add to the reason we feel comfortable with that, as Jamie mentioned, we've been investing in some of the capital market solutions for some time. And if I look back several years, I would say 80% of our revenue in capital markets came from the derivative side. If I look at this quarter as a standalone basis, only 25% of the revenue came from derivatives, almost 30% came from syndications and lead arranger fees. We had almost a quarter of the revenue from DCM fees, a little over 10% in FX, 10% in SBA. So it is so broad based that it gives us the opportunity that we're not over reliant on one particular area and that's what gives us confidence that we'll be able to continue with this new kind of high water run rate.

Speaker 10

Okay. And that was actually my follow-up question is if you thought this was kind of a base to grow our flow in 2025 and beyond?

Speaker 2

Yes. I think and think about this, when we start to see loan production pick up again, the derivative income will pick up with it. So I think there's not only a run rate here, but there's a lot of growth that could come off this base.

Speaker 10

Okay. That's helpful. And then lastly, expectations around deposit broker deposit runoff, you had a decline in the quarter. Just how are you expecting that to trend in the back half of this year?

Speaker 3

As we look at the back half of the year, we would expect to see that stable to declining. We saw some decent declines in the first half of the year. But I think it's we'll look to see how loan growth progresses in the second half of the year to really see how broker deposits will play out. But we'd probably would say stable to down.

Speaker 5

Okay. Thanks for taking my questions.

Speaker 3

Thank you.

Operator

Our next question is from Timur Braziler with Wells Fargo. Timur, your line is now open. Please go ahead.

Speaker 2

Hi, good morning.

Speaker 5

Good morning, Timur.

Speaker 9

I guess I was a

Speaker 11

little bit surprised that the revenue guide, the top end of the revenue guide was maybe guided down a little bit following the strong NII quarter and the momentum you're seeing on the fee side. I guess maybe just talk us through some of the dynamics that could still net us to that kind of low end at that negative 3%? Or maybe you have greater confidence given some of the results and expectations for the second half of the year that revenue is going to be more or less flat for the year?

Speaker 3

As we look at the second half of the year, the upside drivers to our guidance would be largely loan growth. And so you think about we took 1% off the top on loan growth and that helped lead to the reduction of the top end on revenue growth. But when we look at the rest of the year, high end of our revenue guide would be, 1, it could be a flat rate scenario, which would be accretive. 2, it would be continued strength in fee revenue that outpaces the mid single digits that we where we've given guidance, which is a possibility. 3, it would be increased loan growth.

Speaker 3

As Kevin mentioned, that the assumptions in our guide include declines in CRE and that is not something that we've seen year to date. It's not something that we expect to see necessarily in the Q3. And so that could be a tailwind as well. And so I guess I would point to loan balances being one of the bigger drivers to the high end of the range in NII for the second half of the year. If you think about the lower end of the range, I would say it would be in fee revenue, it could be deals getting pushed out and pushed into 2025 even though we don't expect that for in fee revenue.

Speaker 3

But it would also be if there's more aggressive easing than what we have in there, which is the December ease. But as I mentioned earlier, we think that if you just add a September ease, that's only a $5,000,000 to $7,000,000 impact to NII in the second half of the year.

Speaker 11

Okay, great. And as a follow-up,

Speaker 4

maybe can you just

Speaker 11

talk us through the strategy of reclassifying your available for sale bonds into health maturity during the quarter, especially the it being longer duration bonds that were moved to HTN kind of locking in that AOCI. Can you just maybe talk through the rationale and that change at this point in the rate cycle?

Speaker 3

Yes, understood. The rationale was first that these are securities that were unlikely to ever be sold because they are longer duration, they were deeper underwater. And so the marks were large enough that it was unlikely there would be a scenario where we were whatever sell these securities. Second, as we do not look at tangible common equity ratios as far as a risk management tool. We use different we use regulatory capital ratios, we use NII volatility, things like that.

Speaker 3

They kind of get to what people use tangible common equity for the ratio of the AOCI impact of that. And but we have seen the press and the Street use tangible common equity volatility in AOCI frequently when they're comparing banks and we thought it was prudent to take a little bit of that volatility off the table. When we moved them to held to maturity, there was approximately $700,000,000 in unrealized losses associated with that portion of the securities portfolio and moving that to held to maturity, reduced tangible common equity volatility of 100 basis point rate move down from 75 basis points to around 50 basis points. And so we just think it's prudent to reduce the volatility in that ratio. Same thing can be said for CET1 including AOCI even though we're not held to that standard.

Speaker 3

And so that was the general thought that there was very little opportunity calls. These were not securities that we were likely to ever trade and it would just reduce the volatility in TCE as well as CET1 including AOCI.

Speaker 11

Great. Thanks for that color.

Operator

Our next question is from Michael Rose with Raymond James. Michael, your line is now open. Please go ahead.

Speaker 12

Hey, thanks for taking my questions. Just a few quick

Speaker 3

Mike, are you there?

Operator

Operator, why don't you move on to the next caller and bring Michael back? Sorry.

Speaker 1

I was going to say,

Speaker 4

why don't you move on

Speaker 1

to the next caller and bring Michael back into the queue?

Operator

Yes. So our next question is from Catherine Mealor with KBW. Catherine, your line is now open. Please go ahead.

Speaker 6

Thanks. Good morning. I just wanted to follow back up on the fee income discussion. And can you just kind of help us just broadly, not just capital markets, but broadly think about maybe the run rate that you're expecting in fees in the back half of the year? If we're kind of if we're trying to look around your mid single digit growth range, then it would imply that your kind of core fee run rate is going back to around the Q1 level, which is a big pullback from what we saw this past quarter.

Speaker 6

So just trying to think about, are you being conservative there? Or is there actually a case to be made that we could see closer to high single digit growth here?

Speaker 3

Catherine, as we look at fee revenue growth, the mid single digit range, you're right, is a little bit higher than the Q1. But we expect, the Q3, again, the timing of the capital markets piece is the uncertainty. But in the second half of the year, we would expect to see similar fee revenue as what you've kind of seen at or close to what you saw in the second quarter.

Speaker 6

Okay. So that is a significant that does make the case that fee income growth will be much higher than your guidance, which is great. Okay. And then as you think about next year, what kind of longer term growth rate in fees would you expect just given some of the momentum you're seeing in capital markets?

Speaker 2

I mean, I think, Catherine gets back to what saying earlier, obviously not giving 25 guidance, but what we've been trying to build is a foundation around some of these core fee income revenue sources that will generate sustainable growth. And to your point, when you look at fee income this past quarter, it was up 15% year over year. And that was a function of many different areas, not just capital markets, although capital markets had a strong growth. We were up in core fees about 4% and that's largely a function of our treasury and payment solutions area. We've been growing at about 14% year over year in annualized fee income.

Speaker 2

We've also had growth in some of our other fee categories like credit cards and other fee income. Remind you there was a big headwind going to this year in wealth management. We had both repo revenue down and that was a product that we were selling to a large municipality that no longer was using that solution and that was providing just a $4,000,000 it's a total of $4,000,000 headwind for the quarter and we divested of our money management firm Global and that was about $2,300,000 So when you think about our results today, you add in those headwinds along with a change in our underlying consumer account structure that minimizes insufficient funds, which also has a headwind. When you look out to 25, you're not going to have those. You're not going to have a headwind with NSF fees.

Speaker 2

You're not going to have repo headwinds. Globalt will be fully off the books and there'll be no comparability. So when we continue to have the performance in core banking fees, capital markets and we get some of the growth in wealth again, I think you could see a growth rate that is even higher than this year, depending on the underlying economic environment.

Speaker 6

Great. That's super helpful. And if I just scan these for one more follow-up. Just the other line, that's been about $18,000,000 in the past couple of quarters. Is there anything kind of one time that you see in that?

Speaker 6

Or do you think that's also a good run rate for the back half of the year?

Speaker 2

There were some one time benefits from some OREO properties where we took some fee income from that. So that was elevated a little bit this past quarter. So I think other will come down a little bit and maybe made up in some other categories.

Speaker 6

Okay, great. Thank you for all the color.

Speaker 2

Thank you.

Operator

Our next question is from

Speaker 2

Yes. We can, Michael.

Speaker 12

All right. Perfect. Catherine actually just asked my question. But just maybe one on the I know it's minor, but you did have an inflection in criticized and classified. Can you just talk about broadly what that's composed of by category?

Speaker 12

And if you're starting to see migration, maybe more into C and I type credits where I think we're seeing an increased number of bankruptcies versus some of the earlier migration and I assume office and I know you talked about transportation in the past, things like that. Are you seeing a broadening or shifting of any sort of migration there? Thanks.

Speaker 2

Yes. Michael, it's Bob. I just took a couple of comments on that, but the inflection was really on our past due ratio. We had a past due credit that settled and resolved and came off list the 1st week of July. So that cleared.

Speaker 2

So that's the bulk of a spike in past dues. In terms of criticizing classified, we were relatively stable overall around 3.7%. So again, that's a little bit of a moving target as you think about loans moving in and out of your watch list and in and out of criticized categories. So there can be some volatility in that, but the general thought from our perspective is that the portfolio is accurately rated. The migration that was negative is still maybe perhaps slightly negative bias, but I would say it's showing signs of stability that gives us a lot of comfort in terms of our guidance.

Speaker 2

And then to your point, as it relates to C and I and CRE, there's no question that we've seen the C and I stress come through again within our expectations, but the C and I stress come through, which is a function, quite frankly, of just rates being this high for longer and the general inflation pressures on some of these leverage corporate credits. From my perspective, the good news is that that list of challenges continues to get smaller. And you couple that with to your point around CRE, we haven't seen the defaults there. We certainly have had 1 or 2 here or there and we expect that over time. But quite frankly, to date, it held up fairly well to Kevin's point earlier.

Speaker 2

And then finally, our senior housing portfolio, which gave us some dings and scratches earlier on, those macro figures in that industry continue to improve. Occupancy is better, rents are better, labor costs have stabilized to some degree as well. So we kind of do all that calculus and we come up and feel pretty good about where we are and feel pretty confident in guiding to flat to slightly down in charge offs and feel pretty good about the position of the portfolio. The risk is the unknowns in C and I and if we stay rates stay higher for longer, but it looks like that risk potentially may be beginning to come off the table as well. So we're getting a little more optimistic.

Speaker 12

That's great color, Bob. And maybe just a follow-up and that your last point kind of leads into it is, if we do get a couple of rate cuts, I would assume that probably too early to call kind of a peak and criticize classified NPAs, things like that. But you could definitely make the case, I would think, right, that we would have peaked with a few rate cuts barring the economy not getting really any worse. Is that fair? Yes.

Speaker 2

I think that's generally fair, Michael. I would a little bit of caution there would be, while criticized classifieds, five, that's $1,500,000,000 right? So it takes a fair amount to kind of move that number. You get into NPLs and we're sitting at 59 basis points today. There's some chunky credits in there.

Speaker 2

So you could have a quarter where it moves up or moves down. Obviously, last quarter we had a big NPL that we spoke about on this call. So we're back down to levels that we feel pretty good about and we quite frankly look ahead and don't see those chunks as I mentioned being quite as big. So that gives us some comfort. But you could still have some movement there.

Speaker 2

But the general trend line we think, particularly as to your point, as rates come down, should be positive for us.

Speaker 12

Perfect. I appreciate all the color. Thanks.

Speaker 2

Thank you, Mike. Thanks, Mike.

Operator

Our next question is from Christopher Marinac with Janney Montgomery Scott. Christopher, your line is now open. Please go ahead.

Speaker 11

Thanks very much. Bob, just to continue your answer from the last question. Do you see restructurings and CRE as possible solutions or is it a little early for those? I'm just curious about our ways to see further progress on the criticized number.

Speaker 2

Yes, good morning, Chris. Thanks for the question. Yes, I do. I mean, we certainly as we've said before, I mean, our intention is to work with our clients on coming up with solutions. If it needs to be restructured, then we certainly want to work towards a mutually agreeable structure.

Speaker 2

So I think that's in a broad sense, certainly one of the tools in the toolbox, we will do that. We've done that. It's not an extend and pretend or whatever the common phrases you hear are. From our perspective, it's let's come up with the right solution. I think it's a little early to your point probably to make any kind of prediction on that specifically as it relates to office.

Speaker 2

We have Chris, we have one office loan on non accrual today. So I mean, we've got a few that are challenged and that are rated certainly and 1 or 2 that are that we're working through modifications on. And again, that'll give us some chunkiness in our FDM categories, etcetera. But for the most part, I think you're dealing with a handful of credits and we feel good about being able to work through them. But I do think it's a little early to say that's a play that equals a certain amount of dollars for us.

Speaker 11

Okay, great. Thank you for that. And then the charge off guidance has been very consistent for quite a while. I'm just curious if you see any risk to that as we head into the next few quarters next year, etcetera.

Speaker 2

Chris, we spend a lot of time forecasting. I feel good about our forecast. I think we're not there's a lot of calculus that goes into being comfortable to tell you that we think charge offs will be flat to slightly down. We feel good about that. And again, the reasons why as we spoke about before, the list of corporate credits continues to get smaller.

Speaker 2

Senior housing continues to improve, although we've still got 1 or 2 we're working through, but the macros are good there. And commercial real estate, to your earlier point, continues to hold up well and probably comes out over a longer period of time. You do all that math, add it all up, that equals where we think we'll be and why we're comfortable with that type of guidance. The risk to that is you don't know what you don't know. And if rates stay up longer and particularly in C and I, you could continue to see some pockets of stress, but I think they're isolated.

Speaker 2

I don't think they're in any particular industry, just the general stress of higher rates being higher for longer could certainly could give you a surprise or 2, but we feel pretty good about where we are right now.

Speaker 11

Great, Bob. Thank you again for the background. Much appreciated.

Speaker 2

Thanks, Chris.

Operator

Our next question is from Samuel Vargas with UBS. Samuel, your line is now open. Please go ahead.

Speaker 2

Sam, are you there? All right, Ezra, I don't think Samuel is there.

Speaker 3

Oh, yes.

Operator

Samuel, your line is now open. Please go ahead.

Speaker 5

Are you able to hear me now?

Speaker 2

Yes, I can hear you.

Speaker 5

Perfect. Awesome. I'm sorry, I'm not sure what happened there. So I just wanted to circle back on the fee income and go specifically to Mast. It's been a long road for the project and I wanted to get an update from you just about the strategic direction.

Speaker 5

Should we be still thinking about Mast as a revenue, sort of a meaningful revenue driver? Or is it has it become a client acquisition tool and that's how we should frame that for the story moving forward?

Speaker 2

Yes, Samuel. I think it's still a meaningful revenue opportunity. What we've done over the last really 6 months is we've taken a step back. We had users on the platform. We had a very active pipeline.

Speaker 2

And what we try to evaluate is are our products that we're offering through the solution of the class that will allow us to continue to expand and have a scalable product. And so we kind of took a step back and we're rebuilding some of the underlying functionality and capabilities within Mast. We also are positioning it not as to many as many clients and prospects. So we had 46 names in the pipeline. We're going to try to onboard far fewer and focus on larger clients and not just focus on the ISV segment, but also the ISO segment.

Speaker 2

And so you'll hear more in the coming quarters as we relaunch the product with maybe a more surgical view of who the target audience is. But we still think it's going to be a viable solution that will not only allow us to generate fee income, but will also generate core deposits. So we'll talk more about it, but we're back kind of in the basement working on the products and solutions and we'll be back out in

Speaker 3

the market later this year. And let me jump back in on the fee revenue. And Catherine, you asked the question about the run rate for the second half of the year. And I said flat to the second quarter. I meant I mean flat to the second quarter, it's flat to the first half of the year.

Speaker 5

Thanks, Alex. And then just a quick follow-up around capital. I guess you'd mentioned that obviously buybacks are firmly on the table as they were this past quarter. Could you just share your thought process around the trade off between doing more buybacks versus perhaps another smaller restructure on the bond portfolio?

Speaker 3

Well, when you look at further restructurings of the bond portfolio, the payback just gets longer and longer. We did the first one we did was about a 3 year payback and the second one was about a 5 year payback. And it's just not that attractive to us at that duration when you get beyond there. The one we just did was attractive just because of the capital generated from the risk weighted asset optimization efforts. And so it's unlikely that we will do another repositioning of the securities portfolio.

Speaker 3

And we're very comfortable with capital ratios where they are. They're near our target the high end of the range of 10% to 10.5%. But you should expect to see us continue doing what we've done in the past, which is prioritize client growth, be ready for client growth when it comes and grow the balance sheet. And if we're sitting here with excess capital, you should see us use share repurchases to balance it out.

Speaker 5

Got it. Thanks for all the color. I appreciate it.

Operator

Thank you very much. This concludes our question and answer session. I would like to turn the conference back over to Mr. Kevin Blair for any closing remarks.

Speaker 2

Thank you. As we close out today's call, I'd like to thank you all for your attendance and your continued interest in Cenovus. I'd also like to thank and recognize all of our team members who are listening in today. Our financial results that we presented this morning are a direct result of what you do daily to serve our clients and differentiate us from our competitors. During the Q2, we did continue to receive national recognition for our work environment and service excellence.

Speaker 2

We are in a great place to work certification for the 4th year in a row. Our family office won 2 awards from the Family Wealth Report. Our customer care center and team members were awarded several best of the best awards by customer contact week. I am proud of our teams and the recognition of their efforts and the impact it has on delivering on our purpose to help people achieve their full potential. As we look forward in 2024 and we approach 2025, I am confident that we will sustain our momentum and see key improvement in our financial performance.

Speaker 2

This confidence is driven by the following facts. Our net interest margin and our net interest income troughed in the Q1 with deposit prices peaking and future NIM expansion fully supported by our actions. Our credit cost and our credit outlook have improved. Our fee income has hit a new high watermark due to the broad based success and execution. Expenses have been well contained with flat year over year growth and with an adjusted efficiency ratio of 53% this quarter, we continue to outperform our peers.

Speaker 2

In addition, our efforts to optimize the balance sheet to better position us for growth is largely complete. The benefits derived from risk weighted optimization efforts allowed us in the 2nd quarter to restructure the bond portfolio, which increased yields by roughly 50 basis points. Our loan portfolio optimization efforts around 3rd party, medical office, national syndications and senior housing have resulted in a reduction of 2 point $3,000,000,000 in outstandings over the last 12 months, reducing the percentage of loans in these categories from 18% to 13%. Our capital levels are 8 year highs and these strong levels provide for additional flexibility and fuel for future growth. And lastly, we remain well situated in a great footprint.

Speaker 2

Whatever the economic forecast is for the foreseeable future, we have the opportunity for relative outperformance. Look no further than the recently released Atlanta Fed research titled Poised for More Growth, The Southeastern Economy is Outperforming the U. S. So yes, I'm optimistic about our future and our ability to drive meaningful and sustainable growth and improved profitability. And I look forward to future earnings calls to provide updates on our progress.

Speaker 2

In the meantime, we look forward to seeing many of our investors in upcoming meetings and scheduled conferences. So for now, Ezra, that concludes our Q2 2024 earnings call.

Operator

Thank you very much everyone for joining. This concludes today's call. You may now disconnect your lines.

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Earnings Conference Call
Synovus Financial Q2 2024
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