Q3 2022 First Commonwealth Financial Corp Earnings Call
Good afternoon. My name is Christian I'll be your conference operator today.
At this time I'd like to welcome everyone to the first Commonwealth Financial Corporation, Q3, 2022 earnings conference call and webcast.
All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there'll be a question and answer session.
If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad.
To withdraw your question.
One again.
Thank you.
Ryan Thomas Vice President of Finance and Investor Relations you may begin.
Thank you, Chris and good afternoon, everyone. Thank you for joining us today to discuss the first Commonwealth Financial Corporation third quarter financial results.
Just feeding on today's call will be Mike price, President and CEO , Jim Murasky, Chief Financial Officer, Dwayne Gubins Bank, President and Chief revenue Officer, and Brian Carroll, Our Chief Credit Officer.
Binder copy of yesterday's earnings release can be accessed by logging onto the F. C banking dotcom and selecting the Investor Relations link at the top of the page.
We've also included a slide presentation on our Investor Relations website with supplemental financial information that will be referenced during today's 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 three of the slide presentation for a description of risks and uncertainties 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 non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with GAAP 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.
Hey, Thanks, Ryan and good afternoon, everyone.
Net income of 34 million increased $3 2 million over the second quarter on the heels of significant improvement in net interest income and better fee income, partially offset by pressure on noninterest expense and an uptick in provision expense.
Our pre provision net revenue of $48 9 million was strong and produced a core pretax pre provision ROA.
Of 2.0% to 3%.
Our core ROA in the first quarter was 143%.
Elements of the quarter follow straw.
Strong loan growth of three 3% percent annualized coupled with the burgeoning net interest margin of 376% propelled and eight $7 million increase in net interest income to a record third quarter figure of $82 $6 billion.
Both was again broad based with commercial lending leading the way followed closely by indirect lending and mortgage all of our regions are reporting healthy pipelines in both our consumer and commercial lending businesses. Our strong core depository was especially valuable and maintaining a low cost of funds further supporting margin.
<unk> expansion as our cost of deposits only increased by one basis point between now and year end higher rates will result in more muted fourth quarter loan growth and bringing that.
Figure two we project mid single digit guidance.
Noninterest income rose, one 4 million to $25 9 million in the third quarter, our swap income in commercial lending hit record levels.
Gain on sale picked up steam as well third quarter non interest expense rose $3 6 million and it was a function of investments in talent and technology brought an inflationary pressure on salaries and a handful of one time items. However, the core efficiency ratio still fell to 54.
4.06% due to the aforementioned growth of top line revenue.
Third quarter provision expense of $5 $9 million was up over the second quarter, even as overall credit quality remained sound for example, commercial 30 cost.
30 day, plus delinquency was only two basis points down from an already low four basis points last quarter.
Nonperforming loans at $35 million or 48 basis points of total loans were down from last quarter as well.
Looking forward, our broad base of both margin and feed businesses, coupled with our philosophy of continuous improvement should translate into continued growth. We've built a well diversified bank that we feel will do well in multiple interest rate and economic scenarios. This is why we strive for.
For balanced in the composition of our lending book with 47% of Outstandings in consumer loans at quarter end, and 53% and commercial categories intentionally inorganically, we've moved towards balance in our loan portfolio starting at least five years ago to the Port point, where we now have roughly.
<unk>, 50% in variable rate loans, and 50% of our loans and fixed rates and we've also methodically built sources of fee income that peaked at nearly 30% of revenue several quarters ago through meticulous execution in mortgage SBA and wealth management and other fee businesses coupled with <unk>.
Credit we've built the bank to thrive and good in tougher times, we will remain focused on what we can control, we strive to get better in each of our businesses and regions with better talent and processes every quarter, regardless of the external environment. We are also excited about our 2020.
<unk> growth prospects with centric SBA equipment finance and continuing growth through our regional business model to name just a few as we look forward to 2023, the emerging strategic themes will likely be largely unchanged from 2022, which are as follows first.
Improve and grow our lending depository and fee businesses in each region of our company second increased digital relevance third maintain operating leverage fourth strengthening our culture of leadership and talent and fifth improve brand awareness for now I'll just focus.
And one of those themes, increasing digital relevance we continue to be pleased with the adoption of our digital banking platforms in total for the quarter, we experienced an 11, 5% annualized increase in active mobile users importantly, our customers continue to show high engagement with our digital tools.
With average logins per user per day at 1.07 times at year to date, which is up 12% year over year with this strong use of the platform. We continue to make investments to bring more features to our customers.
<unk> centric acquisition is proceeding well in large part due to good dialogue between the leadership teams of both organizations, we still intend to close the transaction on January 1st as planned subject to pending regulatory approvals.
Finally, we are pleased to see that first comments Commonwealth earn the designation as the number one SBA lender in western PA and number two in Pennsylvania with that I'll turn it over to Jim <unk> our CFO .
Thanks, Mike.
As Mike mentioned, the combination of 13, 3% annualized loan growth and 38 basis points of margin expansion produced strong financial results for the quarter.
As usual I will try to provide some helpful color on our earnings trajectory.
The margin is benefiting from improved loan yields combined with deposit costs that have remained essentially flat.
We had the advantage of coming into this cycle with a cost of deposits all enough to places in the 90 percentile of our industry and our cumulative deposit beta in the cycle to date has been effectively zero.
Our cost of interest bearing demand and savings deposits was seven basis points in the third quarter, which is exactly the same as it was in the third quarter a year ago.
Our total cost of deposits, which includes the non interest bearing deposits that form roughly one third of our deposit base was five basis points from the third quarter.
Up from four basis points last quarter, but it's actually down from six basis points a year ago.
We do expect deposit betas to change however, as we witness deposit competition heat up in our markets steadily over the course of the third quarter.
We had been using a 25% deposit beta assumption based on our historical experience.
But a refresh of that analysis leads us to expect deposit betas of 20% going forward both for rate increases from here on out and key cumulatively through the cycle.
So assuming a beta in the fourth quarter of 20%.
And the fed funds rate of roughly four 5% by year end we.
We would expect that NIM to expand by at least 20 basis points in the fourth quarter.
The NIM is quite sensitive to the beta assumption.
If for example, the beta were to come in at just 10% of fourth quarter rate hike that will result in about 10 basis points of upside to.
So the NIM projection I just gave you.
We will update 2023, NIM guidance going forward to reflect the centric acquisition once we receive regulatory approval.
Expenses were elevated in the third quarter compared to last quarter for several reasons.
Some things represented normal quarterly volatility.
For example, hospitalization expense was up by about $5 million.
After being well contained all year.
Other items represent the impact of inflationary pressures and are likely here to stay for example, salaries are up by about $5 million as we filled open positions and work to improve improve employee retention rates.
So other items reflect increased activity and long term investments in the company.
This would include roughly another $5 million for incentive accruals that were adjusted upward and recognition of higher loan production in the third quarter and improved performance.
And the continued build out of our equipment finance business.
And finally, there were about $800000 in one time expenses that we feel are not part of our normal run rate we.
We had one time technology expenses in the third quarter of about half a million dollars related to a conversion of our credit card system.
Along with costs associated with the cancellation of certain contracts and a reconfiguration of our telephone service.
There was also about $325000 in expenses that we don't expect to be ongoing for facilities projects, the largest of which was related to some flood damage at one of our branches.
In light of third quarter results. However, we are updating our previous noninterest expense guidance of 56 to 57 million per quarter to 58% to 59 million per quarter, but we'll obviously update guidance for 2023 to reflect.
With centric acquisitions when appropriate.
Provision expense was a bit higher than in previous quarters.
But the ACL coverage ratios stayed unchanged at 131% of total loans.
Provision was driven by our strong loan growth and the normal charge offs.
We did increase reserves due to changes in our economic forecast, but these increases were largely offset by the release of some COVID-19 related reserves that we still had on the balance sheet.
We would emphasize that we still see very few signs of stress in our credit credit quality metrics and as Mike mentioned, we actually saw improvement in a number of credit metric year to date, including reductions in nonperforming criticized and classified loans.
Finally, our effective tax rate was 19 eight 2% in the third quarter.
And with that I will turn it back over to Mike.
Thanks, Jim and operator, we will turn it over to you for questions.
Thank you as a reminder, if you would like to ask a question. Please press Star then one on your telephone keypad.
First question is from Frank Schiraldi with Piper Sandler Your line is open.
Good afternoon.
Frank.
I think Mike I think you mentioned in <unk>.
<unk>.
Loan growth.
An expectation of mid single digits, if I heard right. So is that.
Is that for the fourth quarter.
The guidance.
It is we've had some ebb and flow to our loan growth like this year, we were at 9%, 11% and 13 I think the year before we had a down quarter and then three up quarters, and there's just an ebb and flow to some payoffs in the third quarter and hopefully we'll be back off to the races.
The first we expect to be in the first quarter of 2023.
Okay and then.
Please I kind of thought about maybe a little bit of a handoff from consumer to commercial and then I guess commercial is a bit stronger.
But.
As you look out in <unk> sounded like you talked about strong pipelines involved so do you think it's.
Maybe sort of 50 50 growth in consumer commercial and <unk>.
Yes, it's been surprisingly so.
So throughout this year.
Corporate banking has some nice pipelines and quality investment real estate projects in good markets. We also built up a nice construction book, where advances should average about $25 million a month next year.
And they are in growing markets like Columbus, you have projects coming in there with Honda and Intel So theres a lot of tailwind in those markets on even on the C&I side, we should see some nice pipelines.
In the regional books in Cincinnati Columbus.
Cleveland, Pittsburgh and community, Pennsylvania, really excited about centric and what theyre going to add to the equation.
We expect some good swap fees in the first fourth quarter, probably a little bit muted over the third quarter, then as we move to the consumer businesses, they're off a little bit but not much indirect is having a strong quarter SBA pipelines are getting deeper.
Mortgage has settled down at probably.
30% less in peak, but we really still like the business and the operator, there is scale that for that size and then interestingly on the branch based side, we've seen the HELOC volume moved.
Our loan volume moved to HELOC, which you have to wait for the draws but we like the activity we like the way it sets up for 2023, all things being equal and.
And thats kind of trudging along with.
Despite inflation tight employment and really constructive.
Business outlook at least in our markets.
Okay, Great and then just a question for Jim on the on the margin I wanted to make sure I understood or I heard it correctly on the.
As expected beta so was that 20%.
Data through cycle and then.
Just just curious if you could talk a little bit about why the change in expectations.
Simple as what you've seen to date on that side of things.
Yes, Frank a good question and glad you asked because we've been saying, 25% beta all through this cycle and we say that every quarter and then the data comes in at zero.
And looking back to be honest, we thought we were pretty clever at the beginning of the rate cycle.
Tooting a delay in our expectations. So we said at the beginning that rather than just 25% from the get go we thought we would be able to deal with the first two rate hikes with no beta zero and then 25% thereafter that was three or four quarters ago.
On our earnings call as you may recall us saying that.
And then of course, we've got 300 basis points of <unk>.
<unk> data through this time so the beta study we have is based on our historical data with a look back and look back was done in October of last year that was very consistent in our store experience at that time was 25% that led us to the 25% conclusion, we just refreshed that analysis and taking into account that low beta this year, the new numbers, 20% of the aggregate.
Now obviously, there's a different patent every deposit category, but the aggregate numbers 20%.
So we think going forward if the fed does hike in the fourth quarter, we're going to pass some of that along with our depositors and Thats. The current period beta assumption.
And then over time, the beta will catch up so we can if there are no hikes in the first second and third quarter next year, if the fed holds Pat.
Our deposit rate will continue to rise just like everybody else such that we still think at the end of the cycle cumulatively.
End up totaling around 20% hopefully that gives a little clarity I appreciate your question.
Yes, Thanks, and then just on the.
For Q NIM expansion.
So that was based on.
Betas.
Moving higher over time, not necessarily 20% cumulative beta <unk> is that right.
Yes, it's not accumulative not thank you again for asking its not saying that we'll have reached a cumulative beta of 20% by the end of <unk>, It's only thing in.
And our assumption is that it will be at 20% current period betas. So if the fed raise rates basis read raise rates by 100 basis points, we would expect passing on 20% of Thats depositors in the fourth quarter only the current period and the rate forecast I gave you actually is based on our that's based on our latest.
Rate forecast that we received that.
And currently expect $2 75 basis points to 150 basis point basis points of our rate increases in the fed funds rate by year end.
Great. Okay. Thanks for all the color.
You bet.
The next question is from Daniel Tamayo with Raymond James Your line is open.
Okay.
Thanks, Good afternoon guys.
Not too.
You are on this on this margin discussion but.
That's great color on the fourth quarter, obviously, the margin is going to be.
Kind of above historical levels, but by that point, just curious how youre thinking about.
The margin going forward past past the fourth quarter, assuming we get some stability in rates.
If those start to come down to two.
<unk> historical levels or you think there's something structural about the margin now where you can maintain hired veteran.
Net interest margin.
Why do you think it will be able to maintain a higher net interest margin for some time differential link it'll continue a little bit and we keep the pricing the loans operated repriced the fixed loans, even though.
And do we replace those effort.
Nice steady progression of that throughout the third quarter.
So there is the incident repricing and fed raises rates here in the fourth quarter, but even if the fed stops raising rates all through next year, we'll still see some uptick.
Loan yields just since we repriced the book upward.
But I think the question is getting at kind of.
At this notion of a peak and when do we think that is nimble peak.
It's hard to predict because we are in the middle of an acquisition.
Hard to read.
Can't really talk about some of those numbers right now.
But it does look like the nimble peak sometime over the course of next year and then if if if.
Fed holds rates Pat for a while a lot of the loan book repricing will kind of settle into a nice higher NIM and stay there for some time.
I would just add.
The five acquisitions that we've done notwithstanding centric have all been accretive to our margin or profitability and we expect the same.
Okay, Alright, that's very helpful. Thank you.
And then maybe we talk a little bit about <unk>.
The income I think we've talked about guide.
Guidance in the $26 million to $27 million range per quarter.
I'm wondering what your current thoughts are on that.
Probably roughly the same.
Yeah.
We have SBA ticking up a little bit maybe.
The swap income ticks down.
Even with the strength of Christmas.
I think our.
Interchange will probably be roughly the same maybe up a little.
So that's kind of the tale of the tape at least from this vantage point Youre always surprised a little bit.
And in a mortgage has been chugging, along and doing well, but it's certainly not at the height. It was.
Two or three years ago.
But we were long on that business, we get.
Young <unk>.
Creditworthy household.
With a mortgage and that's also important to the bank.
Understood terrific.
And then and then lastly, just from a credit perspective.
I'm wondering if your.
Kind of purposely pulling back anywhere as we prepare for perhaps in the colonic slowdown next year.
Any categories or just a little bit less aggressive in terms of.
Blending.
We're not yet.
We're reading the tea leaves with.
The economy from quarter to quarter.
We're not yet we feel like we could not with good standards and we can at least learn through the cycle, notwithstanding severe shocks or unanticipated consequences in the economy.
Alright, well thanks for all the color guys Thats all from me I appreciate it.
The next question is from Michael Perito with <unk>. Your line is open.
Hi, good afternoon, thanks for taking my questions.
You bet.
I wanted to start.
Jim You mentioned, a new kind of expense run rate for the fourth quarter. I know you guys will provide more commentary for next year specifically in January but.
Just curious if you guys have any initial thoughts kind of excluding centric when do you think about that NIM stepping up towards 4%. The investments you guys are making some of the digital progress.
Do you guys. Thank you.
You will be able to generate.
Positive operating leverage on the kind of the core business next year.
If rates kind of do what the consensus forecast say theyre going to do at this point.
Yes, that's our history and as we think about deposit betas understand too if the growth doesn't materialize the beta will be lower.
And if the growth is higher.
The loan growth is higher the beta will be higher so were.
Jim and Jane our deposit Committee meets.
Every other week and the monitor that very very closely.
Okay.
And what.
Yes.
What are some of the.
The pressure points I guess for lack of a better way of putting it where.
The loan to deposit ratio sits at about 90% today like lets say you guys do high single digit loan growth. The next couple of quarters right I mean, what's the flexibility too.
Maybe shrink investments or cash or or would you guys look to maintain the liquidity level and just try to be more aggressive adding funding and pushed the beta a little bit can you just maybe spend a little bit more time, just on that element of the dynamic in terms of deposit betas.
Yes, we've only begun to hung hang right in the last 30 to 60 days. So we have not hung any rates deposit rates deposit rates. So we just haven't been in.
Deposit acquisition mode, we haven't had to be.
We could sop up a lot of liquidity out there.
Yeah, and I'll give some additional color just component to your question, we basically the letting of securities portfolio run off and it's been a nice source of funding for the bank kind of runoff slow down a little bit because we put us on the securities.
At lower rates.
If you look at <unk>, obviously, a lot of that is under water. So the prepayment speeds have slowed but it's still producing cash flow. So our plan is to let that continue to produce cash flow and reinvest it into loan growth.
And then the excess cash we had earlier in the year I mean, I think it's early in the year at some point this year a crested in peak at about half a billion dollars during calendar year 2022, I think it was early in the second quarter of excess cash we deployed a lot of that into.
We put all that in the loan growth.
So.
The plan.
As Mike stated, we would know that.
Pursuing.
We want them, we want to pursue the pause we want to fund our loan growth deposit growth that.
And that obviously is at the higher rate environment is left to keep up with competition and but that is a long term plan.
Helpful.
And then just lastly for me I know you can't be too specific but just kind of love to check in on this.
This whole Aoc.
Book value tangible capital dynamic has kind of had a.
And what I'm, saying, but an interesting impact on the way the stocks are trading and the way I think people are thinking about M&A and obviously with centric you guys youre kind of managing about $1 billion or so over 10 billion threshold and just curious Mike do you have any kind of just general thoughts about how you're viewing the markets and the opportunities that will be out there and obviously.
There's not a huge rush and we discussed that when you announced the deal but just curious if anything that's gone on in the last 90 days has been noteworthy or change the way you kind of view that the M&A environment.
Nothing in terms of the M&A environment, I'll, let Jim speak to al.
Hi.
I mean, we're really constructive on the deal we have right now.
And they're a branch light franchise with high.
<unk>.
Net interest margin commercially oriented bank and just fits like a glove for us swell run with good producers. So we just think like the other opportunities that will be very positive for the forward momentum of our company and as Jim mentioned, we cant speak about that for another quarter, but.
Jim Why don't you talk about the other aspect of this question. So I just think I think.
Okay Bifurcate your question in two different.
The streams of thought one is that there is definitely an impact of ACI as things go on so for example from the time you negotiated deals and the time you actually close a deal that can be such a movement in rates now.
Your calculation of Marx will change and you have to take that kind of thing into account, but I don't think any of that effects and it really impacts our long term thinking on M&A, we want to do deals that are both strategic fit and our franchise and our community Bank philosophy and that are financially accretive to the bank. So I don't think.
Even though.
Kinds of M&A that we have considered in the past the geographic regions being considered in the past the general M&A, our long term strategy for us really hasnt changed as a result, this phenomenon we have taken into account.
You take the rate environment into account, but it doesn't change anything for us long term yes.
And what also doesn't change is our superior in 'twenty, four and 25 on the other side of Durbin impact and striving to be as profitable and I've set if not more profitable than we were the last several years in terms of ROA.
Pre tax pre provision all of the above that's the goal and.
Obviously M&A gives you nice operating leverage but we also have businesses that are growing like SBA like equipment finance, our core businesses in our regions, our consumer lending businesses. I mean, these were hard gang I mean, we we were in a de novo three or four years ago and now.
They create a broad base of revenue for our company and opportunities for growth and to serve our customers and they also help us through thick and thin when things get tough, we're not reliant on a category or two of loans.
Hope that helps.
Yeah, no. It does good color and thanks again for taking my questions.
Again as a reminder, if you would like to ask a question. Please press Star then one on your telephone keypad.
Our next question is from Matthew Breese with Stephens. Your line is open.
Good afternoon, Matt.
Matt.
Just thinking about kind of the fed outlook and.
And what happens post fed tightening so if we get a cessation in fed hikes in early 'twenty three.
What are your expectations for the NIM in the aftermath of that I mean, a lot of asset sensitive banks are talking about somewhat of a peak in some decline in the margin after that curious if that's your expectation.
Patients.
Yes, it would be it will be because there'll be a continuing lingering effect of <unk>.
Repricing the loan book Upper but also repricing deposits deposits upward to get to an accumulative beta we've talked about before so just to kind of get more clear about that we would think that we'd probably would reach peak NIM sometime in the first half next year.
It's hard to pinpoint the exact time for its first quarter second quarter late first quarter early second quarter, but it is probably sometime in the first half next year.
Okay, and then as we approach that point.
And given to the earlier question about youll be running it at.
Above historical average kind of NIM do you do anything to preserve it yet any any sort of balance sheet swaps or migration of the balance sheet towards a more interest rate neutral position should we expect that.
Well, yes.
We've done that organically with how we've constructed the balance sheet 50, 50 variable fix so we've done that and then also in the past we have layered in macro swaps to protect upward or down downward movement.
And we've done it a number of times, so we'd be open to that.
Okay.
Yeah.
And then secondly, just on some of these fixed rate loan resets I'm curious what the incoming new loan yields are on some of the commercial real estate and multifamily and things like that.
And then on a reset are you seeing any stress on.
On the borrowers kind of bottom lines as you go from.
Rates from 345 years ago in that call it 4% range till today Im guessing its.
North of 6% is there any sort of stress on their bottom lines and have they been able to kind of mitigate that higher interest rate with higher rents and the like.
Well they have to when they bring US project, because we're all stressing the projects with.
A different interest rate assumptions and if you have better developers they understand that.
So that would be the way I would answer that question and variably there will be stress for four projects, but it depends on the quality.
Sponsors and developers that you've underwritten and their wherewithal to work through it.
Should.
Things get even tougher.
Yeah and on the right lease debt question.
Not have it by category in particular to give to you, but I would just tell you. This is just a nice such a nice progression over the course of the quarter. So for the entire quarter. The new loans are coming on at four.
459 old loans are going off at $4 39, so a nice replacement yields.
It's a really solid progression month over month through the third quarter. So for example, the new loan yields.
The three months of the quarter were coming out of $4 30, and $4 60, and then the last one was in accordance September 497% pushing 5% in subcategories. Some commercial categories over 5%. That's just a really nice progression month over month, that's the bank as a whole that's in the aggregate.
It's a nice progression month to month in the third quarter and so we'd expect that to continue even after the fed for some time anyway, even after the fed stops raising rates.
Got it Okay. I appreciate you taking my questions. That's all I had thank you.
Thanks, Matt.
We have no further questions at this time I'll turn it over to Mike price, President and Chief Executive Officer for any closing remarks.
Sure. Thanks for your interest in our company and questions and its good to be with you. This afternoon.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
[music].
Okay.
Okay.
Yes.
Yes.
<unk>.
Yes.
Okay.