First Bank (FRBA) Q4 2018 Earnings Report, Transcript and Summary

Hello, and welcome to the First Bank Fourth Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to Mr. Patrick Ryan, President and CEO. Please go ahead, sir.

Thank you. I'd like to welcome everyone today to First Bank’s fourth quarter and full-year 2018 earnings call. I am joined today by our Chief Financial Officer, Stephen Carman; and our Chief Lending Officer, Peter Cahill. Before we begin, however, Steve will read our Safe Harbor statement.

The following discussions 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.

Thank you, Steve. I'll start off with some high level commentary then turn it back over to Steve and Peter for a little more detail. I think all in all, fourth quarter was an okay finish to the year. There was certainly some noise in the numbers, which we will talk a little bit about. We did come in a little bit below expectations for the quarter. Although looking back overall for the year, I think we did have a pretty decent 2018. Looking at the balance sheet, we didn't quite reach our organic loan growth goals for the year, although that was mostly a function of higher payoffs. Our new production was actually up quite significantly from last year. When we looked at our pipeline and looked back at our closed loans data, we had 347 new loans closed in 2018, which was up almost 20% from the 291 new loans that we closed in 2017. So significant growth in terms of new production on a unit basis. On a dollar basis, now these numbers are a little bit different than what you see on the balance sheet because these relate to expected fundings over time, rather than a point in time data as you see in the financial statements. But just to give you a sense, if you looked at the dollar volume of production, it was close to almost $500 million in terms of expected fundings over the life of the loans in 2018. And that compared to about $350 million in 2017 or an increase of almost 40%. So overall for the year, certainly a lot of great things happening on the new production side. We did see an uptick in terms of payoffs and paydowns. It's hard to tell whether that is a trend that will continue, but we will certainly be watching it closely heading into 2019. We did have solid net loan growth for the quarter of over $50 million. And once again, that was with some significant payoffs and paydowns in the quarter, which Peter will provide some additional detail on. Total deposit growth for the year was almost in line with loan growth, which is obviously what we are hoping for. We did have $20 million in non-interest-bearing deposit growth for the year. Most of that was commercial and then we had another $60-plus million in other commercial deposit growth for the year. So we’re pleased with the activity on the commercial side. One thing we didn't do during the course of the year was raise rates on our consumer transaction accounts. Part of that was strategic related to trying to manage the margin. Part of it related to some excess liquidity that came in through the Delanco acquisition. So we had some time to hold off on the consumer deposit accounts. So I do think over the course of the year that helped from a margin standpoint, although from an overall growth of consumer transaction accounts, we actually were flat to down slightly in that category as a result of holding the line on rates. Overall asset growth for the year was $259 million, which was an increase of 18%. Shifting over to the income statement, we continue to see good net interest income growth. We are up over 15%, almost 18% for fourth quarter of 2018 compared to the fourth quarter of 2017. I want to spend a little time talking about non-interest expense. They were clearly elevated in the fourth quarter. I think part of that was related to specific intentional investments we made in terms of new hires, primarily on the commercial deposit and overall deposit gathering initiatives, although part of it quite frankly was related to some timing effects that happened. If you look back at the third quarter, overall net interest expense for the quarter, we’re at $8.2 million, which was down fairly significantly from the second quarter, which was about $8.6 million. And part of what you saw in the fourth quarter was a bounce back where some of the decline in Q3 was related to timing of some open positions and some folks that retired, moved on that we had positions to fill, which ended up leading to probably an artificially low expense number in Q3. And again, half of the positions that we filled in Q4 were new hires and new positions and about half of them were just filling positions and openings that we had in the third quarter. And so when you look over at the trend line on the expense side, we think a decent estimate for kind of the core run rate for fourth quarter and moving forward is something closer to $8.6 million to $8.7 million in kind of the operating quarterly expense space as we look out into 2019. I’ll talk a little bit about some strategic developments. We did have compliance exam and safety and soundness exams towards the end of the year. Both of those wrapped up and went well. So I'm pleased to say that the investments we've made on – making sure things are going well for compliance and safety and soundness standpoint are doing what we intended and the relationships there are good. If you take a look at some other things that happened in the fourth quarter, we did kind of finish what we needed to finish in terms of taking steps over in the PA market to extract the remaining cost savings from the Bucks County acquisition. We had some people that ended up leaving as well as, we announced the closure of one additional branch in Levittown. I will talk a little bit more about the one-time costs associated with the branch closure. But if you look at the steps that we took over PA in the fourth quarter, a lot of the savings didn't show up in the numbers in Q4. But based on steps taken, we think we will not only hit, but do little bit better than what we expected from a cost saving standpoint from the Bucks County acquisition. And we think the benefit to those actions taken in Q4 will show up in the first quarter and moving forward into 2019. Last point, I'd like to hit on strategically, as many of you know, we did hire a new Chief Deposits Officer, Emilio Cooper. Emilio has jumped in and hit the ground running and he has taken a number of steps, which I think are going to position us well for core deposit growth in 2019. Specifically, we've gone a step deeper throughout the organization in terms of setting not just regional and branch deposit goals, but now getting jobs specific in terms of our production and growth targets. We simplified our reporting structure. We've added to and enhanced the commercial deposits team and we've also taken a more integrated approach to our marketing efforts. So I think each of those initiatives will position us well for good core deposit growth in 2019. I want to talk a little bit about our plans for next year. We think plus or minus our organic asset growth goal will be about $250 million. We expect that asset growth to be primarily funded with new deposits. Our quarterly expense base, as I mentioned, we think heading into next year is probably about $8.6 million starting the year, growing to probably plus or minus $9 million by the fourth quarter of 2019. We think we'll see some continued, but modest NIM contraction throughout the year. We will continue to see cost saving opportunities to drive our efficiency ratio back down under 60%, hopefully getting closer to the mid-50s range. And we will continue to actively pursue M&A opportunities to not only enhance the core deposit franchise, but also drive operating efficiencies as we move forward. At this time, I'd like to turn it back over to Steve to give a little more detail on the financials.

Thanks, Pat. Throughout 2018, we have experienced consistent net interest income growth, a strong asset quality profile, and a lower annual effective tax rate. Result has been strong quarterly earnings and subsequent strong earnings performance for full-year 2018. Net income for the fourth quarter of 2018 was $4.1 million or $0.22 per diluted share compared to $583,000 or $0.03 per diluted share for the fourth quarter of 2017. During the fourth quarter of 2017, we recognized a one-time charge to income tax expense of approximately $2.6 million, or $0.15 per diluted share, as a result of the federal tax legislation that lowered corporate statutory income tax rates, requiring a revaluation of First Bank’s deferred tax assets. Net interest income growth was $1.9 million higher for the comparables fourth quarters for 2018 and 2017. Net income for 2018 was $17.6 million, or $0.95 per diluted share, compared to $7 million, or $0.48 per diluted share for the same period in 2017. Net interest income growth for 2018 was $15.3 million, or 38.5% higher for the same period in 2017. I would like to take a couple of minutes this morning to discuss our net interest margin. Efficiency ratio and our effective tax rate for 2018 and how we see that effective tax rate as we begin 2019. First, our net interest margin. Our tax equivalent net interest margin for the fourth quarter of 2018 was 3.44%, a decrease of 7 basis points compared to 3.51% for the prior year quarter. On a linked-quarter basis, our margin declined 16 basis points from 3.60% for the third quarter. The addition of $447,000 to interest income from the payoff of a non-accrual loan contributed about 11 basis points to our margin in the third quarter. Absent that item, our fourth quarter margin would have declined 5 basis points. As we've discussed before, there are several factors that affect our margin, some of which we are experiencing now. The shape of the treasury yield curve, for example, which is now basically flat, has affected loan pricing. Deposit pricing in a rising interest rate environment has been impacted by the competitive markets we are in as other banks look to track new deposits to fund earning asset growth as well. Other factors affecting the margin include the level of prepayment penalties, which are a normal part of our business; purchase accounting associated with our acquisitions and further Federal Reserve rate actions. The rising cost of interest-bearing liabilities, particularly deposits is reflected in the comparative margin results I just discussed. For example, the average rate paid on interest-baring deposits for the three months ended December 31, 2018 was 1.50%, 44 basis points higher than the average rate paid of 1.06% for the same period in 2017 and 16 basis points higher than the third quarter of 2018. The full-year results for our margin tell a different story. Our net interest margin for 2018 was 3.57%, an increase of 18 basis points from our 2017 margin of 3.39%. In 2018, the increase in the yield on earning assets outpaced the level of increase in interest-bearing liabilities. During 2018, we realized the benefit of floating-rate loans repricing higher as the Federal Reserve moved the federal funds rate higher, while effectively managing the level of increasing deposit costs. We understand there will be continued pressure on our margin as 2019 begins. First and foremost will be the pressure on deposit costs. We believe with the additions to our retail and commercial deposit teams in late 2018 will result in a generation of lower cost deposits and a manageable cost of funds as we move forward. A flat-to-inverted yield curve has increased loan pricing pressures as well. That said, we are projecting a moderate declines for our margin in 2019. Our efficiency ratio for the fourth quarter was 61.78%. Our comparatively higher efficiency ratio compared to the prior quarter was due primarily to a modestly declining net interest margin and higher non-interest expense. Higher salary-related expenses and a one-time depreciation costs related to the Levittown branch closure both contributed through a higher level of non-interest expense for the quarter. As stands to be a typical at year-end or other one-time type items expenses reflected in our fourth quarter results. Absent these one-time items, which totaled about $575,000, we estimate our efficiency ratio would have been about 58%. Our efficiency ratio for the full-year of 2018 was 56.1%, which compares to 55.3% in 2017. During 2019, we expect our efficiency ratio to return to levels we have experienced in the past. For the first quarter of 2019, we believe an efficiency ratio of 58% is a reasonable expectation. Lastly, our effective tax rate for 2018 benefited from the Federal Statutory income tax deduction from 35% to 21% in our state tax saving strategy. As a reminder, tax legislation passed in 2018 in New Jersey will result in combined tax filings for corporations that are part of an affiliated group, which may impact our state tax saving strategy. Our effective tax rate for 2018 was 18.70%, while we await further clarification from the State of New Jersey related to the new tax legislation passed last July. We believe at this time, our state tax planning strategies will continue to be beneficial for us. And we are projecting an annual effective tax rate of about 21% at this time as we enter 2019. If however certain tax strategies are curtailed, we estimate our effective tax rate for 2019 would be about 28%. Even with the challenges of the flat yield curve and the subsequent impact to our net interest margin, we believe we're well positioned as we entered the New Year to meet our financial objectives for 2019. The primary areas driving net interest income growth is lending. To further discuss our results in lending this past year is Peter Cahill, our Senior Lending Officer. Peter?

Thanks, Steve. As Pat mentioned earlier, loan growth in the fourth quarter was approximately $52 million compared to growth in the third quarter, which was $41 million. Loans for the year were up $236 million, some of course includes the $57 million in loans acquired from the Delanco Federal Savings Bank acquisition. Importantly, organic growth for the year was $178 million, a 15% growth rate from the end of 2017. While we finished the year strong with a solid fourth quarter as in some of our previous quarters we experienced significant loan prepayments. In the third quarter, our loan prepayments were relatively light at around $32 million, which was less than what we saw in the first two quarters. The fourth quarter, however, the loan growth I just described was after loan prepayments well in excess of $50 million. We’ve outlined in our earnings release a breakdown of the components loan portfolio in comparison of where we were at year end 2017, other than a noticeable uptick in residential and consumer lending from the Delanco acquisition. There were no dramatic changes. We’re pleased however, to see some growth in the Commercial and Industrial segment and a modest decline as a percentage of total loans in the Investor Real Estate segment as we try to keep the portfolio balance between those two areas. We continue to have a strong loan pipeline. Last quarter at September 30, after a slow loan growth quarter, the pipeline stood at $200 million, which was our high point for the year. This led to a good fourth quarter. At 12/31/2018 after a good month and quarter, the pipeline stood at $178 million. This level is well above the 12-month average for 2018, which was around $160 million. So as we head into 2019, I think we're in pretty good position to meet early loan growth plans. Regarding asset quality, we continue to hold the line and assist internally on conservative underwriting and structure as we seek new business, its asset quality more than pricing that becomes our main focus. We wrapped up the year in good shape as it's pointed out in the earnings release after two quarters of recoveries exceeding charge-offs, net charge-offs in the fourth quarter were only $7,000, which continued a very good trend. Non-performing loans as a percentage of total loans improved compared to last quarter and we are in line with where we were at the end of 2017. Delinquencies continued to be modest and are also in line with previous quarters. Jumping away from the numbers for a second and summarizing what we accomplished in 2018. First, obviously, we substantially met our loan growth goals and asset quality is good. We also unveiled near the end of the second quarter a new product to help us underwrite small business loans more efficiently and help drive small business deposits. Business Express uses a credit scoring system, which is the same one the SBA uses for small lines of credit. So far results have been very good and we are rolling out a plan this month to offer it to our retail network, which would create even greater efficiencies for us. We onboarded the staff in loan portfolio from the Delanco acquisition effective in the second quarter. And related to that, worked with Steve and his finance team to sell a portfolio of long-term residential mortgages freeing up some additional liquidity. Organizationally, lending team is fully staffed and functioning well. All open relationship management positions in the Doylestown team that occurred after the Bucks County Bank acquisition have been filled and RMs are out doing business. Construction loan manager overseeing construction lending for us has now been here for almost six months. He has acclimated in improving our process and procedures. We also announced during the third quarter, the opening of a full-service office in West Chester, Pennsylvania. That's the home base with a three-person commercial relationship team that we've had in that region for just over a year now. And lastly, the lending team has been working with our IT folks over the past three to six months to ensure that our upcoming core system conversion from Jack Henry to Fiserv goes smoothly. This conversion takes place in March. While it's not the most glamorous thing to talk about, it's time consuming for the team, but very important, obviously, it will make us a better lending team once it happens. I think that's it for my fourth quarter lending report and year-end summary. I'll turn it back now to Pat Ryan.

Thank you, Peter. Well, at this point, I'd like to open it up to any questions.

Yes. Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Nick Cucharale with Sandler O'Neill.

Hey guys. Good morning.

Good morning, Nick.

I just wanted to clarify on the expense base in the $575,000 of the one-time items. How much of that was due to the one-time depreciation increase related to the Levittown branch closure?

It was about $160,000, Nick.

$160,000. Okay, great. And then is it fair to say cost savings from the recent acquisitions are complete at this point?

Yes. Well, complete, I guess, it’s question of timing really. So the actions taken – the action necessary to achieve the savings are complete, and so we expect going forward, while some of last few things we did in terms of the branch closures and changes in staff really didn't show up in the Q4 numbers we will see the benefits of those starting in Q1 and going forward. Some of it relates to the timing of leases. So the Bensalem branch now is closed. The lease itself I think expires in the middle of the year, so we still have a little time left on that. So we’ve kind of gotten the people and the operating side of the savings and we'll get some of the lease savings as we move into the year. The Levittown lease does expire at the end of March, I believe. So the benefits there will accrue to us starting in the second quarter. But everything we need to do to make sure the savings would be realized has been done, and just a question of timing at this point.

Okay, great. And then I've heard your organic asset growth target of $250 million for 2019. How much of that target is attributable to loan growth?

Most of it, I'd say. We're targeting deposit and loan growth pretty close to that. Our hope is that, we will be generating deposits to fund loans and that won't end up being a lot of activity outside of deposits and loans from a balance sheet growth standpoint, although obviously timing matters. So within any given quarter, there maybe a need for some borrowings or other things as we're trying to match up the deposit and the loan growth. But overall, we don't budget a lot of kind of miscellaneous liability or asset growth outside of those two categories.

Okay, great. And then lastly, I just wanted to ask a quick question about the pipeline. Is it pretty consistent quarter-over-quarter? Or is it more skewed towards C&I after a very nice year for that in 2018?

It's fairly consistent. The point I tried to make was at the end of September, which was a relatively slow quarter, the pipeline, as you might imagine, was up. Loans didn't get closed and funded. But that helped us as we headed into the fourth quarter. But even so, after a good fourth quarter, our pipeline is still well above the average, where we were throughout 2018. So we're optimistic as we head into this year that we're going to hit – start hitting our numbers right off the bat.

Yes. I think it’s important. So Nick, as well, obviously, we're trying to have a balanced portfolio and even see a moderate increase in owner-occupied and C&I, but I think we're talking about percentage point changes, not [sea] [ph] changes. So if we're at 13% C&I, we'd like to get it up to 14%, 15% over time, but it's not going to get to 25% overnight so.

That's great. Thanks for taking my questions.

Thank you.

Thank you. And the next question comes from Joe Gladue with Merion Capital Group.

Good morning.

Good morning, Joe.

Pardon me, if you've covered this. I was interrupted briefly. But just curious about that, you deployed a lot of the excess liquidity by the end of the quarter, but it looks like that was still in the averages. Just curious when that came out and what impact we might see on average asset yields because of that?

Yes. It's a good question, Joe. I mean we did have some, as is typical for whatever reason, a lot of people really like to get their loans closed before the end of the year, whether that's a psychological or a practical goal. And so inevitably you tend to see a lot of loans closing towards the end of December, which obviously then it doesn't show up much and shows up in the year-end numbers as far as liquidity being down by year-end. We probably did have a little bit of extra during the quarter. Although quite honestly, with the Fed moving short-term rates, money sitting in cash doesn't hurt quite as much as it used to in terms of the margin impact. So we're not really expecting a boost, if you will in Q1 on the margin related to the deployment of the excess liquidity. If we get a little bit of a benefit, that's great, but it's not something we'll count on having a huge impact for us.

Okay. Thank you.

Thank you. And as there are no more questions at the present time, I would like to return the floor to Patrick Ryan for any closing comments.

Okay. Well, I'd like to thank everybody for taking the time to listen in this morning. We appreciate your interest in First Bank and we look forward to catching up with folks at the end of the first quarter. Thank you.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.