First Bank (FRBA) Q3 2019 Earnings Report, Transcript and Summary

Good morning, and welcome to the First Bank Third Quarter 2019 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.

Thank you. I'd like to welcome everyone to today's third quarter earnings conference call. I'm joined by Steve Carman, our Chief Financial Officer; and Emilio Cooper, our Chief Deposits Officer. Before we begin, Steve, will you please read the safe harbor statement?

The following discussion may contain forward-looking statements concerning the financial condition, results of operation and business the first time. We caution that such statements are subject to a number of uncertainties and actual results could differ materially, and therefore, we 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, 2018, filed with the FDIC. Pat, back to you.

Thanks, Steve. I'd say the third quarter was a mixed quarter. We had some positive developments and some challenges. On a positive note, we had good organic loan and deposit growth. We saw good growth in our noninterest-bearing deposits. We did close our grand Bank merger at the end of the quarter, and we realized some benefits from cost-saving efforts that we've been implementing throughout the course of the year. So core expenses, excluding merger-related costs, were down in the quarter. We did receive a BBB sub debt rating from Kroll, which in and of itself, I think it's good to have, but also is a positive for us as we look ahead to May of 2020 when we have sub debt maturity and refinancing opportunity, and we believe that BBB rating from Kroll will certainly help with that process. We did have our tangible book value increase during the quarter despite some dilution from the Grand Bank deal, but we also had a positive there in that our ultimate dilution from the Grand Bank deal came in at about 2%, which was lower than our original estimate of 3%. As I mentioned, we had some challenges as well. Margin compression was somewhat greater than we anticipated, as the timing of our deposit repricing only started to get realized toward the end of the quarter and the potential benefit from that repricing did not really show up in the third quarter numbers. We also had an elevated provision to cover loan growth and higher charge-offs. The bulk of the charge-offs did come from acquired loans and we took a look back in our acquired loan recoveries from loans that we initially wrote down to 0, still outpace any charge-offs we've gotten from those acquired portfolios, but we'd obviously prefer to keep these acquired charge-offs to a minimum. So net debt, our core normalized EPS, excluding merger-related costs and using a more normalized provision came in at around $0.21 a share, which is a level pretty much in line with where we've been for the last several quarters when controlling for onetime unusual event. Our primary goal for 2020 will be a return to solid EPS growth more consistent with what we've seen and been able to produce over the last several years. We plan to accomplish this goal in a few ways. Certainly, our focus on core commercial deposit growth will continue, and we hope to have that core commercial growth fund future loan growth, both improving our mix and lowering our cost of funds. We will take a look at partially slowing down loan growth to give us an opportunity, at least in the short run, to more aggressively reprice our deposits. Obviously, if we have a little less stress on the funding mechanism from the loan side, we believe that will allow us to take adequate action on the deposit side to push down those deposit costs. And we will continue to look for noninterest expense savings. We're currently working hard to minimize any impact from any underutilized real estate and branches as well as reorganization efforts that are underway, both on the deposit and the lending sides of the house. I will be providing a brief lending update as Peter Cahill, our Chief Lending Officer, is not with us today. So I'll just hit on a few highlights there. We had net organic loan growth in the quarter of about $50 million, which is a similar level to what we experienced in Q2. Our loan pipeline is very active, and we're using that to our advantage to ensure we're selecting the very best opportunities. There was some important cleanup in Q3, which bumped up our level of charge-offs. I will say, for the 3 significant charges in the quarter, each of those charge-offs fully resolved any issues related to those loans. But certainly, with the heightened level of economic uncertainty, we continue to keep a close eye on the loan portfolio, especially within the C&I portfolio. From a departmental management perspective, we recently made some changes, which we believe should drive some efficiencies going forward. We've created a centralized investor real estate lending group. We will still continue to do some investor real estate lending within our market teams, but the bulk of the investor real estate going forward will be handled by designated teams we've created with leadership in both New Jersey and our [PA] markets. We also shifted some resources across markets, which is allowing us to get an opportunity of some cost saving benefits by not having to rehire to replace some recent departures. Our commercial lending RMs have also gotten much more focused on commercial deposits in addition to loans, and this is adding strength to the efforts underway by Emilio and his team, which he will discuss later. At this time, I'd like to turn it back to Steve.

Thanks, Pat. Net income for the 9 months ended September 30, 2019 were $10.0 million or $0.53 per diluted share compared to $13.5 million or $0.73 per diluted share for the same 2018 period. Net interest income for the comparable period was up $1.4 million or 3.4% to $42.2 million. Net income for the third quarter of 2019 was $2.9 million or $0.15 per diluted share compared to $5.4 million or $0.29 per diluted share for the third quarter of 2018. Net interest income was $14 million for Q3 2019, a decrease of about $582,000 or 4% compared to $14.6 million for the third quarter of 2018. On a linked-quarter basis, earnings for the third quarter of 2019 were $2.9 million or $0.15 per diluted share compared to net income of $2.8 million. For the second quarter of 15 -- second quarter were $0.15 per diluted share. Results for the 3-month comparative linked quarter reflected a modestly lower level of net interest income, due, in part, to a decline in net interest margin. Noninterest expenses were higher in the third quarter due primarily to higher merger-related costs. Absent these merger-related costs, noninterest expenses would have been $507,000 lower compared to the linked second quarter. The provision for loan losses for the third quarter reflects net charge-offs of $1.1 million inorganic loan growth for the quarter. Asset merger-related costs and gains on recovery of acquired loans, net income for the third quarter would have been about $3.5 million or $0.18 per share, diluted share. Throughout 2019, our focus has been on trying to mitigate margin compression in managing noninterest expense growth. The combination of the Federal Reserve lowering the federal fund rate twice during the quarter, and then ongoing inverted yield curve has resulted in loan pricing pressures. Our cash equivalent net interest margin for the third quarter of 2019 was 3.15% compared to 6.37% for the linked second quarter of 2019. The lower comparative margin was due primarily to lower yields on our floating rate loans and overnight cash balances, which resulted in a lower earning asset yield for the comparative quarter. In addition, a higher cost of interest-bearing deposits, primarily CDs, also contributed to the margin compression in the third quarter. So what are our thoughts regarding the margin in the near term? The ongoing inverted yield curve presents ongoing challenges, particularly related to loan pricing. From a deposit perspective, we have lower deposit rates as the Feds reduced the targeted Fed funds rate. Our current asset liability position is liability-sensitive. This is reflected in our CD portfolio of about $705 million, including Grand Bank CDs at the end of September. Approximately 83% of these CDs will be priced over the next 12 months. In the fourth quarter, 22% of the CD portfolio will reprice at a minimum of 30 to 40 basis points lower, based on our current CD rates being offered. We have made strides in growing demand deposits, an initiative of great importance to improving our margin and profitability as we move forward. Demand deposits growth as of September 30, not including Grand bank -- Grand Bank's numbers was $20.2 million. During 2019, we have emphasized and taken actions to manage the level of noninterest expense growth, excluding merger-related costs. Those actions include reduced occupancy and equipment expenses due to branch closures and the streamlining of certain personnel costs. We have also benefited from an FDIC assessment credit in the third quarter. Our efficiency ratio for the third quarter of 2019 moved below 60%, to 58.22% compared to 60.51% from the linked second quarter. While the current interest rate environment and yield curve remain a challenge, the actions we've taken to stabilize the net interest margin and controlling noninterest expense growth should benefit financial results going forward. We continue our emphasis and focus on growing our core deposit base. Emilio will now discuss our progress in growing core deposits. Emilio?

Thanks, Steve. My comments will focus on the organic growth of First Bank without the impact of Grand Bank included. Overall deposit results for Q3 were strong. Total average deposit balances were up by $56.9 million during the quarter versus Q2. We accelerated our disciplined focus and execution around generating and acquiring new noninterest-bearing relationships and built upon our momentum from the second quarter. We posted growth of nearly $11 million in NIB average balances. Our organic noninterest-bearing growth for the year is now up over 9%. We feel good about this growth when you consider this is happening during the year of a core system conversion. Nearly all of this growth has occurred post the first quarter and post the system conversion. We are excited about our opportunity to continue to increase these results as we strengthen the skills and abilities of our team to win this business in the marketplace. Our value proposition resonates well and our brand message and service delivery model of personal bankers, real relationships, provides unique advantage in an increasingly disruptive and shrinking competitive landscape. In Q3, we acquired 33 new relationships for over $8.7 million in average noninterest-bearing balances. We also saw growth in savings in CD balances during the quarter of $3.4 million and $52 million, respectively, as customers raced to lock in fixed rates, given the declining rate environment. The good news here is this growth allowed us to retire higher priced, more volatile funding sources that we leveraged in Q2 and positions us nicely to capitalize on falling rates as we retain and renew these CDs at reduced pricing upon maturity in 2020. This is a very positive theme, I'd like to highlight. As we look out on our maturing CDs over the next several months, you can expect to see us bring down our cost of funds with the majority of our CD portfolio slated to reprice at levels more than 30- to 40-basis points lower than their current rate. This is an added benefit and strong complement to our strategy focused on improving the mix. This will provide protection to the margin as rates fall and our variable loans reprice. As stated on prior calls, our primary focus remains on growing our noninterest-bearing deposits. We continue to move the needle in this regard and have many key initiatives underway to accomplish this goal. Some of the key initiatives underway include the following: our planned Q4 launch of a targeted marketing campaign focused on our business Express line of credit product, coupled with the core operating account; we've completed cash management training for lenders and branch managers; we started and have recurring in-market deposit [listed]; in Q4, we launched our online account opening so we are very pleased with the continued growth we see happening in the deposit business and based on the calendars and the pipeline we see for Q4, we're looking forward to seeing an increased pace of growth as we finish the year and ramp towards a much faster start to 2020 than we experienced in 2019. And we'll spend the fourth quarter welcoming our new customers from Grand Bank and ensuring they experience firsthand the value of a real relationship with a First Bank personal banker. That wraps my Q3 update. Back to you, Pat.

Thanks, Emilio. I appreciate that. And at this point, I'd like to turn it back to the operator.

[Operator Instructions] Our first question comes from Nick Cucharale with Sandler O'Neill and Partners.

So I wanted to start with expenses. I know you've been working on some cost initiatives in recent months. Can you update us on your progress and your expectation for savings from the Grand Bank deal?

Yes. Well, we certainly hit on the first part of that, which is folks that we didn't have slated to be retained at closing. So there were certainly, I'll call that a Phase I, that was completed. We also have a handful of folks that are being retained, basically, through the end of the year to help with the conversion, which we expect will take place in early December. So I think the people side of the equation as well as eliminating unnecessary contracts and other kind of general G&A expenses. Those things should basically be completed by the end of the year. So the bulk of those savings we should start to realize in the beginning half of 2020. We will also look at the branch footprint as we move forward. We don't have anything slated there yet, but certainly something we're taking a look at now that we have a few more branches within a pretty tight geographic radius here in Mercer County. So that may be a future opportunity. But so far, I think things are on track, Nick.

Okay, great. And then I appreciate your commentary on the margin and the moving factors. Do you anticipate some inflection in the NIM in the fourth quarter? Or do you see that kind of occurring in the -- in 2020 as the deposited [ street ] price?

Well, I would tell you, we certainly anticipate inflection from a funding cost standpoint. The trick, of course, is while we are liability-sensitive, to the extent that a portion of that sensitivity is in CDs. There's always a little bit of a timing delay. So the Fed moves and we got 20% of our assets that are floating rate that move immediately. And then we'll kind of play catch-up over the next several months to reprice liabilities and CDs to offset the impact of the rate move. So if we knew for certain that the Fed was done moving, then I would say, a margin inflection point would be nearby. As the Fed continues to move lower then, unfortunately, we'll have to chase for a little while until that stops, and then we can finally let the benefit of the repricing on the liability side take hold. So.

Fair enough. And then another strong quarter for organic loan growth. I heard you were remarking potentially slowing growth to protect the margin. Can you help us -- can you help quantify that impact? And more broadly, how are you thinking about that trade-off?

Yes. I mean, I think what we see as prudent in the near-term is to have an emphasis on growth being driven by the deposit side of the house, more so than lending. As you know, in the early stages of our development as a bank, we were in an all-out growth mode in terms of bringing in both loan and deposit customers. But it's easier to grow on the loan side than the deposit side, which led to situations where we had to backfill funding to bring in those good core loan customers. I think we're at a size now and we're at a position in the market based on interest rates and the economy that it makes sense to really focus on driving the core deposit growth, being willing to -- be a little bit more selective on the lending side, which gives us more flexibility to be disciplined on the deposit pricing side. So I can't tell you exactly what that means in terms of dollars because if we can exceed expectations on the core deposit funding side than we may be able to do a little bit more on the lending side as well. So my expectation is that the percentage loan growth will come down. I think we will continue to grow at a reasonable rate organically, but probably not. 2020, I wouldn't expect the same percentage loan growth that you've seen in years past.

Okay, great. And then I know there's been some fluidity with respect to the tax rate. But is this quarter's level a good rate going forward?

Yes. I mean, I think we're hopeful we can even slide it down a little bit. But I think, plus or minus, it's a decent number.

[Operator Instructions] As we have no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Patrick Ryan for any closing remarks.

I'm sorry, it does look like there may be another question that's come in?

Oh, yes. This question will come from Howard [ Henick ] with ScurlyDog Capital.

I'm not amiss in the release, but we had a large C&I loan that was -- we took some charges against and then, but we weren't sure how it would be resolved. And you said earlier that all reserves that are taken to satisfy basically, any kind of issues that we have going forward. Does that include that loan that we talked about in the prior quarter or no?

Well, to clarify, the charges that were taken in the quarter fully resolved the issues associated with those loans. The C&I loan that we mentioned in Q2 is still being worked through, but there were no charges taken in the third quarter related to that. We do have a specific reserve associated with that, which, at this time, we believe is adequate, but that's still a bit of a fluid situation.

So there's no further updates on this -- at this point in time?

No, it's something that we're still working through.

And what -- just remind us, what was the total amount of that loan? And how much is currently reserved? So how much of it is still theoretically at risk or could do better?

We didn't disclose the amount of the specific reserve associated with that credit relationship. But there were -- there was a line of credit and a term loan and a mortgage loan, which aggregated about $8.5 million.

And we're not saying how much of it we've already basically [indiscernible] [up against it].

No, we're not, because we're still working through the situation.

This will conclude our Q&A. I would like to turn the conference back over to Patrick Ryan for closing remarks.

Well, that concludes our comments for today. So we appreciate folks calling in, and look forward to providing an update at the end of the fourth quarter. Thank you very much.

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