FIRST BANK (Hamilton) (FRBA) 2018 Q3 法說會逐字稿

Good morning, and welcome to the First Bank Third Quarter 2018 Earnings Conference Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Patrick Ryan, President and CEO.

Please go ahead, sir.

Thank you.

I'd like to welcome everyone to today's First Bank Third Quarter 2018 Earnings Call.

I'm joined today by our Chief Financial Officer, Stephen Carman; and Chief Lending Officer, Peter Cahill.

Before we begin, however, Steve will read the Safe Harbor statement.

The following discussion may contain forward-looking statements concerning the financial condition, results of operations and business of First Bank.

We caution that such statements are subject to a number of uncertainties and actual results could differ materially, and therefore, you should not place undue reliance on any forward-looking statements we make.

We may not update any forward-looking statements we make today for future events or developments.

Information about risks and uncertainties are described under item 1A, Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the FDIC.

Pat, back to you.

Thanks, Steve.

So the third quarter of 2018 was a very good quarter, in fact, our best ever.

From a financial highlights standpoint, we had very good core operating results with loans and deposits both growing nicely during the quarter.

Year-to-date, our net organic loan growth, excluding the impact of the Delanco acquisition, is about $120 million.

That puts us just a little bit behind plan from an organic growth standpoint, but we believe we're well positioned to finish the year strong.

Deposit growth picked up nicely in the quarter.

Year-to-date, organic deposit growth is $110 million with a big chunk of that coming in the third quarter, about $65 million.

Growth in commercial deposits led the increase during the quarter.

The margin held up pretty well, but we did get a nice payoff from a problem loan that boosted the yield during the quarter.

Steve Carman will provide some additional detail on the impacts from that payoff later in the call.

We continue to show good operating leverage when comparing link quarters with net interest income up almost 7% compared to just over 3% growth in noninterest expense when you exclude the impact of merger-related costs in prior quarters.

Good growth, steady margins, strong operating leverage and some additional, what I'll call, good news events all led to very strong earnings of $5.4 million in the quarter, or $0.28 per share on an adjusted or "core" basis.

That's an improvement of $0.08 a share or 40% over the prior year.

In terms of strategic updates, the integration of BCB and Delanco are basically complete.

We expect to meet or slightly exceed our cost savings projections on both deals.

Our new branch in West Chester, PA, is doing well.

The lending team, as many of you know, has been in the market for a while and performing well.

And we're excited to have deposit gathering services to complement those lending efforts now.

Our Bensalem location is going to be consolidated into our Trevose office, which is just a couple of miles away at the end of October.

We should see some additional good cost savings and we hope or expect that we'll have minimal deposit runoff given the proximity of our Trevose location.

As some of you may have seen, we had an exciting announcement earlier in the month.

We hired a new Chief Deposit Officer, Emilio Cooper.

He's been there for a few weeks now, he's hit the ground running.

He already has some great ideas about initiatives to help drive continued deposit growth in 2019.

We recently finalized an in-depth project to review our IT core system contract.

We ended up going with the Fiserv Premier system.

The conversion is in the early stages and we expect to be completed in the spring of 2019.

The new system should provide improved operating performance and functionality, along with cost savings associated with being able to negotiate better terms this time around.

And finally, we saw a continued improvement in asset quality.

Not only did we get some payoffs and paydowns on some problem loans, but overall levels of delinquency and nonperformers continued to move in the right direction.

At this time, I'd like to turn it over to Steve Carman to discuss the financial results in more detail.

Thanks, Pat.

As Pat discussed earlier, we had a very strong third quarter.

While there are a few onetime-type items for the quarter reflected in our press release, we continued to experience the following: consistent core operating earnings growth led by consistent net interest income growth, a strong asset quality profile, effective management of noninterest expense growth reflected in our efficiency ratio of 53.02%.

Net income for the third quarter of 2018 was $5.4 million or $0.29 per diluted share compared to $2.5 million or $0.16 per diluted share for the third quarter of 2017.

Net interest income growth was $3.9 million or 36.6% higher for the comparable third quarters for 2018 and 2017.

Just a couple of brief comments regarding contributory factors for our strong third quarter results: payoff of a nonaccrual loan, which resulted in recouping about $448,000 in interest income; we did sell some residential loans related to the Delanco acquisition, which resulted in a gain of $136,200; we had gains on recovery of a legacy BCB and legacy Delanco loan totaling $258,000; we had a onetime loan fee of $117,100; and we had net gains on sale of OREO of about $53,000.

Net income for the 9 months ended September 31, 2018, was $13.5 million or $0.73 per diluted share compared to the $6.4 million or $0.47 per diluted share for the same period in 2017.

Net interest income growth was $13.4 million for the first 9 months of 2018 or 48.8% higher for the same period in 2017.

Last quarter, I discussed 2 items, one of which all banks are focused on, the net interest margin, and the other specifically related to New Jersey banks and the new tax legislation passed on July 1. Here's an update on these 2 important items beginning, first, with our net interest margin.

Our tax-equivalent net interest margin for the third quarter of 2018 was 3.60%, an increase of 2 basis points compared to 3.58% for the prior year quarter.

As mentioned earlier, the addition of $447,000 to interest income from the payoff of that nonaccrual loan contributed about 11 basis points to our margin in the third quarter.

Compared to the linked quarter of June 30, 2018, the margin was down 3 basis points.

If you take a look at the 9-month comparison, our tax-equivalent net interest margin was 3.62%, up 28 basis points from 3.34% for the 9 months ended September 30, 2017.

As we have discussed, there are several factors that affect our margin, which include the shape of the treasury yield curve, which is now relatively flat, affecting both loan and deposit pricing; the level of prepayment penalties, which are a normal part of our business; purchase accounting associated with our acquisitions; and further Federal Reserve rate increases, to name a few factors.

The challenge we continue to face from a margin perspective is the rising cost of interest-bearing liabilities, particularly deposits.

For example, the average rate paid on interest-bearing deposits for the 3 months ended September 30, 2018, was 1.34%, which was 27 basis points higher than the average rate paid of 1.07% for the same period in 2017.

With projected loan growth, our funding costs will continue to move higher in our very competitive deposit markets, particularly if the Federal Reserve continues to raise the federal funds rate.

While our tax-equivalent margin has been relatively stable, specifically when looking at our quarterly financial highlights, we are expecting a moderate decline in our net interest margin in the fourth quarter and into 2019, based on the expectation that the Fed will continue to raise rates.

The other item I discussed last quarter was our effective tax rate.

The beneficial impact to our 2018 earnings was contributed by a federal statutory income tax rate, which decreased from 35% to 21%, and also we did have some new tax legislation on July 1 from the state of New Jersey.

As a reminder, New Jersey imposed a tax surcharge on corporations of 2.5%.

Also, the new law reduced the dividends received deduction for certain dividend income retroactive to January 1, 2017.

Our effective tax rate for the 9 months ended September 30, 2018, was 19.28%.

Based on current state tax planning strategies and discussion with our tax experts, we are expecting our effective tax rate for 2018 to be approximately 20.5%.

So the tax surcharge in the reduction of the dividends received deduction for 2018 is expected to have only a minimal impact on us.

However, we do not expect that to be the case as we look at 2019.

New Jersey's adoption of combined tax filings for corporations that are part of an affiliated group are expected at this time to negate state tax strategies we have in place today.

We are currently estimating that the impact of the New Jersey tax legislation will put our effective tax rate in the range of 28% to 31%.

As we move towards the end of 2018 and look to 2019, we expect continued growth in core operating earnings led by commercial loan growth and a subsequent increase in net interest income.

Our recent expansion into West Chester and other new markets is expected to be beneficial in generating new business and to the bottom line.

Couple that with an expected strong asset quality profile, and we remain well positioned to increasing profitability and shareholder value moving forward.

To further discuss our results in lending is Peter Cahill, our Senior Lending Officer.

Peter?

Thanks, Steve.

As was mentioned earlier, loan growth in the third quarter was around $41 million, most of which was organic growth.

Loans for the 9 months were up $184 million, some of which includes loans acquired from the Delanco acquisition.

We were down a little bit from what we did organically in the first 2 quarters, but our pipeline is stronger than it's ever been.

One issue we continue to be faced with is loan prepayments.

In the third quarter, we experienced extraordinary loan repayments of around $32 million, a significant amount -- a little less, actually, than what we saw in the first 2 quarters.

As described in the earnings release, we did earn approximately $277,000 of prepayment penalties as a result of these payoffs in the third quarter.

We've really worked hard to negotiate prepayment penalties into loans where appropriate and we've been seeing results.

Thus far, in the first 9 months of the year, we've earned prepayment penalties of $814,000, which is 42% greater than total amount earned in 2017.

This certainly helps the bottom line in periods where we're experiencing large loan prepayments.

Organizationally, the lending team is in good shape.

All open relationship management positions in each of the teams were filled earlier in the year and RMs are staying active with their clients as well as prospects in their respective regions.

During the quarter, we did hire an experienced construction lender to manage construction lending here.

Though not large in comparison to total loans, construction lending has been slowly growing.

We've had no issues in the portfolio from a credit quality standpoint, thus we continue to grow.

We believe now is a good time to have someone oversee that specific concentration.

As Pat mentioned, we also announced during the third quarter the opening of a full service office in West Chester, Pennsylvania.

This is the home base for the 3-person commercial relationship management team we've had operating in that region for almost a year now.

In addition to their efforts, the West Chester office is also staffed by a branch manager and related staff whom we think will be very successful in finding deposit business as well as generating small business lending relationships.

Last quarter, I mentioned that we unveiled a new product to help us underwrite small business loans efficiently and help drive deposits associated with this kind of loan.

Business Express uses a credit scoring system, which is the same one the SBA uses for small lines of credit.

So far, 1 quarter in, the results have been very good and we're now working on a plan to offer it through the branches and get some even greater efficiencies using that network that we already have in place.

Regarding the makeup of the loan portfolio.

As I've mentioned in previous quarters, there's been no significant changes in the types of loans we're doing.

We continue to stress the need for a healthy mix of both C&I loans and investor real estate loans.

An important ratio of that by our regulators is the ratio of investor real estate loans to capital.

At quarter end, we were at 333%, right in line with the second quarter, better than the first quarter and exactly where we started the year.

I mentioned earlier a strong pipeline.

At 9/30, it was very strong, higher than it's ever been from the standpoint of dollar volume of loans and just a couple of loans less than the high point in number of loans that we experienced last year.

At quarter end, we were up 20% over the level at the end of second quarter.

As we discussed in previous quarters, pipeline levels do move around a bit and the strong level that we have as we head into the fourth quarter is due in part to a number of loans not closing in funding at the end of the third.

So based upon this, I think that despite having only a decent third quarter from the standpoint of loan growth, I think we'll finish strong with a very good quarter to end the year.

Lastly, I usually touch on asset quality.

We have discussed a number of times that it's asset quality that is our main focus on seeking business.

We haven't wavered from that.

Things at the end of the third quarter continue to be in very good shape.

As is pointed out in the earnings release, recoveries exceeded charge-offs again for the quarter.

Nonperforming loans as a percentage of total loans fell a few basis points compared to last quarter.

Other than that, things continue to be very good.

Delinquencies are few, in line with the previous quarters.

That's it for the third quarter report from lending.

I'll turn it back now to Pat Ryan.

Thank you, Peter.

At this point, I'd like to turn it back to the operator to open it up for any Q&A.

(Operator Instructions) And our first question will come from Nick Cucharale of Sandler O'Neill.

So first, I saw that cash balances were up significantly on an average and end-of-period basis.

Is the plan for some of that excess liquidity to roll off the balance sheet?

Yes.

I mean, some of it is timing related.

Certainly, as we grow, I think we're going to want to keep more cash on hand than we have in the past just to deal with the fluctuation.

But I think if you looked at the average for the quarter, probably we're up a little bit higher than where we would be going forward.

So I think the short answer is there's probably a little bit of a margin impact from some excess cash in the quarter, but I'm not sure if it was a large impact.

Okay.

And then, secondly, just to clarify on the future margin trajectory.

You're referring to further pressure from the 3.60 reported level or 3.49, which removes the payoffs?

Well, yes.

I mean, I think the question is, as I think about it, is where is it going from here.

So if you look at the 3.60%, you look at the 3.49%, I think the trends over the last, call it, 4 quarters when trying to control for some of the larger onetime events, you saw earning asset yields up plus or minus 12 or 13 basis points and funding costs are closer to 25.

What that looks like going forward, obviously the big question mark is what the Fed does and ultimately the shape of the yield curve.

But if we have another 12 months like the prior 12 months, then I think we could expect some similar slight compression quarter-over-quarter as we move forward.

Okay, great.

And then you mentioned a few initiatives affecting expenses, considering the branch consolidation and core system conversion plan for the spring.

Could you help us quantify the impact of those items, and more generally, how you're thinking about expenses as we head into 2019?

Well, answering the second question first.

I think generally, our goal is to continue to grow core revenue in excess of expense growth.

Given acquisitions and given the need to add staff incrementally as we grow, we do think expenses will continue to move higher.

We've tried to target revenue growth on an annualized basis in the, call it, 10% to 15% range and then expense growth maybe in the 5% to 10% range.

Those are pretty big windows, I understand, but it's a little hard to get more precise rolling forward just because some of the impact of the acquisitions as we realize the cost saves, but also make future investments.

Specifically, in the branch, our typical branch costs are in the plus or minus $500,000 range.

I think this branch might have been a little bit less expensive from a lease standpoint and personnel, but figure -- there should be at least $400,000 pretax and cost savings should come from that as we move forward once the lease expense rolls off.

And we're constantly looking at things on the expense side, too, Nick.

We understand we need to add staff from certain areas as we grow, but we also take a look at where we have resources, and as things change, we make adjustments where we need to, to make sure we keep expense growth under control.

Okay, great.

And then, Peter, just one for you.

When you look at the pipeline, has the geographic distribution changed very much?

Or is the growth pretty broad based?

No, it's very broad based, almost -- it's kind of amazing when you look at it.

It's all the teams are doing equally well.

I mean, there was a slow start in the Delanco -- not at the Delanco, the Doylestown team from the Bucks County Bank merger.

We had some turnover there that we talked about since last quarter.

But those positions have been filled, business is starting to get generated there and all the teams are contributing to the pipeline.

The next question comes from Bryce Rowe of Baird.

Just, I guess, a couple of questions here.

Pat, obviously you've hired the Chief Deposit Officer and noted it in the prepared remarks.

Just curious, what exactly will be Emilio's goals in terms of is it a deposit mix, deposit growth type numbers?

Just curious how you guys are thinking about that.

Yes.

Good question, Bryce.

I mean, we're kind of in the early stages of our kind of 3-year financial planning process with an obvious focus on 2019.

At this point, we haven't finalized the numbers.

But I think it's fair to say our organic loan growth goals over the last couple of years have been plus or minus $200 million, and certainly, our goal is to try to fund as much of that, if not more than that, with deposits than any other alternative funding sources.

So that gives you a rough idea of overall dollar growth.

And then the second part of your question will there be mix goals tied to that, the answer is absolutely yes.

When we look at mix, we look at it a couple of ways.

We look at it broken up by type of customer, so we'll have specific goals for commercial deposit growth, for consumer growth and municipal as well as the 3 main categories and then separately by type of product.

So we're going to have growth goals related to noninterest-bearing, related to transaction account growth.

And over time, our hope and intention is we'll drive our ratio of core higher, .and like I said, I think we're already looking at some good initiatives that should help us on that path moving forward.

Great, that's helpful.

Wanted to kind of shift gears, talk about the core system upgrade and obviously, that's a process that will be ongoing here for the next few quarters.

But how do you think about First Bank's capacity from an asset or balance sheet perspective?

What's the upgrade?

And does the upgrade put you in a better position to acquire?

I noticed the comment in the press release about you guys looking like an attractive candidate for other smaller banks that are looking to partner.

So just curious if you're seeing any influx of conversations or questions from some other smaller banks?

Yes, so a couple of things in there.

Related specifically to IT, I mean, we didn't really have a capacity issue per se.

We could continue to grow on our prior platform.

But I think the new system has some good functionality, specifically on the commercial side, both within commercial lending as well as commercial deposit gathering, which I think will make us a little more competitive or make the process a little smoother for our customers.

So we're hopeful that, that will be a positive.

But the other thing, when you just kind of look at the landscape, part of our research in researching vendors was figuring out which players had the greater market share and specifically within the universe of banks that we think could be short or long-term M&A opportunities and Fiserv's market share within our broad geography was significantly better, significantly more penetration.

And if I'd say, well, why does that matter?

And I think specifically, it matters for two.

One is the cost to convert is significantly better or less if you're converting Fiserv bank into Fiserv.

But also the customer and the user experience from the partner bank side, the amount of time to train that's required to get them up to speed if they already have familiarity with the system is a lot less.

So there's a few ways that kind of indirectly we think that could help from an M&A standpoint.

And then to try to address your question around M&A, I think this continues to be an active market.

I think there's a lot of folks that view us as being in the later innings of an economic growth cycle and I think there are many of them that are thinking about whether they want a type of deal with another recession, and if they don't, that could be fueling their desire to at least want to look around and see if there's good partnership opportunities out there on top of the fact that one of the key industry issues within community banking is as the prior generation of management has moved up, there isn't always a good succession plan in place.

So I think those issues together continue to create an active market for conversation.

Whether or not things will happen, especially with the recent downturn in bank stock prices will -- time will tell there.

But I think there's an appetite on the other side, so we'll see how it plays out.

Excellent.

And then maybe one last one for me.

On loan pricing, if I exclude the interest recovery and the prepayment fees in the quarter, I'm showing a relatively flat loan yield second quarter to third quarter.

Just kind of curious what you're seeing from a pricing perspective?

And if there's an opportunity to see some loan yield expansion, ex prepays over the next quarter or so with Fed moves.

Well, I'll start and I'll let Peter jump in.

But again, I think with the Fed move late in the quarter, so the 20%-plus of our balance sheet that reprices right away, we should absolutely see an impact from that in the fourth quarter, but not much of an impact in the third quarter.

As it relates to fixed-rate loan pricing, you started to see the longer end of the curve move a little bit in the last couple of months and that's certainly flowing through, right?

I mean, most banks end the price off of either FHLB or treasury with the spread.

And so with both of those benchmarks moving higher, I think that will translate into better loan pricing going forward.

But Peter, if you want to jump in and...

Yes.

I mean there's not too much to add to that.

As the benchmarks increase, I think there was some pressure from certainly from the borrower standpoint, but also from some competitors to keep rates low, which kind of compressed margins for us.

But as each week goes on, I think it's easier for us to get back to kind of the normal margins that we look back when we price the loan over the benchmarks.

So I'd like to believe that those spreads will improve as we move forward.

(Operator Instructions) And showing no additional questions, I would like to turn the conference back over to Patrick Ryan for any closing remarks.

Okay.

Well, I'd like to thank everybody for taking the time to listen in.

We appreciate your interest in First Bank, and we look forward to getting back to folks early in '19 with an update on the last quarter, but we're hopeful it'll be a good one.

So thanks, everybody.

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.