Q1 2020 Earnings Call

[music].

Good afternoon, and welcome to the yes, Yes first quarter 2020 earnings conference call. All participants will be in listen only mode should you need assistance, we signaled comping specialists are pressing the star key followed by zero.

After today's presentation, there will be an opportunity to ask questions.

Ask your question that press Star then one well your Touchtone phone.

Well I draw. Your question. Please press Star then too.

Please note. This event is being recorded I'd now like to turn the conference over to Ryan Thomas Vice President Finance and Investor Relations. Please go ahead. Thanks.

Thanks Grant.

Good afternoon, everyone. Thank you for joining us today participating on today's call from a separate locations across our footprint in Pennsylvania, and Ohio will be might price President and CEO, Jim risky Chief Financial Officer, Brian care up Chief Credit Officer.

After prepared remarks for management, we will open the call to your questions for that portion of the call. We will be joined by our bank President jingle beds.

As a reminder, a copy of today's earnings release can be accessed by logging on to FC banking dotcom and selecting the investor relation to link at the top of the page.

We have also included a slide presentation in our Investor Relations website with supplemental financial information that will be reference throughout todays call.

Before we begin I need to caution listeners that this call will contain forward looking statements. Please refer to our forward looking statements disclaimer on page two of the slide presentation for a description of risks and uncertainty that could cause actual results to differ materially from those reflected in the forward looking statements.

Today's call will also include non-GAAP financial measures. These non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with GAAP. A reconciliation of these measures can be found in the appendix of today's slide presentation.

And with that I will turn the call over to Mike price.

Hey, Thank you Ryan.

The code that 19 pandemic has significantly disrupted the health and wellbeing of our communities. Our banking teams at first Commonwealth are engaged on a variety of fronts weve adopted emerging best practices and follow direction from health and government leaders around code at 19 to protect our employees.

Customers and communities, our bankers were proactive early on in reaching out to customers and offering forbearance to consumers and businesses who were pressing forward in the wake of this pandemic.

At quarter end, we had modified over 2200 loans for our borrowers impacting $145 million in loans.

Looking forward to last Friday April 24th payment relief had been extended to over 5800 consumers and businesses on $1.1 billion in total loans. However, the number of modifications had trailed off to a trickle.

The third the team was all in on the first wave of is paid check protection program funding and helping 1500 customers secure.

426 million in government loans, approximately 85% of those loans were less than $350000.

We are preferred SP, a lender in 2019 ranked as the number two SP and lender in Pittsburgh and the number three SPD lender in Cleveland.

We are now eagerly engaged and securing a second wave of PPP loans for our customers as the government funding has resumed we expect the typical loan amount to be lower than wave one.

No for the volumes through our operations areas have been unprecedented.

From loan modifications to P.P.P. loan processing and stimulus checks from call Center, Bobby volumes to mobile chat.

From online mobile deposit account openings to log bands on our digital platforms.

The team has shifted a significant portion of our workforce from our branch and select areas to call centers underwriting documentation and loan processing well training them to meet the new operational reality.

The week or month.

As we work through opportunities with our customers every day. The cobot 19 pandemic is accelerating the change in the banking landscape. We expect ongoing change and are evaluating additional near and long term opportunities surrounding growth efficiency expense and net interest margin.

As we reshape our business.

We're not waiting for business to return to normal our business is undergoing rapid longer term structural change that we must and will anticipate.

As we reflect on the first quarter. It's important to note that we've been preparing for a downturn for years. The team has added new growth engines to include mortgage and SBA.

We've built a geographic based regional President model led by local presidents accountable for their markets and delivering the bank cross functionally to our customers and prospects.

We've moved to a universal business model in our branches several years ago, which enabled the flexibility and staffing and broader talent development.

We have significantly expanded our digital capabilities and most recently our call center capabilities as well.

We saw better balance between our commercial and consumer businesses as well as between our variable and fixed rate lending.

The team has built a strong low cost core funding franchise, we're roughly one half of our deposits our noninterest bearing and now transaction accounts split evenly between consumer and business customers. Our acquisition strategy has been accretive to our low cost core funding and.

Profitability.

Similarly, we have expanded our footprint to adjacent market markets that we know well in both Ohio, and Central Pennsylvania and executed flawlessly on a series of smaller lower risk acquisitions. These newer markets account for the majority of brisk loan and deposit growth in the.

This quarter.

We have paid down our borrowing significantly to give us flexibility for times like these we.

We have fortified our capital position organically and also with the issuance of $100 million in sub debt roughly two years ago, which leaves us ready to withstand the current crisis and from a credit perspective, we've improved the granularity of our loan portfolio and cut the number of larger credits.

By two thirds, while actively managing to segment and concentration limits.

In the first quarter, our net income fell to $4.7 million or five cents per share as a perfect. Our provision expense increased to 30 31 million, despite only three and a half million or 23 basis points of net charge offs.

Using the incurred allowance for loan loss methodology. The reserve build it was some 42 basis points to 1.25% of total loans in the first quarter.

Jim will speak the spread income noninterest income and expenses a number of other things. However, our pre tax pre provision first quarter earnings were good.

The company is well capitalized with ample liquidity.

Our reserve build this quarter is appropriate given the specter of Cobot 19, and what May lie ahead. Our continued focus on building low cost core funding and leveraging our regional business model for growth make us optimistic about the future of our company.

I would now like to turn it over to Jim Roski, Our CFO, followed by Brian care up our Chief credit officer to provide more color commentary on the first quarter capital credit I've also asked change prevents our bank president to join us as well for the question and answer session Jason.

Thanks, Mike Thanks.

Our financial results for the quarter, where of course perfectly affected by the reserve build in response to the coated King crisis.

We're pleased to see that our pre tax provision income calculated on a sequential basis increased 5.8% over the year ago period, and was 38 cents per share for the quarter, which compares favorably to the consensus for 37 cents.

Taking advantage of the optional temporary relief provided to the cares at that allowed for the delayed implementation Cecil.

As a result, our loan loss provision was calculated the incurred loss method.

Brian will provide further detail on our provision expense and element, but first let me take a moment to describe why we stick to it and current method.

Basically we saw no advantage to Cecil adoption and every advantage and delay.

The first it gives us time to see impact to cover 19 on estimated credit losses, including the impact on the economy a fiscal stimulus measures.

We also took note of the extreme volatility of economic forecast over the past several weeks, which led to a wide range of sequel outcomes and gave US pause has to diversity of those forecasts.

Finally, delaying Cecil it's time to see how our internal model react in uncertain economic conditions, which will allow us to further refined our approach before adoption later this year.

Of the $27.4 million in reserve build into first quarter, a disproportionate amount was covisint related including a portion of our specific reserves.

Or is your coverage ratio increased from 83 basis points total loans to 1.25% an increase of 42 basis points or just over 50%.

Without the accretion specific reserves the coverage ratio increased by 29 basis points, an increase of 33%.

We believe that this proactive reserve deal provides further protection for our balance sheet.

We note that while we continue to use we incurred loss method this quarter, our reserve building coverage ratios compare favorably with any banks that have a docket Cecil.

That's because we set aside extra qualitative reserves for losses, and we believe have been incurred even though the I'd yet emerged.

In that sense, so ultimately reduce the difference between current allowance NRC fallouts when we adopt Cecil later this year.

Looking beyond the provision there were actually a few other financial developed this quarter was highly.

First the interesting was down $1.1 million to $60.1 million for the period.

Here strong loan growth 134.6 million or 8.7% annualized.

Offset by 80 basis points of contraction in the net interest margin.

Commercial banking indirect lending and mortgage led the way.

Deposits I saw your larger increases with a strong crescendo in March leaving period end deposits up by $245 million, even as we brought a cost of deposits down by five basis points by aggressively dropping rates and letting Cds rental.

At 51 basis, it's our cost of deposits is about 10 basis points lower than it was a year ago and our total cost of funds is down 19 basis points.

We expect our efforts to manage deposit costs will help me to mitigate NIM compression over the course of 2020.

We have approximately $450 million and time deposits maturing before year end.

I've been able to retain approximately two thirds of maturing timed deposits at rack rate. So for example, 20 basis points for 12 months CD.

We have another $300 million in money market accounts with teaser rates roll off by year end and reprice downward as well.

Second non interest income fell by 3.3 million up 15% to 19.3 million in the first quarter, primarily due to a 3.1 night or decreasing swap income compared to last quarter $1.7 million, which was due to a mark to market adjusts for the swap valuation allowance.

On a more positive note mortgage gain on sale was up by $1 million from last quarter.

Beyond that we saw a smaller debit card interchange income due to pandemic spending constrictions that we estimate to be about $300000 for the quarter.

Interchange could come under pressure until economies reopened in spending picks up but our mortgage SP, a wealth and insurance businesses continue to generate income for us.

Third non interest expense improved by $3.1 million to $50.3 million quarter over quarter, reflecting the release of $2.5 million and reserve for unfunded commitments.

This is due to the use of updated loss information from our C., So model and even though we didnt adopt c. So we did update our approach.

More fundamentally even hospitalisation expense remained elevated at $3.2 million for the quarter, we're taking steps to bring our cost down, including a hiring fees and stopping almost all discretionary spending other than investing and digital delivery for our customers.

Stepping back for a moment I would emphasize a first Commonwealth is entering into this period well positioned to financial strength.

We have approximately $3.7 billion of available liquidity and I loan deposit ratio remains comfortable low nineties.

We come into this period of low rates with a relatively high net interest margin and even though we expect additional margin compression. We believe our NIM should benefit income for the P.P.P. program, mostly in the third quarter.

Finally in terms of capital, we have approximately $200 million of excess capital over and above what it takes to be considered well capitalized.

We suspended our buyback program in order to focus on capital preservation.

Our reserve build further protect our balance sheet.

While we are not required to run capital stress tests due to our size, we do so anyway and even in our most severely adverse scenarios, we remain well capitalized.

With that I'll turn it over to Brian.

Thank you Jim and good afternoon.

It's clear from our reported provision that we're building reserves in response to the impact of Cobot 19.

Our reserve build primarily reflect three factors first at 8.9 million dollar.

Qualitative adjustments within our incurred model framework to reflect general economic and business conditions second $7.8 million of additional qualitative overlays.

To address the risk portfolios and Forbearances.

Third and increased $7.4 million and specific reserves.

Let me provide a little more color on each one of these.

First.

We ran our standard incurred loss model as of March 31st.

At that time, many of our standard indicators were not reflecting economic strength.

However management new to take measures to estimate.

The loss content in the portfolio has at 331.

As a result, we increase qualitative factors within our model appropriately.

For example.

We assume the effective unemployment rate of 11.9%.

At 331, even though the level of unemployment had not yet been evident and the most recently published materials.

Second the risk portfolios that.

The risk portfolios. They drove what we refer to as the overlays are set forth in some detail and our earnings release supplement.

As the coldest crisis began to develop we lived through our loan portfolio and identified certain sectors that have the potential to be impacted by elevated 19.

Well some of the segments such as energy in restaurants might be immaterial as a percentage of the portfolio.

Management felt it was important to review each one to accurately identify the risks.

These portfolios generally exhibit good diversification granularity and conservative underwriting characteristics.

For example in the retail segment the largest Sun sub segment is our freestanding retail book.

Well that's sub segment has an average loan size of $3 million.

And 59% LTV and debt service coverage ratio of 144.

And hospitality approximately 80% of the portfolio is under either a Hilton and Marriott flag.

And the average LTV, excluding enterprise value, let's 64%.

The debt service coverage ratio is 1.59.

We know our borrowers.

And when coal that emerged we walk through each same.

Name by name and reviewed each of the larger relationships.

I would note that at the end of first quarter, 96.4% alone in these portfolios were past rated.

97% or underperforming status.

The other part of the overlay has to do with Forbearances and additional detail on the consumer Forbearances.

Is contained within the supplement.

Early in the crisis, we signed the Pennsylvania care attack it made forbearances available to our consumer and commercial customers.

We added qualitative reserves for consumer losses within the portfolio that have not yet emerge.

And third.

We set aside $7.4 million in specific reserves largely related to five underperforming borrowers.

Most of these were showing signs of weakness before the crisis, but of course the crisis made.

There are problems worse.

Three of these underperforming borrowers were downgraded in nonaccrual status in the first quarter, which drove an increase of $27.6 million and non performing assets.

We could have simply offered for ferrets it to these customers and kick the can down the road of that but that's not what a forbearances for and that's not the right thing to do.

These downgrades in associated specific reserves are in keeping with our credit culture of early recognition of problem credits and we believe will serve us well through this crisis.

In closing, we take it many steps to reduce credit risk in the portfolio.

We've reduced told levels.

We adhere to our strict concentration in segment limits.

We reduced our out of market commercial loans.

We drove a more balanced mix of commercial and consumer loans to diversify the portfolio.

We have mitigated concentration risks by creating a more.