Truist Financial Corporation (TFC) — Q3 2022 Earnings Call Transcript

Thank you, Jake, and good morning, everyone. Welcome to Truist's third quarter 2022 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 third quarter results and share their perspectives on our efforts to transition from an integration focus to an operating focus, current business conditions and our continued activation of Truist's purpose. Clarke Starnes, our Vice Chair and Chief Risk Officer; Beau Cummins, our Vice Chair; and John Howard, our Chief Insurance Officer, are also in attendance and are available to participate in the Q&A portion of the call. The accompanying presentation, as well as our earnings release and supplemental financial information, are available on the Truist Investor Relations website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures regarding these statements and measures as well as the appropriate reconciliations to GAAP. In addition, Truist is not responsible for nor does it guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcast are located on our website. With that, I'll now turn the call over to Bill.

Thanks, Ankur, and good morning, everyone, and thank you for joining our call today. Our third quarter reflected strong progress in many areas overall. However, financial performance was mixed, reflecting continued challenging market conditions. Strong spread income resulted from significant margin expansion that exceeded our guidance and strong broad-based loan growth. Credit quality remains excellent. At the same time, capital markets revenue did not rebound as anticipated and, in fact, declined quarter-over-quarter. Strategically, we continue to realize the benefits of shifting from integrating to operating, which I'll share more on later. I acknowledge that operating losses continue to be too high. However, other expense growth reflects targeted investments in talented technology in key areas of long-term sustainable growth. Merger costs diminished again, and our remaining decommissioning activities are mostly complete and will be finalized by year-end. We'll share details on each of these themes throughout the call. Truist is a purpose-driven company that's dedicated to inspiring and building better lives and communities. This commitment to purpose and our value of care could not have been more apparent in how our teammates responded to each other and their clients in the aftermath of Hurricane Ian. I experienced this firsthand when I visited our teams in Southwest Florida soon after the storm subsided. Clients expressed their significant appreciation that we opened our branches to care for them during this time. The many truckloads of food, water supplies, and other critical items that we sent to the region made a real difference. The $1.25 million donation from the Truist Foundation will continue to provide support to affected areas in Florida. We have begun, and Truist is committed to supporting these communities in the short term, but also helping them be more resilient in the long term. And this is one of the many ways we're living our purpose. In order to inspire, it's often necessary to be bold and to be first, and that's exactly what we did on October 1. We made a significant investment in our teammates by raising our minimum wage to $22 per hour. The new minimum wage benefits approximately 14,000 teammates, about 80% of whom are in client-facing roles. We strongly believe this action will drive purposeful growth and offset the estimated $200 million increase in annual personnel expense through improved teammate recruitment and retention, lower turnover expense, better execution, and an all-around better client experience. In fact, we're already starting to see the benefits of the higher minimum wage. Teller turnover in August and September was down about 25% compared to the first seven months of the year. Our branch vacancy rates have been cut in half since July. We also advanced our commitment to inspire with the launch of Truist One Banking in July. Truist One is our differentiated suite of checking solutions that reimagine everyday banking, including two new accounts that eliminate overdraft fees and provide greater access to credit. The flagship Truist One checking account has zero overdraft fees and the capability to provide qualifying clients the liquidity they need through a simple $100 negative balance buffer. We also introduced the Truist Confidence Account, which provides consumers access to mainstream banking services and no overdraft fees. These accounts meaningfully advance financial inclusion in our communities and have been embraced by new and existing clients. Since their launch, overall branch deposit production has increased 13% in August and September compared to the prior year despite having 16% fewer branches. We're also in the process of rolling out our cash reserve deposit base credit line up to $750. We began a pilot earlier this month and expect the cash reserve feature to be available across our footprint later this quarter. Merger costs totaled $152 million, down 30% sequentially and 58% year-over-year as our integration activities wind down. The final merger costs expected in the fourth quarter are primarily related to our decommissioning efforts, which will conclude by year-end. The completion of merger activities is a monumental move forward that will reflect a seamless client experience, simplify our narrative, enhance our earnings quality, improve capital, and help us realize industry-leading returns. We earned $1.5 billion or $1.15 per share on a reported basis. Adjusted earnings totaled $1.7 billion or $1.24 per share, up 3% sequentially as 5% adjusted PPNR growth was partially offset by a higher provision due to our higher consumer net charge-offs. Net interest income grew 10% to a post-merger high, benefiting from higher short-term rates and well-controlled deposit costs, all of which drove significant margin expansion as well as strong broad-based loan growth. Despite solid forward progress, the pace of PPNR growth was weaker than we had anticipated, primarily due to ongoing pressure in investment banking, as well as unfavorable valuation marks taken at quarter end. Adjusted expenses increased 2.6% quarter-over-quarter mostly as expected; however, operational losses remain elevated. While we made a purposeful decision to proactively refund our clients for fraud losses, our overall goal is to reduce them significantly to improve our results and the client experience. Adjusted operating leverage was a strong 260 basis points compared to the third quarter of last year, reflecting strong net interest income growth combined with modest expense growth. Asset quality remains excellent, notwithstanding normalizing trends and a seasonal uptick in net charge-offs within our consumer portfolios. We deployed 10 basis points of capital to support strong loan growth and complete the BenefitMall acquisition, which expands our capabilities and fills a strategic gap in our wholesale insurance business. Our capital position remains strong relative to our risk and profitability profile, and we're confident in our ability to withstand and outperform in a range of economic scenarios. Digital activity continues to increase from the first quarter levels, reflecting strong momentum post-integration. This progress reflects our significantly improved agility and responsiveness from being on one digital platform. Year-to-date, we've delivered three times more production releases across business, retail, and wealth than in all of 2021. Client satisfaction with their digital experience has also improved rapidly each quarter. Our technology and digital teams are allocating more of their time, energy, and resources to transformation and innovation. To that end, we recently launched Truist Assist to our retail and wealth clients through our mobile and online banking platforms. Truist Assist is our AI-enhanced virtual assistant that leverages natural language processing and natural language understanding to interact and respond to client questions. Through September 30, Truist Assist had been deployed to our personal banking clients and had been utilized by 114,000 unique clients to handle 147,000 interactions that otherwise might have occurred in a branch or contact center. We're also expanding LightStream, both by enhancing the sophistication of its underwriting models through artificial intelligence and by piloting a new savings product to broaden its capability set. In addition, the recent acquisition of the Arena platform from software startup Zaloni will help accelerate our data journey through the development of a stronger integrated data infrastructure solution deployed in a hybrid cloud environment. As a result, our data quality, analytics, and speed to market will all significantly improve. Overall, I'm highly optimistic about the potential of our increased investments and capabilities to enhance performance and client experience. Loan growth was strong and broad-based for the second consecutive quarter. Average balances grew $13 billion or 4.3% sequentially in part due to our shift from integrating to operating. C&I remains strong as average balances grew $7 billion or 4.5%. C&I loans grew across most CIB industry verticals and product groups, reflecting higher revolver utilization, the current shift to banks from the bond market, and our increased competitiveness for new and existing clients. Near term, our loan growth outlook remains healthy as our pipelines are relatively strong and teammates continue to shift their capacity from integrating to operating and take advantage of new tools in their toolbox. Over the medium term, loan growth may moderate as clients absorb and digest the impact of higher rates, higher inflation, and slowing growth. Truist continues to remain well-positioned to advise clients across a broad range of economic scenarios, given our capabilities, talented teammates, and increased capacity post-integration. Average deposits decreased $3.7 billion or just under 1% in the third quarter driven by tightening monetary policy, reduced savings in response to higher inflation, and seasonal patterns. But we remain confident in our deposit strategy and ability to manage costs effectively. Interest-bearing cumulative deposit betas have been 21% thus far, well below our modeled assumptions. As the interest rate environment evolves, we'll continue to take a balanced approach to managing deposit growth and rates paid, particularly given our broad access to other forms of funding. Before I turn it over to Mike, I’d like to acknowledge and thank Daryl Bible. He has built a best-in-class finance function, was instrumental in the success of our merger, and has been incredibly supportive in helping Mike transition into the CFO role.

Thank you, Bill, and good morning, everyone. Before I begin, I would also like to thank Daryl for his guidance and support throughout my transition into the CFO role. I'm excited about the opportunity, and I'm confident that the transition will be seamless for all of our stakeholders. Currently, net interest income increased 10% sequentially to $3.8 billion as higher short-term interest rates and strong loan growth more than offset lower purchase accounting accretion. Core net interest income was up a strong 14%. Deposit costs remain well-controlled, reflecting the strength of our deposit franchise. Fee income decreased $146 million or 6.5% sequentially. Insurance income decreased $100 million primarily due to seasonally lower property and casualty commissions. Investment banking and trading income decreased $33 million as lower fees from structured real estate, investment grade and high-yield bonds, and syndicated and leveraged finance were partially offset by increased M&A fees. Wider credit spreads, tightening liquidity, and general macroeconomic and geopolitical uncertainty are all contributing to slower activity levels. Despite these current headwinds, we continue to make strong strategic progress within Corporate and Investment Banking. Adjusted non-interest expense increased $83 million or 2.6% sequentially, reflecting forward-focused investments in talent and technology, as well as elevated operational losses. We continue to focus on generating expense reductions in certain areas to fund longer-term investments in talent and technology and to generate ongoing operating leverage. Overall, we continue to believe in our operational efficiency and our ability to adapt to changing market conditions. Asset quality continues to be excellent, reflecting our prudent risk culture and diverse portfolio. Non-performing loans decreased 1 basis point and loans 30 to 89 days past due decreased 7 basis points. Net charge-offs remained benign at 27 basis points, up 5 basis points from the prior quarter, primarily due to normalizing trends and seasonality in certain consumer portfolios. Our total allowance increased $18 million to support our loan growth. Looking into the fourth quarter, we expect a mid double-digit basis point increase in both our core and reported net interest margin due to benefits from the recent rate hikes. Moving to our fourth quarter outlook, we expect adjusted earnings growth based on our year-to-date results and fourth quarter expectations. We remain on track to achieve positive operating leverage for the full year. Our expectations for the net charge-off ratio will remain between 25 and 35 basis points for the full year due to our performance year-to-date and normalizing trends across our loan portfolio.

The financial benefits of our ongoing momentum will be increasingly visible as market conditions normalize and merger-related expense noise abates. To conclude, Truist is on the right path, and I'm highly optimistic about our ability to realize our significant post-integration potential. We believe the economy is generally healthy, and while persistent high inflation and a rapid tightening of monetary policy have increased uncertainty as we move into 2023, Truist is well-positioned given our advice-oriented model for clients, conservative credit culture, and strong liquidity position relative to our risk profile.

Thanks, Bill. Jake, at this time, if you don't mind, 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 yourself to one primary question and one follow-up so that we can accommodate as many of you as possible today.

Bill, you mentioned that you had a positive operating leverage on an adjusted basis of 260 basis points. Can you share your thoughts on what that might look like for the next 12 months?

Yes. I think, obviously, for the balance of the year, we talked about this as well, but I think we'll have positive operating leverage for the year. As we look into 2023, obviously, there are a lot of puts and takes. Positive operating leverage will be a core tenet of what we do. So if we look at the revenue potential in terms of the loan growth and deposit production we’ve had, being able to capitalize on those opportunities with those clients as we move forward, so even if the economy slows down a bit, we still have momentum in that area. We’ve got great strength in our insurance business and overall capital markets business.

And then as a follow-up question, you pointed out that the deposit beta was 21% on a cumulative basis and then 14% without the brokered CDs. Can you tell us what your model would have suggested the deposit beta would have been?

This is Mike, I'm happy to take that one. So, you're right, we've been very pleased by the performance of the deposit portfolio so far at 21%. I think we said earlier this year, we expected betas to be closer to 30% as we get to the second half of the year. We still expect that to be the case by year-end. In terms of terminal beta, it's very hard to tell.

Just want to ask a question on funding and deposits. You guys are showing fairly good resiliency as is the industry. Just give a little more context of what you're expecting to see in terms of mix shift and also your thoughts. It looked like you did add a bunch of wholesale borrowings relative to your incremental cost of funding through deposits.

Ken, it's Mike, I'll start here as well. Again, we have been pleased from the deposit perspective with only a sequential decrease of 1%. We are expecting, I think, over the near term, to continue to have some pressure on deposits, as well as some pressure on mix. We did see some shift from DDA into interest-bearing. But we're still well above levels that we experienced pre-COVID. We feel really good about our funding capability.

The strength of our deposit franchise is quite granular, 42% under $250,000. We've got really good market share. Our deposit production's strong and we've leaned into this in terms of our own capabilities from the deposit production side. For the fourth quarter, I think we'll be stable.

Bill, I noticed a nice sequential growth and it seems likely to keep growing into the fourth quarter based on your outlook and the asset balance. Given your comments about betas in the mid-30s or possibly slightly higher, do you believe you can maintain sequential growth in net interest income as we move into the next few quarters while considering seasonal impacts?

To Mike's point, a lot of it also depends on loan growth and what we see going into next year, really positive momentum through this quarter, which I think will continue into the fourth quarter.

It's Betsy. I wanted to just dig into a couple of things, one is on loan growth. It's been really strong. And I heard the comments around how you're funding it and how you're thinking about driving that from here. I wanted to get a little bit of an understanding on how you're thinking about the quality of the book relative to its ability to absorb this interest rate hike.

Yes, I’ll start, Betsy. We've not diminished our commitment to credit quality. We're underwriting at new rates and new environments. Our production just reflects our competitiveness. Our quality, particularly in the wholesale side, is improving. Clarke, why don’t you embellish that, if you would?

Yes, thanks, Bill. We're very careful in our underwriting right now. We're looking obviously at rate shock and the ability to absorb that. We're looking at other things like pricing power and their margins, liquidity, and overall strength. We feel really good about the core underwriting. For the quarter, about 95% of our C&I production was investment grade or near investment grade credit, so really high quality there. From an SNC standpoint, we have about $59 billion in outstandings in our SNC book, which is about 19% of our balances, and that's been fairly steady. The performance has been very, very good.

I'll continue my analogy with your franchise as a core. You're clearly in the country's sweet spot for population growth. So, you're certainly in the sweet spot. But I hear your target for positive operating leverage of over 0%. It seems like you're aiming for the Charlotte Motor Speedway instead of Indianapolis 500, right? It seems like you're not quite there yet. What do you think are some of the headwinds that may or may not go away? And what are some of the tailwinds you might see?

Yes, thanks, Mike. If we define speed as related to how are you doing against your markets, I actually think we're at a really good high rate of speed. If we define the opportunity, it is to have improved positive operating leverage over time and increased revenue and PPNR growth. We’re consciously investing to make that happen, which may have quarter-to-quarter implications. We can grow disproportionately over time, it just won't look that way quarter-to-quarter.

At this point, I don't come to the table with some predefined view or silver bullet. We have some great tailwinds as well—whether it’s realizing the benefits of the savings, some automation, and overall productivity.

I guess one follow-up first for Clarke on the reserves. What is the base case of the weighted unemployment rate that's baked into your reserving at the end of the quarter? And what are the other inputs that could change the reserving outlook other than unemployment?

In our base case, we have unemployment going up to 4% and then going higher into the mid-4s as we go into '23 and beyond. Other big drivers would include housing prices and GDP.

Right now, our focus is on investing in Truist. That's where our primary focus is, and our ability to expand and create more capacity within our existing markets is really our primary focus right now.

Can you talk about the openness to maybe some restructuring of the securities portfolio? It might be some opportunities here and there as you think about the strong capital generation.

There are no plans to restructure the securities portfolio. We do view the portfolio as a tool for funding loan growth.

Alright, thank you, everyone, that concludes our earnings call. If you have any additional questions, please feel free to reach out to the Investor Relations team. Thank you for your interest in Truist. We hope you have a great day.