First Commonwealth Financial Corp (FCF) 2019 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to the First Commonwealth Financial Corporation Fourth Quarter 2019 Earnings Conference Call.

(Operator Instructions) Please also note today's event is being recorded.

And at this time, I'd like to turn the conference call over to Mr. Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Jamie.

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 will -- have also included a slide presentation in our Investor Relations page with supplemental financial information, which 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 call for your questions. For that portion of the call, we will be joined by Jane Grebenc, Chief Revenue Officer and President of First Commonwealth Bank; and Brian Karrip, our Chief Credit 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 generally accepted accounting principles. 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.

Thanks, Ryan.

Jim Reske, our CFO, will provide some detail around fourth quarter earnings in a moment, but first, I'd like to reflect on our progress in 2019 as a company.

2019 marked the seventh straight year of growth in earnings per share since the current management team came together. We ended 2019 with core earnings per share of $1.10, which represents 16% compound annual growth from a 2012 starting point of $0.40 per share in core earnings. In 2019, we produced $108 million of core net income, a net interest margin of 3.75% and a core efficiency ratio of 56.9%.

The earnings capacity of First Commonwealth continues to grow. Adjusted for securities gains in 2018, earnings per share grew by 6.8% in 2019, driven by year-over-year growth of $17.4 million in spread income and $4.7 million in fee income.

Our momentum as we enter 2020 is good, and I would highlight the following. Loan growth of 7% in 2019, or 6% without the acquired loans associated with the 14 branch acquisitions we got from Santander, and deposit growth of 13% helped stabilize the margin at 3.73% in the fourth quarter and continued to meaningfully and granularly grow our company. Corporate banking, mortgage and indirect lending led the way with loan growth. Total deposits grew to $6.7 billion, with an average cost of 56 basis points.

Our deposit base is comprised of 25% noninterest-bearing DDA accounts and another 21% in checking, NOW accounts at a relatively low cost of funds. So $3 billion or 46% of the deposit total is in transaction accounts, of which 56% are business accounts. The culture of deposit gathering is strong. As an aside, we required -- we acquired roughly $470 million in deposit balances in early September following the acquisition of the Central PA branches from Santander and, as of December 31, 2019, had grown those deposits by $22 million.

Despite the quarter-over-quarter uptick in our provision expense, our credit metrics continue to strengthen, as does the credit culture of our company. Several key credit indicators were at either -- were either at or near historic lows for our company: for example, net charge-offs of 18 basis points; nonperforming loans to loans at 52 basis points; and nonperforming assets to loans at 57 basis points, with criticized loans also at an historic low for our company. The sharp decrease in special mention loans at $48 million in the fourth quarter is particularly encouraging. Our ongoing focus on improving granularity, maintaining concentration discipline and increasing geographic diversity leaves the bank well positioned at this stage in the economic cycle.

Our noninterest income of $85.5 million also was an historic high for our company and now comprises roughly 25% of our total revenue. Interchange income and deposit fee income set internal records for our company in the fourth quarter. Excluding security gains, our average quarterly noninterest income was $21.4 million in 2019, up from $19.9 million per quarter in 2018 and an average of only $16 million per quarter in 2016. Moreover, our mortgage, wealth, corporate banking and SBA and insurance businesses have become a meaningful part of our noninterest income momentum. Additionally, our 5 acquisitions over the last 4 years have added precious new checking households.

Core efficiency of 56.9% in 2019 improved year-over-year despite the integration of the Santander branch acquisition and as the interest rate environment pressured margin. That being said, we're ever mindful of the importance of operating leverage not only in our forecasts and budgets but also in our actual quarterly results, and we pay close attention to that. In short, the bank has a broader base of fee businesses. And our 2 key businesses, retail and corporate banking, are getting better each year and now growing across geographies. These same businesses are led by a strong line of business leaders and coordinated through regional presidents who are focused on winning and fulfilling our mission in their respective communities. Our credit metrics and balance sheet are stronger even as we experienced a tougher external environment in 2019.

And with that, I will turn it over to Jim Reske for our fourth quarter detail and other insights.

Jim?

Thanks, Mike.

Fourth quarter core earnings per share came in at $0.27 per share. The return on -- the core return on average assets and the core efficiency ratio were 1.29% and 57.23%, respectively.

Major fourth quarter headwinds compared to the prior quarter included an additional $2.2 million in provision expense, bringing provision to $4.9 million; and an additional $2.1 million in noninterest expense, bringing noninterest expense to $53.3 million. Provision expense was impacted by strong loan growth, which added $1.2 million in provision expense compared to last quarter. Noninterest expense remained well controlled overall, though it was impacted by onetime professional fees, elevated hospitalization expense and a full quarter of expense associated with the acquired Santander branches. The largest portion of the professional fee expense was associated with consulting fees surrounding the renegotiation of a third-party contract that is expected to result in significant expense savings for the bank. FDIC insurance expense was unchanged from last quarter because we used a $616,000 credit in the fourth quarter. We have $723,000 in credit remaining for 2020, which we expect to use up in the first half of the year.

Fourth quarter positives included a net interest margin of 3.73%, which when coupled with solid loan growth of 5.6% annualized produced growth in net interest income to $69.2 million despite a challenging interest rate environment. Additionally, noninterest income excluding securities gains recorded a quarterly all-time high of $22.5 million. A $1.3 million improvement in swap fee income more than offset a seasonal $900,000 decrease in mortgage fee income. Interchange income of $5.9 million and deposit service charges of $5.1 million both grew due to the 10% growth in our total customer base as a result of the successful completion of the acquisition of the Santander branches.

Our forward guidance remains essentially unchanged. We continue to expect mid-single-digit loan growth in 2019, with deposit growth lagging slightly behind as the newly acquired deposits allow us to maintain discipline in deposit pricing. The margin is expected to compress to the low 3.60s over the course of the year, consistent with our past guidance.

Our effective tax rate for the fourth quarter was 19.50%.

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

(Operator Instructions) Our first question today comes from Steve Moss from B. Riley FBR.

I wanted to start on expenses here. Just wondering how we think about the professional line item. Will that remain elevated for quarter 2 as the renegotiation of the contract goes on? And perhaps any color around potential cost saves you expect to see and total expenses overall for the upcoming year?

Sure. Yes, the professional fee line item probably should come down a little bit. But the overall -- I'll just give you more explicit guidance. The overall fee picture for next year will probably be fairly similar to the fourth quarter, hovering between $53 million and $54 million a quarter.

Okay. And in terms of the potential cost saves that you could realize, would that be a 2020 event? Or would that be a little further out?

The cost saves from the renew of each contract were already experienced and netted into fourth quarter results, but we -- the number I gave you reflects those expected cost saves.

Okay. Got you. And then in terms of the -- just on loan growth here, another good quarter. Just wondering any color around the pipeline and where you're seeing loan demand these days.

There are really 2 fronts. On the commercial side, commercial solutions are lower end of corporate banking. Private equity space is pretty active. We feel like we've weathered the storm of payoffs on the commercial real estate side. And at least for now in the first quarter, production is outpacing payoffs. And also, the real story in 2019 was the consumer side of the business. We had almost $1.2 billion of originations, with mortgage and indirect really leading the way there. And our branch production was up markedly as well.

Okay. That's helpful. And then just on the margin guidance here. As we think about the margin compressing down to the mid-3.60s, does that include any rate cuts? And any -- how should we think about funding costs versus loan yields?

Yes, sure. In our planning, we assume no rate cuts in 2020. We've assumed that the 10-year yield is right around 1.75% for the full year, but no rate cuts contemplated in our planning. If there are rate cuts, we would obviously update that guidance.

So pretty much the bulk of the margin compression, it's fair to assume, will be just earning asset yields coming down relative to funding costs, Jim.

That's exactly right. That's exactly right. We didn’t raise deposit costs very much through all the rate increases. There's some benefit we'll get from lowering deposit costs and obviously, with the influx of new deposits, that gives us some pricing power on that side. So those deposit costs should come down a little bit, but most of the compression is going to come from negative replacement yields on new loan originations compared to the rates on the loans that are running off.

Our next question comes from Russell Gunther from D.A. Davidson.

I want to just circle back to Steve's line of questioning on the loan growth side and particularly, Mike, given your comments that it looks like you've weathered the payoff storm. Can we infer from this that the 6% organic result that you guys put up for 2019 is achievable again in 2020, perhaps even with some upside bias to it?

Well, our guidance is mid-single digits. I would say that compared to years past, we have more oars in the water and some of the de-risking we did with larger, chunkier exposures is really behind us. And so -- and also, I will just say my commercial real estate guidance was with the purview of the pipeline in the first quarter. So we'll see how that unfolds over the next 3 quarters, but indeed, at least in the first quarter, it looks better. But I would say yes. But I think, like this year, we were very resilient. We had 3 decreases like everybody else. And we found a way to get to a number and still grow our earnings per share about 7%. And I think we have to be equally resilient this year if we get dealt some different cards or the structures get a lot more aggressive and we kind of choose to sit on the sidelines.

Okay. Got it. No, that makes sense. And then how about directionally from within the loan portfolio, be it mix or geography, what the bias is to the -- to production of the mid-single-digit result?

Yes, that's a great question. And I'll give you the same guidance I did last quarter. We probably have about 25% of our depository in Ohio, and that is producing an outsized portion of the growth. That being said, our markets in Pennsylvania are more mature. We have greater share. And we really feel quite good about how we're doing in the community of Pennsylvania and up where we've done acquisitions in Central Pennsylvania with Santander in State College, Williamsport and those small towns along I-80. So we can grow a little bit more there, but Ohio is indeed driving an outsized portion of the growth. The other thing is the regional presidents model for us, which is really about 2 or 3 years old. It's really coordinating cross-functionally and you're seeing that in the market show up on the noninterest income side, with better cross-selling and better fee income in wealth, insurance and those businesses. So lots of good synergy there. So we kind of feel like we're just hitting our stride.

That's good to hear. I appreciate the color, Mike. And then last one for me, guys, would be on capital deployment. Thoughts around putting the buyback to work here but as well as just general comments on the M&A landscape, your appetite would be very helpful.

Go ahead, Jim.

Sure. I'll start off on the buyback and turn it over to Mike for thoughts on M&A. The -- we had a $25 million buyback authorization last year. We had executed about $5 million of that. And then we [expended] the rest of the buyback authority in favor of deploying the capital on the branch acquisition. Now that the branch acquisition is behind us, we do expect to resume share repurchases and probably will execute the remaining $20 million over the course of -- hopefully, over the course of the first half of this year. It's a little bit price dependent. But hopefully, we'll execute that $20 million remaining buyback authority over the first half of 2020.

Yes. On the M&A side, we've seen a little bit more dust kicked up, and we're really looking at things in our footprint and contiguous to our footprint. But as you know, in the past, we've maintained a lot of discipline. As we've -- Jim and I have shared in the past, we've looked at 30-plus things to look to get to 5. And so I suspect that could continue. That being said, if there's a lot more that's a little larger, we would not shy away from that. We tend to fall $1 short on those kinds of deals, at least historically.

Our next question comes from Collyn Gilbert from KBW.

Just maybe if we could, Jim, just on the NIM. So I think, if I heard you correctly, you had guided to kind of a mid-3.60% -- I'm sorry, low 3.60% for 2020. And I think, before, if I had it right, in last quarter, it was kind of a high 3.60% NIM. Just curious to what the change in trajectory might be there. Is it more on the asset side? Is it on the funding side? Or am I slicing hairs that are not necessarily needing to be sliced?

No. No problem, Collyn. Actually, if you're sensing a change in the guidance, that's just because I haven't been clear enough. It really is supposed to be the same guidance. What I meant to say was we see low 3.60s by the end of next year. So drifting down over the course of the year slowly, mostly due to those negative replacement yields. So you could see, yes, ending the fourth quarter of next year in the low 3.60s. The average for the year will probably be mid-3.60s just because we're starting off now. That's what I meant to say.

Got it, okay. Okay, okay. That's helpful. And then just on the OpEx guide. So it seems as if you guys are trending -- you're going to be trending higher on the percentages but a fair bit higher in 2020 relative to what you've done in 2019. I know it's obviously the impact of the branches. But just is there anything else within that -- that's going to be -- that's kind of a driver in that higher OpEx? Especially, Mike, to your point on perhaps seeing some savings from some vendor renegotiations. Just trying to understand the dynamic on that.

We think that will continue. I think we have added a producer or 2, a high-end producer or 2, in our mortgage business, corporate banking business and elsewhere that has maybe created some of the strain. I think you're seeing that in the production that flows through on the loan side. But nevertheless, I mean, quarter-to-quarter, Collyn, we understand exactly where we're at with operating leverage; and that we need to grow the revenue of the company, net interest income and noninterest income faster than the expenses. And so we've ebbed and flowed there. Right now, we've -- the last 1.5 years, we've gotten in a little better stride on the revenue side and the growth side. And we feel good about that. But that's probably not as helpful as you want me to be. We're always renegotiating contracts. This one that Jim alluded to, we can't really share any details, but it's a big number. It's over 7 figures.

Yes, if I could add a little more color to some of that, Collyn. I think the big picture macro view is that we do see continued operating leverage in 2020. In other words, even with a declining margin, just due to increased volume, the growth in revenue should outstrip the growth in expense. And the growth in expense is mostly coming from the fact that we expanded our branch footprint and our customer base by about 10% with the branch acquisition. We've internally stripped out some of those numbers to say, to look at how much is our expense rate flowing -- expense base growing without the newly acquired branches, and it's less than 2% even with normal merit increases for our employees. So it's relatively -- that's why we're confident in saying it's well-controlled expenses. The one dynamic in expenses that we talk about from time to time that may be meaningful is hospitalization. Hospitalization expense is up significantly year-over-year. We have a plan where we self-insure essentially. And we have reinsurance when costs get to be too high. But the cost of that plan in 2019 was about $2.3 million more than it cost in 2018. So very significant. We think over time that will revert to the mean. That's because -- just due to some extraordinary experience in 2019. So we do think some of that expense will come down. But all of those dynamics are all baked into the kind of guidance I gave a moment ago.

Yes. After about 3 or 4 years with the same health care expense in the self-insured side, last year was an outlier, but you have to watch it closely. And we'll see if that becomes a trend. It could be -- it could end up being a tailwind this year. But right now, we still have operating leverage in our plan for this year, with it at a higher number. So we have some ways to beat plan.

Okay. That's really great color. And then Jim, did you -- have you given guidance or -- on CECL? Have -- can you offer any color on CECL?

Yes. No, we haven't given guidance in our earnings release or on this call. I mean the guidance we would give is of a more general nature. [Particularly], we -- our CECL planning is on track. We have put in place the proper governance structures. We've run parallel runs, and we have -- are actually in the process of having an external firm do a model validation for us. Because that process is not complete we're not prepared on the call today to give an exact number. We will, however, do so in a 10-K which we'll be publishing in a few weeks.

(Operator Instructions) Our next question comes from Steven Duong from RBC Capital Markets.

So I just want to make sure I heard the NIM guidance right. So the low 3.60s, that was by the end of this year, not next year. Is that correct?

That guidance was for the end -- by the end of calendar year 2020.

Got it. Okay. Great. And your noninterest-bearing DDA growth, where did it come from this quarter? And what can we expect? Is that just a seasonal thing? And what can we expect going out to 2020? And where would you expect that to come from?

Yes, it's really coming a lot of efforts across the board with small business calling. We have to do a lot with direct mail both in the consumer and the small business side and just the culture -- and our President, Jane Grebenc, I think, is on the line. This good culture around deposit gathering and really getting our commercial team and treasury management team focused on deposit growth. And it was just a good quarter. There really wasn't anything in particular but just the culmination. Even some -- this is silly, but I mean really getting escrow balances for mortgage clients. I mean that's pretty tactical and granular, but that's -- Jane, do you want to comment on this? I think you're on the phone.

Thank you, Mike. I would agree with everything that you said. And I would add that we also had a nice tailwind in Q4 because that was the first full quarter of the Santander balances. And that was a home run for us. Nice, nice depository. And by the way, we grew the Santander deposits in, I think, 14 out of 14 offices. So we're really bullish on it. Thanks.

That's great, guys. So that looks really good. And then just getting back to the loan growth. You guys had a solid consumer -- solid growth on the consumer side this past year. Now if rates don't get any lower, they stay the same, are you still looking for similar growth prospects, especially in the indirect and the mortgage side, or maybe a little lighter?

For now, the demand seems to be there. One tailwind we had in the fourth quarter is we portfolio-ed a few more mortgages than the third quarter. So our gain on sale went down in the noninterest income side. That's probably one difference, maybe 10% more portfolio, Jim, but it was just good production across the board and really up year-over-year in retail and commercial.

And with that, what's your typical amount that you portfolio going through the year?

It's been running more like 35% to 40%. And then this past quarter, it was a little over 50%. Does that sound right?

That's right. That's right.

Okay.

Got it. Okay. And let me see if there's anything else here. And then just the 2 commercial credits, could you just give some color on that?

Yes. We have Brian Karrip, our Chief Credit Officer, here. Brian?

Yes. In previous earnings call, we announced some nonperforming loans, and we successfully resolved those 2 credits in the fourth quarter. And there was some charge-offs associated with the resolution. That came in around $500,000.

(Operator Instructions) Our next question comes from Frank Schiraldi from Piper Sandler.

Just thinking about -- it sounded like from your commentary, Mike, that positive operating leverage is important in 2020. And I just want to -- so you guys -- it sounds like you anticipate delivering positive operating leverage. And then to me then, given your comments around margin and loan growth and expense, it seems to me that fee income growth is going to have to be quite or would need to be quite strong in 2020, high single digits or so. So just is that doable? And just back on the positive operating leverage, is that important to deliver for 2020?

As Jim alluded to, that's in our plan. And I think the -- as we think about our plan, similar trajectory, 6% or so noninterest income growth as part of that positive operating leverage.

Okay. And then -- sorry.

No, I was only going to add. I think that, given the recent track record and the kind of traction we're getting in fee income growth recently, that seems really doable for us.

Okay. And then just back to M&A, just one last one on how we're thinking about your interest level in something along the lines of an MOE. I mean we've seen a number take place in different markets across the country. Wondering just your thoughts there, the potential in your markets and if it's something that you guys would have interest if the -- over the next, call it, 12, 24 months?

Yes. I mean we -- in front of our Board, every July, we have -- we talk about what we could sell the bank for, MOE possibilities and who are potential acquirers. And we think about how we return -- create above-average returns for shareholders. And if you're putting 2 companies together and you're taking out $75 million to $100 million of cost, times P/E, that's meaningful to shareholders. And so I think, not just at this time but at any time, all things have to be kind of on the table. And that just -- it keeps you honest on your organic growth and continuing to produce, particularly in light of interest rate headwinds and flat long ends of the yield curve. And we have to move our feet. We all do.

And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the floor back over to management for any closing remarks.

Yes, there were a lot of good questions about the NIM. And the one thing I would just give kudos to my finance team is it's like a 9-inning baseball game. Every inning, every month, every quarter, Jim and the deposit team, which includes Jane Grebenc, Norm Montgomery, they tell us what replacement yields are. We get a scorecard on what's happening with margin every single month. And Jim's looking at it right now. So there is discipline and focus on where we're at and where we're going and what pressures are arising. And Jim, just what did it look like the last month or 2? I'm just...

Yes. Actually, it was -- negative replacement yields were only 9 basis points in the last quarter. So it's actually a little bit less than we had internally expected, [which there's little] -- makes us hopeful for next year that we -- it's something we need to say on top of.

Yes. So I just want you to know, I mean, we're holding the reins. We're -- we understand what's happening. And the margin is key. And as Steve, as you -- and Frank, as you took us through the guidance with operating leverage, it has to be a tough budget. It has to be one that we're [stretching] to grow. And indeed, we've hit those kinds of budgets now 6, 7 years in a row, and we expect to do it again.

Thank you for interest -- your interest in our company. We appreciate it.

Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for joining today's presentation. You may now disconnect your lines.