First Bank (FRBA) Q4 2019 Earnings Report, Transcript and Summary

Good day and welcome to the First Bank Fourth Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Patrick Ryan, President and CEO. Mr' Ryan, the floor is your sir.

Thank you. I'd like to welcome everyone to First Bank's Fourth Quarter 2019 Earnings Call. I'm joined today by our Chief Financial Officer, Steve Carman; and our Chief Lending Officer, Peter Cahill; and our Chief Deposit Officer, Emilio Cooper. But before we begin, however, Steve, please read the Safe Habor statement.

The following discussion may contain forward-looking statements concerning the financial condition, results of operations and business of the 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, 2018, filed with the FDIC. Pat, back to you.

Thank you, Steve. I'd like to start at high-level comments before turning over to the team to provide a little more detail. I think overall from a strategic perspective, it was a strong finish in Q4 to a challenging year. I think in the fourth quarter we produced some very good results, even despite a one-time non-recurring expense related to the valuation of our New Jersey deferred tax asset. Our primary goals for the quarter were to lower our deposit costs, improve our net interest margin and successfully integrate the Grand Bank team. I think we deliver on all fronts. The cost of interest bearing deposits declined 14 basis points from 1.82% to 1.68% on a linked quarter basis. Our net interest margin correspondingly increased 19 basis points quarter-to-quarter from 3.15% in Q3 to 3.34% in Q4, and our systems integration of Grand Bank occurred on December 9th, the things went very well and we are excited about having the Grand Bank folks as part of the first First Bank team. Furthermore, we had very good quarter related to our ancillary income sources in the fourth quarter. I'll highlight a couple. A prepayment total income was $361,000 in the quarter, which is a fair bit above our quarterly average for the year of $216,000 in prepayment income per quarter. We also saw a significant uptick in our loan swap fees income in the quarter. We've realized income of $349,000, which is up significantly from earlier quarters. We had gains on sales at SBA loans which are part of our normal business, but also can be a little bit lumpy from quarter-to-quarter. We had a 170,000 in income during the fourth quarter and now as a nice rebound about a couple of quite quarters in Q2 and Q3. We also realized some gains on recovery of acquired loans of $190,000 in the quarter, but that's roughly in line with what we've been generating an average over the past few quarters. Because of changes in the tax rules in New Jersey, we had to bring down the value of our New Jersey deferred tax asset by approximately $730,000 during the quarter, that was a dollar for dollar reduction to net income. Fortunately, we believe the impacts from the changes in the New Jersey tax law are behind us and we continue to believe that the appropriate effective tax rate going forward is between 24% and 25%. Given some of the movements on the ancillary income side, a little difficult to pay a normalized profit run rate going forward, but certainly we feel very good about the trends in our core business. As we look at our cost of funds moving forward, we think there is continued opportunity to move our funding costs lower, both through improving our mix, reducing the cost of our CDs. And we also have an opportunity for some significant savings based on our subordinated debt, which is hitting at 5-year anniversary in late April and we believe that there will be opportunity to refinance that debt at better rates in the near future. We will have, we believe, some continued downward pressure on yields, so we're hopeful that our savings on the funding side will offset any yield pressure and that we can see a stable net interest margin going forward. We believe we're in a good position from an expanse management standpoint. We believe we continue to keep a tight lid on expenses going forward and while we believe that ancillary income resources will move around from quarter-to-quarter, we believe the trend there are all positive. The expense numbers in Q4 also required a little bit of explanation. Certainly, it was a very good quarter from an expense standpoint and we feel good about the underlying trends. That said, Q4 numbers were artificially low because of lower FDIC assessments and some adjustments to accruals we made around incentive comp and marketing. We believe that on a go forward run rate basis, our quarterly non-interest expense run rate is probably closer to $9.7 million. On the credit quality front, we did have a movement higher in our NPA ratios which we certainly were not happy to see; although, we also had a some very good news in the form of executed sales contract on our primary collateral related to our largest C&I non-performer and we believe that loan should be paid-off and gone during the first quarter of this year. Regarding the overall balance sheet, in the fourth quarter, we did see some declines in loan and deposits. Some of this was a timing issue, but some of that also related to strategic choices we made. The level of pay-downs obviously to some degree, were outside of our control, but we did in certain instances choose not to match lower rates or churns by competition and rather taking the prepayment penalty income. We were also very focused on lowering our deposit costs and we did not want to put undue stress on our funding sources, as we are focused on driving cost lower. Thankfully, it turns out the retention rates we had as we are re-priced CDs and other deposits during the quarter were very good, and Emilio will get into a little later more detail on that later. Looking first quarter to 2020; again, I feel good about the core operating trends. Our deposit costs are coming down and our non-interest bearing pipeline looks very good. Our loan yields will continue to triple down, but I believe at a manageable pace. Expense management plans are working and healthy but moderated growth goals will allow for continued expense management going forward. We're hopeful and expecting the credit trends will show an improvement during the upcoming year and our tax rate will stabilize at a much lower level than what we realized in 2019. In summary, we are pleased with the positive progress we've made in Q4 and we are cautiously optimistic about the prospects for 2020. At this time, I'd like Steve to discuss some additional details regarding our fourth quarter and full year performance.

Thanks Pat. Net income for 2019 was $15.2 million or $0.79 per diluted share, compared to $17.6 million or $0.95 per diluted share for 2018. Net interest income growth was 6.2% and an increase in non-interest income was offset by higher non-interest expenses and tax expense. As Pat mentioned, we finished 2019 on a strong note with net income for the fourth quarter of $5.2 million or $0.25 per diluted share. Included in our quarterly results was a revaluation of First Bank's deferred tax asset, a one-time charge, based on the clarification in December 2019 from the State of New Jersey regarding the tax legislation passed in July of 2018. The revaluation of our deferred tax asset resulted in additional tax expense of approximately $730,000. Excluding this adjustment, net income for the fourth quarter would have been about $5.8 million or $0.28 per diluted share. Net income for the fourth quarter of 2018 was $4.1 million or $0.22 per diluted share. Pre-tax income for the fourth quarter of 2019 included loan prepayment income of about $361,000, loan rate swap fee income of $349,000, and gains on sale of SBA loans of $172,000. And improving net interest margin also contributed to our positive results for the three months ended December 31, 2019. During 2019, we've discussed our efforts to stabilize our net interest margin during the period of lower interest rates, a relatively flat to at times in inverted yield curve. Our tax equivalent net interest margin for the fourth quarter of 2019 was 3.34%, compared to 3.15% for the linked third quarter. For illustrative purposes, excluding the impact of loan prepayment penalty income, a regular component of our business, our core margins for the fourth quarter of 2019 improved due to lower our cost which declined 14 basis points during the quarter and the positive impact from the Grand Bank acquisition. Our goal in 2020 is to maintain a stable net interest margin. As we have discussed on previous earnings calls, our strategic focus remains adding non-interest bearing deposits and lower-cost commercial deposits, which Emilio will discuss in his remarks shortly. Regarding interest bearing deposits, decrease in higher cost CDs has been a priority. The cost of time deposits is down almost 15 basis points in the second half of 2019, approximately $572 million of our $711 million CD portfolio will re-price lower during 2020. In the first nine months of 2020, $519 million of CDs were re-priced at an approximate average rate of 35 to 40 basis points lower based on current rates being offered. Clearly, there are other factors that will impact on margin in 2020 such as rates on loans, a level of loan prepayment penalty income, purchase accounting associated with acquisitions, et cetera. That said, lowering our cost of deposits will be very important in maintaining a stable net interest margin. During 2019 and into 2020, we will continue to emphasize and take actions to manage the level of non-interest expense growth, excluding any merger-related costs. Our efficiency ratio for the fourth quarter of 2019 was 53.21% compared to 58.22% for the linked third quarter. Absent the impact of loan prepayment income and long rate swap fees in the fourth quarter, we do expect our efficiency ratio in 2020 to remain below 60%. A note on taxes, higher tax expense in 2019 reflects the impact of clarifications to New Jersey State tax law passed in 2018, such as the affirmation revaluation of our deferred tax asset in the fourth quarter. Absent the revaluation impact, our effective tax rate for 2019 would have been 25.55%. We expect that our effective tax rate will improve somewhat in 2020 as New Jersey surcharges reduced in 2020 and we plan to employee additional state tax planning and strategies. Lastly, in the fourth quarter, we announced a stock buyback program. There was no activity in the fourth quarter. However, in the first quarter that program has commenced with a transaction in January. At this time, I'd like to turn it over to Peter Cahill for his update on lending. Peter?

Thanks, Steve. Loan growth for the year was $261 million or just under 18%. This of course includes loans originated or acquired via the Grand Bank acquisition, which totaled of $146 million and represented around $56 million of the 2019 total growth in loans. In the fourth quarter, loans declined by about $20 million, virtually all of which took place right at the end of the year in December and was due mainly due to prepayments of investor real estate loans. There is any good news to be had from the payoff is that we generated a decent amount of prepayment income from them as Pat and Steve both mentioned. Organic loan growth for the year, which excludes former Grand Bank business, totaled $150 million. With the loan prepayments, we had a disappointing finish to the year after averaging monthly organic loan growth of around $15 million through the third quarter. Prepayments are a trait of the investor real estate business that makes a big part of our portfolio. Those investors at some point take profits. The timing there works against us this past quarter. At the end of the day, organic loan growth reflected 8% growth over the balance of loans outstanding, at 12/31/18, and relative to many of our peers was no too bad. Overall, looking forward in 2020, our new business pipeline continues to look good. At the end of the year, adjusted for probably, it stood around $178 million which is right in line with month end averages during 2019. Maintaining a good loan pipeline is critical to ensuring the growth. We know we had loan prepayments levels of $130 million at 2019, and we estimated our monthly loan amortization to be around $6 million a month or $72 million annually. This means to grow our loans organically by $150 million. In 2019, we had to generate over $300 million in new loans. We continue to work on finding new C&I relationships and we continue to see good opportunities for investor real estate business and we of course are very focused on generating deposit. Our portfolio of C&I loans was one area that did increase during at very flat fourth quarter. During the fourth quarter, we made some adjustments organizationally within lending. We took a few of our top real estate lenders and informed an investor real estate team. Investor real estate will always be a major focus of ours. We want to make sure we have the right people focused there. We also want to make sure the remaining staff, the majority of our relationship managers are focused on C&I relationships and the deposit to come with them. Also as a result of Grand Bank acquisition, we acquired a small team that's making SBA loans in the Central New Jersey market. Historically, we seem to do a fee each year, and we think that new team we can conservatively grow that business a bit and respond better to borrowing needs in our market. Lastly, I've spoke in the past about relationship manager turnover and our efforts to get fully staffed during times of growth. In the second half of the year, we reallocated some resources, and at this point from a relationship management headcount perspective, all openings are filled. As we move forward in the 2020, our plan will be to support more modest via additional support staff such as portfolio managers, underwriters and loan administrators to support regional sales teams. I should also comment on asset quality. We did reference some further deterioration in some of the asset quality metrics in the fourth quarter. This was outlined in the earnings release and touched upon earlier by Pat. Almost all of this was caused from two commercial relationships, both are C&I relationships and both we believe are adequately collateralized by real estate. As our earnings release stated, the real estate securing the larger loan is under contract to sale and that closing should take place later this quarter. As we have in the past, we continue to monitor the loan portfolio closely including a formal, very detailed asset quality meeting that's held at end of every quarter. We continue to be within portfolio limits set by our Board of Directors and the portfolio remains well diversified. Our underwriting standards have not changed and as we move into 2020, we will be focused on improved profitability… [Technical difficulty] In lending, we think we had a pretty good year in 2019. We grew at decent rate. Our first quarter core system conversion which did put a bit of strain on the lending efforts is well behind us, and we on-boarded the Grand Bank staff and their book of business. Looking forward, we have got lending area well organized and signs are good for continued growth, and we believe that we have our hands on asset quality and we expect improvement there in the coming quarter. That's it for my fourth quarter lending report. I will turn it over now to Emilio Cooper to discuss deposit initiatives.

Thanks Peter. Overall, deposit results for Q4 were positive and helped us deliver a strong finish for the year. Our primary objective in Q4 was a successful integration of Grand Bank customers, reduction of deposit cost and improvement in our mix. We did well in all three areas. For the quarter, average deposit balances were up by $151 million versus Q3. That was primarily driven by the Grand Bank acquisition. Total deposits increased by 18% for the year, driven by good organic deposit growth and the Grand Bank acquisition. Non-interest bearing average balances grew by over $55 million for the full year. Non-interest-bearing balances met our targeted mix levels built into our strategic plan and now represents over 17% of total deposit balances. We feel very good about this movement and this will remain a key area of focus for us in 2020 and beyond. As Pat and Steve alluded to in their comments, we're being very disciplined in our deposit pricing. As a result, we were able to reduce the cost of our interest bearing deposits by 14 basis points in the quarter, while maintaining strong CD balance retention in line with our strategic objectives. As an example, in December, we retained over 80% of our CD balances while lower than the average rate by over 60 basis points on the CD that matured in December. This is a trend we expect to continue throughout the majority of the year in 2020. There were many key accomplishments in the deposit business for First Bank in 2019 that included the following. Keep in mind, these accomplishments were delivered against the backdrop of 2019 being a year where we converted our core operating systems and integrated a newly acquired bank. Organic deposit growth was $76 million for the year, representing a 6% increase versus 2018. Total growth including Grand was 18%. Non-interest bearing deposits grew organically by over $15 million, which represents a 26% improvement in growth versus 2018 and overall non-interest bearing growth of 7%. We have built a solid foundation in 2019 which supported this growth and continued to improve our ability to execute each successive month. We increased the mix of non-interest bearing balances up to 17% versus 15.7%, at the end of 2018. We successfully launched two new products with an enhanced marketing approach that facilitated the growth in consumer deposits by $72 million versus a loss of $13 million in 2018. We upgraded our core deposit system which enhanced our capabilities and positions us with increased flexibility to partner with modern solutions providers to be functionality of our product offering versus the competition. We launched the new commercial analysis account, which is leading to increased fee capture for cash management and deposit account service charges and will drive improved non-interest income over time. As we look at the 2020, there are many initiatives underway that will continue to lead to improved profitability and growth in our business. Some of the initiatives we are most excited about include banker business development training that will begin in Q1 and continue throughout the year as we ingrain a new approach to creating compelling reasons for C&I customers to switch to First Bank. The launch of our online account opening platform and digital marketing campaign, which will increase the reach of our brand beyond the geographic footprint of our physical location. The optimization of our staff mix to increase the number of proactive business development team members in the marketplace, improved reporting to track individual sales goals versus monthly production and a continued lowering of core deposit cost and flexibility in deposits portfolio through shift in our deposit mix. These represent just a few of the initiatives we have underway that we know will lead to continued value creation in our business. We are pleased with the continued growth we see happening in the deposit business. Last quarter, I communicated that, we will working towards a much faster start in 2020 than what we experienced in 2019 and we are off to a solid start. That wraps my Q4 update, back to Pat.

Thank you, Emilio. That concludes our prepared comment. At this point, I'd like to turn it back to the operator to start the Q&A session.

Alright. Thank you, sir. [Operator Instructions] And our first question will come from Nick Cucharale of Piper Sandler. Please go ahead.

So, I wanted to start with expenses. With this systems conversion on December 9th, can you update us on progress of cost savings from Grand Bank and the likelihood of future extractions in coming period?

Yes. So, there were certain people that were retained immediately at close and so, some of those savings did materialize in the quarter, but we also had some other folks that we kept through year end to help with the system conversion and the transition. And so, there are some additional savings opportunities on the personnel side that will materialize moving forward. So, I would say, we probably got half of what we're looking for right away and the rest we expect will start to see a benefit as we move forward in 2020.

Okay. And then, I appreciate the commentary on the choice to moderate growth relative to prior years. Can you help us quantify your expectations? Or is it quite fluid given the operating environment and your success on the funding side?

Well. Listen and certainly fluid in the sense that, we have the capital and we have the ability to grow, if the success on the deposit side exceeds expectations, I think we are prepared to grow a little bit faster, but I think the key difference Nick in the past, we were in the start-up phase for the bank. We had to bring in the good loan business as they became available and figure out how to fund it. And now, I think we're trying to rebalance and scale a little bit and make sure that, the quality of new loan business we're bringing on is getting funded by reasonably cost, quality deposit. So, I think we're probably looking at growth in mid, maybe up towards a high single-digit, as we move forward rather than historically I think organically the growth has probably been more than 10% to 15% range.

Yes. That's great color, and then just lastly on asset quality. Was this quarter increased the non-performers due to the acquired book or the legacy First Bank relationship?

No, it was primarily -- there were a couple of things related to Grand, but it was primarily related to the C&I loans that we mentioned on the call, the one that we think is basically resolved and we hope through a sale and expect to get that, we believe taken care of in Q1. The other one was a situation that emerged and we were able to renegotiate and restructure that loan to put us in a position where we think we're secured, but because there was a restructured loans it's probably going to be in the numbers for a while until we get resolution there.

[Operator Instructions] Next, we will have Howard Henick with Scurlydog Capital.

Hey, guys. I'm just a little confused on the two loans we're talking about and the comments that basically there going to get solved and taken care. I know there's been reserves taken against those loans. So are you expecting to take a loss equal to your reserves, so there will be no kind of net difference? Or are you expecting a full recovery and therefore, actually, recovery in the reserves and make a profit? Not that it's really a profit, but you know what I'm saying.

Yes, the loan that we had talked about last quarter had a specific reserve initially set up, but based on the contract purchase price. That specific reserve was removed as it was no longer necessary given the expected proceeds we believe we'll get through the sale. So the major change there, obviously, is the contract for sale and the value at which the property is being sold relative to our initial estimates. So I think that's all good news there. On the new loan, that's a situation that emerged. And as we mentioned, we believe we're adequately collateralized there, but that's going to take some time to sort it out.

And how large is the new loan? I know you say the two loans are like $8 million in total, but I don't know what the difference is.

No, that the -- the loan that the -- where the property is under contract for sale that was when we announced it in the third quarter, I think it was an $8.5 million principal balance. We've gotten some payments down on that total credit facility. So at year-end, it was at $8.2 million versus $8.5 million. The other loan is under $6 million, I think $5.8 million.

And that's a C&I loan, but you believe adequately collateralized, correct?

Correct.

Well at this time, it appears that we have no further questions. We'll then conclude our question-and-answer session. I would now like to turn the conference call back over to the management team for any closing remarks. Gentlemen?

Okay. Thank you. Well, we appreciate everybody's time, and we look forward to regrouping with everybody at the end of the first quarter. Thank you very much.

And we thank you, sir, and to the rest of the team for your time also today. Again, the conference call has concluded. At this time, you may disconnect your lines. Thank you again everyone. Take care and have a great day.