Q3 2022 Financial Institutions Inc Earnings Call
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[music].
Hello, and welcome to todays financial institutions, Inc. Third quarter 2022 earnings call. My name is Elliott's and I'll be coordinating your cold stacked.
I would like to register your question during the presentation you may do so by pressing star followed by 1 million telephone keypad.
I would now like to hand over to Kate <unk> director of Investor and external relations. The floor is yours. Please go ahead.
Thank you for joining us on today's call, providing prepared remarks will be president and CEO , Marty Birmingham and CFO Jacques <unk>.
Community Banking officer, Justin Burgher, Chief administrative officer, Sean Willa, and director of financial planning and analysis, Mike Grover who will join us for Q&A today's prepared comments and Q&A will include forward looking statements actual results may differ materially from forward looking statements due to a variety of risks uncertainties and other factors.
We refer you to yesterday's earnings release, and Investor presentation, as well as historical SEC filings available on our Investor Relations website for Safe Harbor description and a detailed discussion of the risk factors relating to forward looking statements. We will also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures.
Reconciliations of these measures to GAAP financial measures were provided in the earnings release filed as an exhibit to form 8-K. Please note that this call includes information that may only be accurate as of today's date October 28, 2022, I will now turn the call over to President and CEO Marty Birmingham.
Thank you Kay.
Good morning, everyone and thank you for joining us today.
During the third quarter, our company produced solid results, including net income available to common shareholders of $13 5 billion already eight cents per diluted share. These.
These results were impacted by nonrecurring enhancement from a company owned life insurance surrender redeploy strategy that Jack will discuss in his remarks, a $4 3 million provision for credit losses, and 312000 income and fees associated with the Paycheck protection program.
Adjusting for these items pretax pre provision income for the quarter was up 770000 or three 9% from the prior year. When we recorded a 541000 benefit for credit losses, and a $1 4 billion of Triple T related income and fees.
Organic loan growth was certainly a highlight in the third quarter with loans growing two 7% from June 30.
Or two 9% when excluding paycheck protection program loans.
The strength of our commercial lending franchise was the driving force behind this double digit annualized loan growth.
The commercial business portfolio, excluding the impact of Triple P loans grew four 8% from the end of the second quarter.
Commercial mortgage was up 8% as much of our committed backlog at June 32020 to success.
<unk> successfully closed during the third quarter, starting with US in February our new mid Atlantic team has hit the ground running and their contributions are evident in our results.
As of September 30th.
Got it on approximately $69 million outstandings with around 41 days of that coming on during the most recent quarter.
This team, which serves the Baltimore and Washington D. C region is also contributing meaningfully to our current commercial pipeline.
As we focus on building the five star brand in this market.
Confident in the strength and experience of the team we've added and the high quality nature of the relationships, they're bringing onboard.
For example, most of our mid Atlantic loans are tied to stabilize and mature mortgages.
Along with some construction lending with excellent sponsors.
Average loan to value ratio for this portfolio was approximately 55%.
That's the majority of these loans are for office space in Washington D. C. Metro that are primarily located in heavy traffic areas near hospitals and have a fair amount of medical leasing with high occupancy levels.
The success to date of the mid Atlantic team together with our long term track record of credit disciplined loan growth and well defined strategic and risk frameworks give us confidence in this strategy as we continue to evaluate opportunities for growth as pleased as we are with our commercial performance. We are aware of and are closely.
During the challenges that the current economic environment poses to our company and our customers.
Like the rest of the industry, we are seeing pricing pressures amid the inflationary environment.
Higher us to be very thoughtful as we evaluate opportunities.
The quality of our portfolio remains strong, which we are committed to defending.
We remain focused on building deep relationships with high quality sponsors in our markets, including our core upstate New York geography that performs consistently in periods of both economic expansion and recession.
Turning to the consumer side of our business our residential portfolio grew 7% during the quarter, but was down one 2% from the third quarter of 2021.
Home equity volume continues to rise helping to balance the softer activity, we're seeing for purchase mortgages and refinancing requests.
Many of the pressures we discussed with you on our last call.
<unk> inflation and rising interest rates and tighter housing inventory remained headwinds in the near term.
That said, we are driving continued operational efficiencies to further enhance our underwriting and application process.
And are pleased with the strength of the talent. We brought on recently who are helping us with these initiatives.
Our consumer indirect portfolio stands at $997 4 million as of September 30th down 4% from the linked quarter, but up 6% from the year ago period while.
While the fourth quarters historically softer in terms of application volume, we're still seeing sufficient demand for vehicles in loans in.
In addition, there was a good deal of M&A activity within the dealer space, which creates disruption and opportunities that we are well positioned to capitalize on having a strong reputation and our network of more than 500 franchised new auto dealerships.
While we did see an increase in charge offs on this portfolio in the third quarter. We view. This has returned to a more normalized level following exceptionally low levels in 2021.
Before turning the call over to Jack for additional details on our financial results and an update on guidance I'd like to spend some time. This morning on our banking as a service or bass operating system, which enables our fintech partners to offer banking products and services to their end customers.
SaaS is a fee based line of business to align with our risk appetite and credit discipline focus driven by fees from servicing interchange advisory and other revenue sharing opportunities.
Additionally, that provides the potential to generate lower cost deposits and enhanced loan diversification.
Our vast pipeline is beginning to translate into success.
We anticipate a growing through the remainder of 2022 and into 2023.
As we noted in our Investor presentation, we have several partnerships in various stages of Onboarding.
Earlier this month, our sponsorship with Atmos financial went live.
Atmos as a fintech aimed at affinity groups focused on climate positive banking.
While this partnership is early stage, we are encouraged by the opportunities to enable their mission and success.
Additionally, we are exploring expanded opportunities to increase revenue, while helping atmos fulfill its mission.
Atmos proven ability for customer acquisition gives us confidence as this partnership also allows us to lean into the fast growing Green finance segment of the market in a responsible way by partnering with a fintech that exclusively works in that niche.
This unique partnership perfectly illustrates our thoughtful and disciplined approach to SaaS, which focuses on partners that are complementary to our risk appetite and values.
Each have the potential to contribute to both our income statement and balance sheet.
We've also filed in our approach to engaging with fin tax on a one on one basis as opposed to using connectors to bring in those relationships is beneficial for both sides.
While it creates a somewhat longer process. It allows both parties to more fully understand the challenges and opportunities to mutually drive near and long term growth and value.
Our best model is centered on a measured direct integration and rollout of clients such as Atmos.
Which helps the bank avoids some of the challenges and regulatory pitfalls affecting some others and the best space.
It's now my pleasure to turn the call over to Jack for additional details on our financial results and an update on 2022 guidance.
Thank you Marty good morning, everyone.
For the third quarter of 2022 solid organic loan growth and continued net interest margin expansion in the current rising rate environment.
Net interest income of $43 1 million.
Up $1 $5 million from the linked quarter.
Just over $6 million and $23 million of Triple P loans were forgiven in a third and second quarters of 2022, respectively.
With related fee accretion of $297000 in the third quarter as compared to 756000 in the second quarter.
In total we have just $2 8 million of Triple T loans remaining as of September 30.
NIM on a fully taxable equivalent basis was 328 basis points for the third quarter of 2022.
Up nine basis points from the linked quarter and 21 basis points from the third quarter of 2021.
Investment Securities were down due to the impact of rising interest rates on the market value of the portfolio as well as the deployment of portfolio cash flow to fund loan originations during the third quarter.
Our investment Securities portfolio is primarily comprised of agency rapt mortgage backed securities with intermediate durations.
Which provide ongoing cash flow.
Coupled with investment grade municipal bonds that are classified as held to maturity.
Cash flow from our securities portfolio allows for reinvestment into loans for additional investment securities. Our cost of funds was 58 basis points in the current quarter.
Up from 28 basis points in the linked quarter due to the impact of higher rates on wholesale borrowings and reciprocal deposits.
Noninterest income.
Which includes revenue from our insurance and wealth management businesses was $12 7 million for the third quarter.
Up $1 3 million or 11, 4% from the second quarter of 2022.
Okay.
Insurance agency generated $1 6 million of insurance income for the third quarter, while Courier capital and <unk> capital contributed $2 $7 million of investment advisory income.
Noninterest revenue categories with the largest changes quarter over quarter were as follows.
Company owned life insurance income was up $2 1 million due to a nonrecurring $2 million enhancement associated with the surrender and redeployment of $25 5 million in cash surrender value of company owned life insurance.
Income from derivative instruments net was $546000 lower than the second quarter of 2022 due to a lower level of swap loan originations.
Gains on sale of loans were down 520000 from the second quarter of 2022, when our loan sales benefited from the opportunistic sale of a portfolio of indirect loans.
Noninterest expense of $32 8 million was at the higher end of our guidance range and relatively flat with the linked quarter.
When we recognized $1 3 million of nonrecurring restructuring charges related to the locations that were closed and consolidated <unk>.
Part of our 2020 retail bank network optimization.
As a reminder, the higher expenses in the second half of 2022 included investments in strategic initiatives, including further enhancements to our new customer relationship management solution digital banking and banking as a service.
Income tax expense was $4 7 million in the quarter, representing an effective tax rate of 25, 4% compared to $3 9 million and an effective tax rate of 19, 8% in the second quarter of 2022.
$1 $5 million of the third quarter expense was associated with the previously mentioned company owned life insurance surrender and redeploy strategy there.
That resulted in modified and Dominic contract penalties and ordinary income tax associated with the gain on the surrender.
Importantly, this along with the remaining related incremental taxes of approximately 500000 that we expect to record in the fourth quarter were fully offset by the $2 million of enhancements that I touched on earlier.
This strategy allows for cumulative earnings improvement on the redeployed company owned life insurance investments due.
Due to incremental yield improvement of approximately 100 basis points.
Accumulated other comprehensive loss increased by $41 5 million in the quarter driven by the unrealized loss position of our available for sale securities portfolio.
Intermediate maturities of the treasury curve negatively impacted the market valuation of our investment portfolio due to its five year duration.
We believe these unrealized losses are temporary in nature, given the high quality of our agency mortgage backed securities that are implicitly or explicitly guaranteed by the U S government.
The unrealized loss position does not impact our forward earnings metrics, because we expect the securities to mature at a terminal value equivalent to par.
If these securities rolled down the curve, we continue to redeploy cash flow into the loan portfolio or current coupon bonds.
As outlined in our Investor presentation.
Realized loss position negatively impacted the year to date TCE ratio by 229 basis points and tangible common book value per share by $8 34.
Excluding the OCI impact, our TCE ratio and tangible common book value per share would have been 775% and $25 11, respectively.
We expect these metrics to return to more normalized levels over time, given the high quality of our investment portfolio.
Regarding our current outlook for the remainder of 2022 weeks.
We continue to expect mid to high single digit full year growth in our total loan portfolio driven primarily by commercial lending.
We continue to plan for a low single digit growth in nonpublic deposits.
We are focused on attracting new consumer and commercial deposit accounts and expect the positive impact of these new accounts to be partially offset by unexpected decline in the average balance per account.
In the first three quarters of 2022 were cyclical in public deposits have declined due to the current interest rate environment.
Customers have look to alternatives like U S treasuries to generate more yield.
For the last quarter of 2022, we are projecting balances to be relatively flat absent typical seasonality in the public deposit portfolio.
We are narrowing the range for full year NIM to 315 to 320 basis points, excluding the impact of Triple T activity.
The noise in NIM relative to Triple B forgiveness will be muted for the remainder of the year since the majority of Triple P has been forgiven or repaid although we are continuing to guide on full year NIM, excluding triple B.
In the past, we guide on NIM using a spot rate forecast.
However, we have recalibrated our forecast based upon current expectations of 150 basis points of <unk> rate hikes through year end.
Guidance also reflects our expectations for deposit betas, given the current rate environment.
With a range of zero to 55% for non maturity deposits, including our public and reciprocal deposit portfolios.
As a reminder, our NIM fluctuates from quarter to quarter due to the seasonality of public deposits and its impact on both our earning asset and funding mix.
In quarters, where our average public deposit balances are higher due to seasonal inflows.
Second and fourth quarters are earning asset yields are lower given the short term duration of the deposits and limited opportunities to invest the funds.
Our balance sheet sensitivity remains relatively neutral.
We saw a modest level of NIM compression in the first quarter as expected with the lower level of Triple P revenue.
However, the higher rate environment positively impacted loan yields in the second and third quarters, and we expect NIM to expand modestly in the fourth quarter.
Approximately 32% of our loan portfolio, excluding triple P index to variable interest rates.
We are maintaining our projections for noninterest income at a low single digit decline compared to prior year.
Excluding gains on investment Securities and limited partnership income as they are difficult to forecast.
Our current outlook reflects continued pressure on mortgage banking revenue as a result of lower refinance activity and tightening of gain on sales spreads due to the interest rate environment press.
Pressure on wealth management fees related to market driven decreases in values of assets under management and it.
A reduction in card interchange income as inflation.
<unk> impact consumer spending behaviors.
We're confirming the full year noninterest expense range of $126 million to $128 million, excluding the second quarter 2022 restructuring charge.
You can expect the fourth quarter to range between $32 million to $33 million.
Our spend in 2022 include investments in strategic initiatives, including further enhancements to our new customer relationship management solution digital banking and banking as a service.
Our expectations for efficiency ratio remains the same.
Within a range of 59% to 60% for the year.
Excluding the impact of second quarter restructuring charges and third quarter company owned life insurance enhancement revenue.
2022 efficiency ratio is impacted by upfront costs associated with our aforementioned investments in strategic initiatives that we expect to recoup in later periods.
Driving our expectation for improvement in the future efficiency ratio.
We now anticipate that the 2022 effective tax rate will fall within a range of 21% to 22%.
Guidance includes the impact of the company owned life insurance render and redeploy strategy executed in the third quarter and amortization of tax credit investments placed in service in recent years.
We continue to evaluate tax credit opportunities and our effective tax rate will be positively impacted by taking advantage of further investments.
We expect quarterly net charge offs for the fourth quarter of 2020 to be within our historical range of 35 to 40 basis points.
Overall, we remain focused on executing on our strategic initiatives, which are designed to improve profitability and operating leverage over time.
That concludes my prepared remarks, I'll now turn the call back to Marty.
Thank you Jeff Our company has made excellent progress in recent quarters to ensure all our business lines are well positioned in the current challenging economic environment.
We brought on exceptional talent expanded our geographic reach and significantly enhanced our digital capabilities and offerings.
In turn these actions are enabling us to enhance the efficiency of our team.
The customer experience and expand our client base to reach Fintech and other non bank financials.
We believe this is the right recipe to build long term value for all our stakeholders, including our shareholders our customers and our communities.
Thank you.
Operator, please open the call for questions.
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Our first question comes from Damon Delmonte from <unk>. Your line is open.
Hey, good morning, everyone hope everybody's doing well today, thanks for taking my question.
Just wanted.
To ask a question about the margin and I appreciate the.
The guidance and the color Jack that you provided and noted that you said that.
You look at the balance sheet as being relatively neutral.
Right. So I'm just kind of wondering.
Once we get through these next couple of hikes. So towards the end of the year kind of how you think the balance sheet will react as you go into 2023 do you think that a little bit of bump you see here in the fourth quarter is kind of your peak.
Things kind of level out or do you think there's still opportunity for margin expansion into 'twenty three.
Thanks, Dave and that's a great question, so as I unpack that a little bit.
Look back at our historic deposit data throughout the year. So year to date total deposit betas were around 11% and that was just based upon the amount of lag that we saw during the first half of the year the year to rate increases.
During the third quarter, they pushed up to about 20%, which is in line with expectations for the fourth quarter. So I would anticipate a modest amount of margin expansion through the fourth quarter as we expected and guided to.
For that to continue into 2023.
Got it okay. That's helpful. Thanks, and then.
Obviously credit credit on a whole is really strong you guys in your guidance of historical.
The 35 to 40 basis points.
When we look at that number and we think about loan growth and we kind of factor in what the outlook looks like for the reserve level as provision pretty much can be driven.
With the.
<unk> 35 to 40 basis point charge offs, one component is the <unk>.
Division going to be.
Kind of reflective of what the current reserve level is.
And I've asked that correctly basically I am saying is your provision going to fluctuate in order to keep your reserves flat.
That level of charge offs.
Yes. This is Jack I'll take that question. So our coverage ratio right now, it's about 114 basis points and that's in line with our <unk>.
<unk> day, one adoption level.
And just given the current economic outlook I'm very comfortable with that coverage ratio and just given the credit quality of our portfolio and you are correct in that.
The expectation would be to provide for about 35% to 40 basis points of <unk> along with loan growth.
One.
Area, that's a little hard to forecast is national unemployment is.
One of our clients on a quantitative driver for our model on that.
Certainly influences the output there so.
Well, we'll continue to focus on.
Providing for a coverage ratio I think aligns with our expectations by 114.
Level.
And just to emphasize the point that Jack made I think in this quarter Jack.
But look for unemployment, obviously is longer term is increasing and thats whats the driver of our increased provision expense. This quarter. In addition to what was required to support the commercial loan growth certainly.
Got it that's great color. Okay. That's all I had thanks, a lot I appreciate it.
Thanks, so much David.
Our next question comes from Alex Tuttle from Piper Sandler Your line is open.
Hey, good morning, guys.
Good morning, Alex.
Yeah.
Hey, Jack you alluded to the cash flows from the Securities portfolio. I was wondering if you could just provide us sort of what your expectations are in terms of the cash flows from securities.
They are a quarterly basis over the next few quarters.
Yeah, actually we run a projection in each quarter.
For a 12 month view just based on current rate environment and prepayment expectations. So just principal cash flow off the portfolio right now is models about $150 million over the next 12 month.
Period.
Okay.
And then if I remember correctly the indirect auto portfolio also has a pretty short duration throws off a lot of cash on a monthly basis do you happen to have the.
The numbers about how much cash come out for the indirect auto book as well.
Yes, I think that our expectation for that portfolio is right around <unk>.
$30 million a quarter.
Okay. So almost the same amount.
And then as you think about sort of managing the balance sheet. Obviously, we've been very focused on seeing loan growth over the last couple of years and it's been great to see I'm just curious as rates go up and obviously funding pressures Mount and I know the municipal funding has been really competitive in your markets and some of these other things I'm just curious how youre thinking about managing that liquidity if if most of.
That you expect to go back into loan growth or do you think maybe there are some opportunities to do some other things and sort of optimize the balance sheet.
From a funding perspective as well at that.
Additional cash come in commentary.
Yes, we have a pretty healthy pipeline on the commercial side with our committed backlog and an overall opportunities. There. So my expectation would be to use that cash flow to support loan growth.
Okay, so but.
Based on the pipeline.
The commercial portfolio, maybe the loan growth kind of becomes a little bit more commercial focused I know that obviously indirect has been a fantastic supplement but do you think we'd see that mix shift a little bit towards commercial in the next 12 months.
I think thats right Alex.
Consistent with really what we've been trying to do in general anyway. Prior to the pandemic was to moderate the indirect exposure and continue to drive.
All other levels.
Some.
On the salaries and benefits line, which is up like 1 million Bucks over the last quarter. How much of that is due to just normal wage increases versus other things that might be in there like I know if I remember correctly, you guys self insurer and maybe medical expenses tend to pick up a bit in the third and fourth quarter of the year I'm just curious how much of that might stick.
Around into early next year versus the component that might be harder to project.
Yes about 350000 of the increase was driven by our claims which were ultimate third quarter.
And then about $450 above it was just pure salaries.
Okay and are you are you there.
At this point consider yourselves to be pretty close to fully staffed.
Are you still looking to bring on more people.
We are open requisitions for replacement so turnover, we've had throughout the year, but I think that we're appropriately staffed at this stage of the game and as we look at other additions next year it'll be viewed under lines of business case and.
Essentially looking for folks that pay for themselves.
I just wouldn't editorial comment that's ongoing at very rigorous conversation that occurs.
<unk> amongst our senior management team and the cascading through other managers in the company.
Okay.
That's great. That's all my questions for now thank you.
Thank you so much.
As a reminder to ask any further questions. Please press star followed by one on your telephone keypad now.
Our next question comes from Erik Zwick from Hovde Group. Your line is open.
Good morning, everyone.
Eric.
I appreciate all the.
Kind of detailed expectations for the fourth quarter, and I guess kind of what I'm curious about today thinking about the loan portfolio. It sounds like it's still strong now and you've indicated that it's lean.
Turning towards more commercial given the environment and I know, it's tough to look out.
More than a quarter at this point given all the uncertainty in the market but.
Im curious if youre seeing any indications.
That higher interest rates and uncertainty over potential recession in 'twenty, three or having any impact on either bar sentiment or the pipeline and just curious how that might translate into into loan growth in 'twenty, three and whether there are some offsets there whether just the fact that you've added the mid Atlantic team, which seems.
So it really be ramping up nicely could could act as an offset or just kind of curious about how that might impact longer longer term loan growth.
Okay.
So I think that definitely sentiment is evolving fast given what's happening in the economy and the outlook for the economy. Some of the offset that you talk about does relate to the additional.
Team that we have working for us in mid Atlantic. We have also been continuing to reinforce and bolster our small business.
Commercial team as well as in general across our commercial business. So the pipeline as it currently stands today is strong we've got commitments flowing through.
<unk> $200 billion I think for the fourth quarter, that's expected and.
Generally the pipeline is closer to $800 million as we speak today across the entire line of business.
That being said, though our borrowers are being very careful and thoughtful relative to.
Incremental borrowing and revisiting underlying projects if they haven't funded yet are closed.
Or under consideration in terms of the impact of higher rates requirement for more equity contribution or however else knockdown effect is given what's happened to interest rates.
That's helpful. Thank you and just last one from me just curious if you could refresh me on your thoughts around.
Buying back shares today in today's environment certainly bank.
Valuations are depressed versus maybe historical averages, but theres also the uncertainty regarding the economy, certainly the OCI impact while you've clearly illustrated as temporary.
But that just may be front from an optical standpoint weighing on decisions at all so just curious how you think about the.
The opportunity to repurchase shares today.
Well I think you listed.
The key issues that would factor into a decision like that we do have a program that is currently in place.
And to the extent that we used it wouldnt use it we would have to consider everything you just referenced.
Historically, when we have bought back shares we've been very pleased.
With the.
Return the.
The capital investment and the return on that investment in the short earn back period, but at this point in time. There is there is so much noise relative to our capital ratios valuations in the industry et cetera that.
We're we're being very prudent.
Great. Thank you for taking my questions today.
Thank you.
This concludes our Q&A I will now hand over to multifamily I am seeing for final remarks.
Thank you everyone for their participation we look forward to continuing to build on this conversation that the conclusion of our fourth quarter.
Today's call is now concluded.
Thank you for your participation you may now disconnect your lines.
Okay.
Okay.