First Commonwealth Financial Corp (FCF) 2019 Q3 法說會逐字稿

Good day, and welcome to the First Commonwealth Financial Corporation Third Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Allison. As a reminder, a copy of today's earnings release can be accessed by logging on to fcbanking.com and selecting the Investor Relations link at the top of the page. We have also included a slide presentation on our Investor Relations web page with supplemental financial information that may be referenced throughout today's call.

With me in the room today are Mike Price, President and CEO of First Commonwealth Financial Corporation; and Jim Reske, Executive Vice President and Chief Financial Officer. After brief comments from management, we will open the phone call to your questions. For that portion of the call, we will be joined by Jane Grebenc, Chief Revenue Officer and President of First Commonwealth Bank; Brian Karrip, our Chief Credit Officer; and Mark Lopushansky, our Chief Treasury Officer.

Before we begin, I'd like to caution listeners that this conference call will contain forward-looking statements. Please refer to our forward-looking statements disclaimer on Page 2 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. A reconciliation of GAAP to non-GAAP operating measures can be found on Page 13 of today's slide presentation.

And now I would like to turn the call over to Mike Price.

Thank you, Ryan. Good afternoon, and thank you all for joining us today. The third quarter 2019 core net income, excluding merger costs, was $29.6 million and was $2.3 million over the second quarter. Core earnings per share of $0.30 for the third quarter was up $0.02 from the last quarter, producing a core return on assets of 1.46% and a core efficiency ratio of 55.73%.

Financial tailwinds included a net interest margin that increased 1 basis point to 3.76%, noninterest income of $22.2 million and well-controlled expenses. Also aiding third quarter results was the successful closing and conversion of our previously announced acquisition of 14 Santander branches over the weekend of September 6, which provided low-cost deposits, which were then used to pay down higher-cost, short-term borrowings. This acquisition is accretive to earnings profitability and efficiency.

Some headwinds to third quarter financial performance however included hospitalization expense and slower loan growth stemming from higher levels of commercial real estate loan payoffs. As an aside, commercial loan production remains healthy. Additionally, mortgage and direct auto lending and SBA lending continue to contribute meaningfully to growth, while helping to offset margin headwind from lower interest rates.

Loan growth year-to-date in 2019 of $334 million or 7.7% through September is within our mid-single-digit investor guidance and is 5.4% even when acquired Santander balances are excluded. Encouragingly, loan growth in 2019 is more equally yoked between our commercial and retail segments, enabled by our investments in the mortgage and indirect lending businesses several years ago.

As expected, our Ohio markets continue to deliver the largest share of our loan growth. Specifically, in the third quarter, we saw strong commercial loan growth in Cincinnati and Northern Ohio as well as strong indirect auto loan production, all across Ohio led by Cincinnati.

Mortgage portfolio growth was strongest in our Pittsburgh region, but in total was still stronger for us in Ohio than Pennsylvania as a whole. I should also mention that deposit growth continued at a healthy pace in the third quarter, growing at 5.8% even without the influx of Santander deposits. Deposit growth was particularly strong in commercial banking in Ohio.

A comparison of year-to-date financial results compared to the same period last year shows how the earnings capacity of the company continues to improve. In the first 9 months of last year, we realized approximately $8.1 million in security gains. Excluding those gains, core earnings per share in the first 9 months of 2019 was up 9% from the same period a year ago. We're on a track to substantially grow our earnings per share at First Commonwealth for the seventh consecutive year.

Also consider the significant improvement in returns in efficiency over this time period. Core EPS and ROA, for example, were only $0.43 and 68 basis points, respectively, in 2013 and our efficiency ratio was 67.1%. It's taken an enormous effort of a whole group of good people over those 7 years, including things like a core system conversion in 2014, the transformation of our retail branch network in 2016, significant investment in our digital tools, a significant investment in a de novo mortgage operation, revamping our SBA platform to where we now are the #2 and #3 SBA lender, respectively, in Pittsburgh and Cleveland. We thoughtfully expanded our indirect lending efforts, and we've intentionally created a more granular less-risky commercial loan book of business and added 5 well-executed acquisitions. We believe the financial results as a product of these strategic initiatives speak for themselves.

As I mentioned earlier, we closed and converted our branch acquisition in the third quarter and early results are promising. Post-conversion weekend on September 9, team had converted 44,838 Santander deposit accounts with $471 million in aggregate deposit balances. As of yesterday, deposit balances had increased to $477 million. That's an increase on the back end of an acquisition. The planning and execution of this branch acquisition was superb. More importantly, First Commonwealth now has over 24,000 additional checking accounts in 14 branches stretching from State College to Williamsport in Central Pennsylvania with some wonderful college towns sprinkled in between.

As we look ahead to 2020, a few thoughts follow to simply share our current vantage point and priorities for the year ahead. First, our core retail and commercial businesses as well as mortgage, our First Commonwealth advisers, our insurance agency, indirect consumer lending and SBA businesses have performed well but must continue to get stronger, each one of them. Our digital approach must continue to get better every quarter to enable us to compete against nonbanks, big banks, fintech and big retail. Third, as always, maintaining the highest of credit standards will be key to our ongoing success, particularly through our next credit cycle. Increased focus on managing costs, particularly in light of expected margin pressure. And fifth, we plan to continue to seize smart growth opportunities via M&A and prepare for recession, which just might be the time to buy due to depressed valuations.

And with that, I'll turn it over to Jim Reske, our CFO.

Thanks, Mike. As Mike mentioned, core earnings per share of $0.30 resulted in financial performance metrics that were all strong for the quarter. Third quarter financial results benefited from the Santander branch acquisition, in which we used the low-cost deposits we acquired to pay off higher-cost borrowings. As a result, our net interest margin expanded at a time when most of the industry is suffering from margin contraction.

Beyond the margin, third quarter noninterest income benefited from approximately $225,000 in seasonal tax preparation fees in our trust business. Noninterest expense was impacted by a $524,000 increase in hospitalization expense over the prior quarter. For the year-to-date, hospitalization expense is running about $2.7 million more than the prior year period.

Now for some guidance. We typically provide guidance as to our forward earnings expectations in the first quarter, but given recent events, we thought it might be helpful to provide some measure of guidance today. First of all, 2 thoughts for the remainder of this year. First, if the Fed cuts rates today as expected, we would expect the net interest margin to hover in the mid-3.70s in the fourth quarter. The fourth quarter will get the full benefit of the new low-cost deposits, but on the other hand, each Fed cut typically results in about 4 basis points of NIM contraction for us.

Secondly, fee income will be affected by some seasonal slowdown in areas such as mortgage originations and there is the potential for a negative mark on our mortgage pipeline hedged in a falling rate environment.

Looking beyond this year, we can provide some measured guidance as to our expectations for 2020. We expect that our long-term loan growth will continue to be in the mid-single-digit range with an increasing contribution from consumer loan categories. Deposit growth will likely trail loan growth as the newly acquired deposits allow us to implement more cost-effective deposit pricing strategies. And our forecasts incorporate one rate cut either today or, if not today, before the end of the year and then a relatively stable rate environment in 2020, with the 10-year Treasury hovering around 1.75% in our expectations. In this context, our net interest margin will be expected to drift down to the mid-3.60s over the course of next year. We will, of course, update this guidance as appropriate.

And with that, we'll take any questions you may have.

Questions, operator?

(Operator Instructions) Our first question today will come from Steve Moss with B. Riley FBR.

This is actually Nick Duafala stepping in for Steve Moss. So in terms of your payoffs here on commercial loans, just wanted to get some color around what you're seeing and, in particular, on the C&I business.

Yes. We -- the payoffs were primarily on the commercial real estate. We did have some in C&I. Those were actually -- we exited 3 credits on the C&I side of the business totaling about $25 million. One, we just felt the leverage was a little high; and one was an old line retailer. And so a little bit of that was just credit control, but we're also seeing a little bit of strain on construction as well.

We do feel like the pipelines and the production in the first 3 quarters was pretty even, although looking on the surface, the growth was much better in the first 2 quarters. We are not stretching for credit, and we are beginning to see some more strain, particularly on certain types of deal with higher loan-to-value, perhaps some nonrecourse and some slimmer spreads.

Okay. I had another question on margin. Just clarity around the deposit impact going forward. You had a lot of noninterest deposit growth this quarter outside of the Santander acquisition. Could you talk a little bit more about what drove that and what you're seeing there?

Yes. Primarily commercial banking, and commercial banking more specifically in Ohio and really just good sales execution and asking for the business. Jane, do you want to expand on that at all?

Thank you. I think we've become much better at creating true commercial relationships, true corporate banking relationships rather than just buying the credit. And so lots of credit to the sales force.

Our next question today will come from Russell Gunther of D.A. Davidson.

I wanted to circle back to the loan growth discussion. I appreciate the comments on the dynamics in the quarter as well as your outlook for 2020 and hear you that consumer will take a bigger piece of that, a big driver. But curious if you could share growth dynamics from a geographic perspective.

Yes. I mean this will be a bit of a swag, but I think when we look back probably 2/3 to 3/4 of the growth, it's happening in our newer markets. I suspect that, that will continue. Interestingly, a lot of our deposit growth happens in our more traditional market. So it's really a nice balance, particularly in community Pennsylvania, which might surprise a lot of folks. And on the business side, again, there. So you might think of it as Pennsylvania seems to be funding a balance sheet that is growing in Ohio, but also as we've saw -- seen our Ohio franchise, particularly this past quarter, we're pretty good deposit gatherers.

And then switching gears on to the expense side of things, a bit of a ticky-tacky question for you guys. But the net occupancy number, around $4.5 million for the quarter. Could you give us the near-term guide in terms of how that will trend now with the Santander deal closed? Or is that fully reflected in third quarter results?

No. It's not fully reflected in third quarter results. Third quarter results would have only reflected by about 1 month. 10 of 24 days' worth of Santander occupancy expense. We'll get the full -- we'll have the full cost of the occupancy expense in the fourth quarter numbers. So we had given previous guidances on the total costs and revenue expectations for the Santander branches. And I think the total amount of expense will be about $2 million a quarter. And I think that the -- on top of that, you'd have intangible amortization costs of about $0.25 million a quarter.

Okay. Great. I appreciate the clarification there. And then just as you look out to 2020, I appreciate the thoughts that you shared. I would imagine the top line environment still remains a bit challenging. And so curious as to any efforts or thoughts around what you could do on the bottom line from an expense perspective to maybe offset some of the pressure there.

We're pretty good grinders, and we have lived with operating leverage in every budget. So to the extent that there's strain on the top line, we plan to actively look for opportunities. And we're working through our budget season here in the fourth quarter with that topic at the top of our list and how do we continue to create nice operating leverage, so we have -- I don't think our earnings per share growth has been below 10% adjusting for acquisitions for the last 5 or 6 years. So we're trying to just maintain that nice trajectory of earnings per share growth and expenses will be key.

Very good. And then last one, guys, bigger picture. Just curious to get your thoughts on M&A here. About $10 billion in assets, how you're thinking about that. And so your appetite from a depository perspective, but also have done a nice job with branch deals in the past and you think you might get an opportunity along those lines as well?

Well, our current trajectory of just organic growth and then the size of acquisitions we've been doing, we're still probably 3 years away. And we're thinking critically about that. We like the deals we've done. We've looked at 25 to 30 to do 5. So we're pretty picky. It has to work for us financially and strategically. We like rural depositories. We're pretty good at putting in commercial franchises in metro markets and enabling the growth there, but we just need to fund them with low-cost deposits. We have a nice mix of deposits and Jane and the team have really ginned up a good depository gathering kind of mechanism on the commercial side, which really helps us.

And our next question today will come from Steven Duong of RBC Capital Markets.

I apologize, I had -- what was the fourth quarter NIM guide? I think I missed it.

Mid-3.70s.

Mid-3.70s. Okay. Great. And do you expect that deposit cost peaked this quarter and should kind of grind its way down after today?

Yes. We do. I mean it's a little bit like slowing down our ship in the ocean. I mean they take some time to -- for the changes to take effect. So -- but we do expect it to trend down from here.

Got it. And can you remind us what your -- generally, what your deposit beta was the last cycle? And do you expect it to be something similar this cycle?

We -- I think our deposit beta on the way up was in the 20s and it probably would -- we would expect it to be similar. We were fairly successful at keeping deposit costs low through 9 rate hikes. So there isn't that much room for us to go down, but I think we're going to be pretty disciplined in terms of deposit pricing, and the recently acquired deposit acquisition has allowed us to pay off all our borrowings and move the loan-to-deposit ratio down to the low 90s. So it gives us a lot of room to execute on deposit pricing strategies.

That's great to hear. And then you guys had a pretty big gain on sale on the mortgages. Is this going to kind of rightsize itself in the fourth quarter?

We really had 2 terrific quarters in a row, and the pipeline remains strong. I don't know it will be as high as the second and third quarter, but we've built a really -- the team has built a really nice business there that's pretty broad-based across 4 metro markets now and a lot of rural geography, and we really have some good producers. So a good foundation there for us.

And the guidance I was giving on that front was really based on what we typically expect every season in the fourth quarter towards the holidays. There is always a -- there's a slowdown in mortgage originations.

Right, right. And then just last one for me. Your efficiency ratio guidance, that 55% mark basically looking at a fourth quarter run rate. Given where rates are coming in, do you guys still expect to hit that 55% mark in the fourth quarter?

Goal. That's a long-term goal. We've set it out there probably about 2 years ago. We're within sniffing distance of it, but indeed, we'll have some headwinds to that, I think short term, but longer term, I -- we want to get at 55% or less.

Got it. And congrats on a great quarter.

Thank you.

And our next question today will come from Collyn Gilbert of KBW.

Jim, maybe just following back up on the funding discussion and the opportunities that you have ahead of you as it relates to kind of mix shifting what you've acquired from Santander. Can you dig into that a little bit more as in terms of what your plans are kind of near term that you can do on the funding side?

Yes. I'll just give you like an anecdote or 2. Like for example, we have -- like everybody else, we had CD specials. We didn't really plan to offer a lot of those in the future because we don't really need to, and our deposit book is not particularly dependent on time deposit funding at this point to begin with. But just a quick story, we had a CD special that was coming due, and we decided to see what the rollover rate would be on that without offering any kind of special to retain those deposits. And we're pleasantly surprised that the retention rates are pretty high, which leads us to think that maybe the rate seeking that have been going on in the rate cycle as the rates were going up is slowing down a little bit and that takes a little pressure off on our deposit funding.

Another anecdote, we have seen some of the smaller banks that have really high loan-to-deposit ratios still pretty aggressive in their pricing, but we have so much liquidity we can afford on the margin to let some of the deposits to go. I hope that helps.

Yes. And Collyn, I also like what Jane and the regional presidents have done. They -- probably half the deposits we gather are commercial, on the noninterest-bearing side.

Okay. Okay. And do you -- can you remind me about your commercial -- or I'm sorry, your municipal deposit exposure? Do you guys have a big slug of that?

Yes. It's about 10% of total deposits.

Okay. Okay. All right. That's helpful. And then just still on the NIM discussion. I appreciate the loan growth outlook. Just within that, 2 questions. One is, are you -- I know it's hard to predict, but just given some of the behavior you've seen so far and what you're seeing in the market, are you anticipating paydowns to kind of stay at this elevated level? Number one. And then number two, we're just curious what some of the blended loan origination yields are that you're seeing in the pipeline and here in the book today.

I think we can lay our hands on the blended because we have a pricing meeting right after this one. Do you have those?

Yes. The blended new origination rates are coming in the mid-4s. So some of it -- it all depends on the mix of originations. So -- and this is some of the consumer categories where we've had some net positive growth in the third quarter, some of the origination rates and those are really holding up pretty well. So that always goes into the mix, but that's what we're seeing right now.

Yes. I do expect that we'll have a little strain short term on heightened payoffs. But we have a nice pipeline here as we approach the fourth quarter and a little downdraft in the third. We just feel good about the guidance we've given, and we've -- first 2 quarters, we were on the higher end of that guidance, but I think, we'll settle in mid-single digits for the year. And I also like the fact that it's more equally yoked between commercial and consumer and at the same time, we're not stretching on credit because we don't have to. And so it just feels good.

Okay. Okay. That's helpful. Along those lines, just in terms of the resi growth, the resi mortgage increased this quarter. Maybe that was partly due to Santander, I'm not sure. But just curious, I presume your -- the appetite is still to sell a lot of the resi production or just curious as to how you're thinking about the resi book as we go forward.

Yes. This past quarter, we sold about over 60% and kept about 35% to 40%. And that's a little less than we portfolio probably over the last year.

Yes. We had just long-term kind of guidance or maybe more near-term kind of guidance I suppose. We do like retaining some of that mortgage production now because it gives us a little bit of needed duration of the loan portfolio. So a 50-50 split of sold to portfolio is probably right for us about right now, keeps the fee engine growing for the gain on sale income, but also give us that duration of the portfolio.

You mentioned the acquired loans from Santander. Some of those are a wonderful -- in fact, a wonderful family, but out of the $100 million that we acquired, about $60 million was home equity lines of credit and just under $10 million was one of our family mortgage. That might help us to look at the numbers.

Yes, that's helpful. Okay. Great. And then just to clarify on the FDIC expense. Do you anticipate a similar credit in the fourth quarter and then normalizing in the first quarter of next year, or how should we think about that trending?

We do expect to use a quarter's worth of credit, so the FDIC expense for us, as you can notice from our income statement, is about $0.5 million a quarter. And so we expect to offset that almost entirely in the fourth quarter. As of today, there is about $1.3 million to $1.4 million left. So we used $0.5 million in the fourth quarter and the remainder of that in the first and part of the second quarter of next year.

Okay. Okay. That's helpful. And then just -- it looked like there was a little bit of a bump up in criticized loans during the quarter. Was there anything, in particular, driving that?

No. I think it was modest. The -- I can't -- well, I'll lay my hands on it in a second here.

Brian's on.

Brian, do you want to speak to that?

Sure, Mike. Yes. We had 2 credits that we moved to OAEM, we watch them closely and we continue to manage and monitor our portfolio. Our numbers are very reasonable relative to our peers.

Yes, yes. Okay, okay. And then just finally, Jim, on tax rate. Any update for what -- I think like 19% maybe is what you had guided to before. Is that still the right tax rate?

Yes. The exact number for it, if it helps you, 19.54%.

And our next question today will come from Scott Beury of Boenning and Scattergood.

Most of my questions have been answered, but just 2. First, could you provide what the purchase versus refi breakdown was for your residential mortgage production?

It was -- Jane?

Today, we are about 80-20 purchase to refi. What's terrific about our mortgage business is that because it was de novo in 2014 there's very little in the book to be refinanced. So it's all new stuff. The second strategic advantage is there is a really nice construction loan program. So when we book a loan, we're still going to have additional fundings that occur throughout the life of the loan because of construction perm. So it's going to be a nice business for us, and I think that construction business will help smooth out any seasonal bumps that you might see in a typical traditional seasoned mortgage portfolio.

Excellent. No, that's very helpful color. And then kind of lastly, I was just wondering if you could give any thoughts on kind of what the dynamics you've seen since the closing of the Santander deal. Has there been any material attrition of the deposit accounts or any other developments that would be important to note there?

It's been very positive. I think we acquired and disclosed $471 million of deposits, and we have $477 million as of yesterday. So we've actually grown them through the acquisition. We like the action we're seeing already on the commercial side and with our commercial calling efforts, both on the loan and the deposit side. So it's very positive. We haven't lost -- there's a lot of talented branch managers up there, which are very important to us, and we've been able to secure a lot of the talent, and we are really well led with a good market leader up there that came from Santander.

Excellent. No, that's very helpful. Well, I appreciate the color, guys, and congratulations on a good quarter.

Thank you.

(Operator Instructions) Our next question today will come from Frank Schiraldi with Sandler O'Neill.

I just wanted to -- just to follow up on the margin. You probably saw since we've been on the phone here, the Fed has cut rates again today. And did you say that you had one more rate cut baked in over the next 12 months?

Yes, we did. So in our internal planning we had one that was going to happen before the end of the year. So that's today. But in our forward planning, there is no more after that. So our plan -- and it is the hope, this could change, and we will update guidance as appropriate, but for now, we think there is stability in the fed funds rate and like I was saying in my prepared remarks that we think the 10-year will be around 1.75% and that context is really important as you think about our NIM guidance going forward.

Okay. So I guess it's just in terms of getting down, maybe I think you said to the mid-3.60s by the end of 2020 that, I guess, would be driven by the shape of the yield curve and...

Correct. Yes. And really driven by replacement yields -- loan replacement yields, not by expectations of further rate cuts.

Okay. And then just the best -- what do you think the best way to model if you were to put another rate cut or assume another rate cut? Is it basically a step function down? You mentioned 4 basis points, so -- in another rate cut. Is that a pretty reasonable assumption for further contraction to NIM?

Yes. I think that's a pretty reasonable guide. In any given quarter, it depends. Like today, it depends when the Fed does it in the quarter. So as they do at the beginning of the quarter, you start getting effect for most of the quarter, and then there is some follow-on effects in subsequent quarters. But a lot of the replacement yield story is driven by, as you said, by the shape of the yield curve, after that. So obviously, the action happened -- the Fed's action happened, while we are on the call today. So I haven't seen what they announced with it, but so much depends not just on the actual cut on the forward guidance they give, but because if there's an expectation of future rate cuts, as we all know, LIBOR starts responding to that. And then so our LIBOR index loans will start responding based on expectations of future rate cuts and not just the current cut in the current quarter, so that all goes into the mix.

Okay. And then just one follow-up on efficiency ratio. You mentioned -- and you've talked about in the past, your goal of 55%. Just as we look at 2020 and given some margin compression at least seems to be in store, given your guidance, do you think it would -- do you expect it to be a challenge to move the efficiency ratio lower in 2020, get operating leverage in 2020? Or do you think there is enough flexibility elsewhere on the expense line that is going to continue to be a goal year-over-year here?

We are in our second of probably 3 budget runs this year as we plan 2020 and beyond. And I have a better answer for you in 30 or 60 days, but we're going to maintain operating leverage and continue to improve the company. The other thing is we have the nice broad base of fee businesses and a broader base of now consumer businesses, and so we feel good about that. That's a little bit more expensive. Those -- some of those fee businesses have higher efficiency ratios but we also have a good portion of our business now becoming more noninterest income, which I think, longer term is important.

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I would like to turn the conference back over to Mike Price, President and CEO, for any closing remarks.

I always say this, but we're just grateful for your coverage and your interest in our company. It's meaningful and it makes us better. And we thank you for your input from time to time, and the good folks that you introduce us to. Thank you so much.

The conference has now concluded. We thank you for attending today's presentation. And you may now disconnect your lines.