WesBanco, Inc. (WSBCO) Q3 2021 Earnings Report, Transcript and Summary

Good morning and welcome to the WesBanco Third Quarter 2021 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, this event is being recorded. I would now like to turn the conference over to John Iannone, Investor Relations. Please go ahead.

Thank you, Andrew. Good morning and welcome to WesBanco, Inc.'s third quarter 2021 earnings conference call. Leading the call today are Todd Clossin, President and Chief Executive Officer; Bob Young, Senior Executive Vice President and Chief Financial Officer; and Dan Weiss, Senior Vice President and Chief Accounting Officer. Today's call, archive of which will be available on our website for one year, contains forward-looking information. Cautionary statements about this information and reconciliations of non-GAAP measures are included in our earnings-related materials issued yesterday afternoon as well as our other SEC filings and investor materials. These materials are available on the Investor Relations section of our website, wesbanco.com. All statements speak only as of October 27, 2021 and WesBanco undertakes no obligation to update them. I would now like to turn the call over to Todd. Todd?

Thank you, John and good morning, everyone. On today's call, we'll review our results for the third quarter of 2021 and provide an update on our operations and 2021 outlook. Key takeaways from the call today are: WesBanco remains a well-capitalized financial institution with solid liquidity, strong balance sheet, solid credit quality. We're committed to expense management while we continue to make the appropriate investments, including strategic hires across our organization and markets, to enhance our ability to leverage our growth opportunities. And we remain focused on ensuring a strong organization for our shareholders and we'll continue to appropriately return capital to them through both long-term sustainable earnings growth and effective capital management. We're pleased with our performance during the third quarter as we delivered solid pretax, pre-provision earnings and managed discretionary expenses. For the quarter ending September 30, 2021, we reported net income available to common shareholders of $45.4 million and diluted earnings per share of $0.70, when excluding merger and restructuring charges. On the same basis, pretax pre-provision income was $57.8 million or $60.4 million when excluding settlement costs with respect to the pending resolution of a lawsuit of $2.6 million that we incurred during the quarter. We reported strong pretax pre-provision return on assets and average tangible equity of 1.34% and 14.73% respectively. Reflecting our strong legacy of credit and risk management, our key credit quality ratios remained at low levels and our regulatory capital ratios remained well above the applicable well-capitalized standards as well as remained favorable to peer bank averages. The significant amount of excess liquidity across our local economies combined with the supply chain and labor constraints continued to temporarily impact loan growth. So far this year, we have generated nearly $1.3 billion in new commercial loan production with 35% of that occurring during the third quarter. Our commercial pipeline is building again and approaching $600 million with more than one-third of that pipeline coming from our more recently acquired higher-growth markets in Maryland and Kentucky. Further, our residential mortgage pipeline remains strong which bodes well for originations the next couple of quarters. While up slightly from last quarter, commercial line of credit utilization is still about 12 percentage points or so below the historical mid-to-upper 40% range as companies have excess liquidity or delayed growth opportunities due to supply issues. We continue to experience high commercial real estate project payoffs via an aggressive secondary market that is flushed with liquidity, searching for yield and offering very generous rates and terms or purchasing projects outright due to a strong cap rate-based valuations. For the first nine months of this year, we've had more than $630 million of commercial real estate project payoffs, far outpacing the $450 million we experienced during 2020 and the $500 million we experienced during the full year of 2019. So while we expect our commercial real estate projects to go to the secondary market for permanent financing, it's been happening at a much earlier point in their projected timelines, creating a short-term mismatch with our new production to offset the runoff. We anticipate commercial real estate payoffs to be slightly elevated during the fourth quarter before returning to more historical numbers around $85 million a quarter range during next year. On the positive side, we generated more than $90 million of new construction loans during the third quarter which will fund over the next 12 to 18 months. A key investment we are making is the investment in our employees as they are critical to our long-term growth and success. During the third quarter, we redeployed some of the savings from our optimization efforts to raise the hourly wage in order to retain and attract which is having a positive impact. In addition, we continue to formulate plans to make strategic hires across our organization and markets to enhance our ability to leverage growth opportunities once they fully return. Throughout the year so far, we have made more than 35 revenue-producing hires in key markets across our organization in order to strengthen our teams and enhance our ability to leverage future growth opportunities. These hires have been concentrated in our commercial lending, residential lending and wealth management groups. Our new residential mortgage loan production office in Northern Virginia which I mentioned in July, has hit the ground running, producing approximately 5% of our originations during the quarter. In addition to ongoing efforts to add wealth management personnel in our metro markets, we are implementing plans to hire an additional 20 commercial lenders, whether individuals or teams, over the next year or so. These hiring plans are focused on both our existing metro markets and potential new metro markets that would be adjacent to our existing franchise footprint. We believe that our diversified revenue engines and footprint, combined with our experienced teams and hiring plans make us well positioned to take advantage of future growth opportunities and over the long term, we still anticipate mid-to-upper single-digit loan growth. I remain proud of our entire organization as they remain diligently focused on serving the financial needs of our customers and our communities throughout the pandemic, the reopening of our economies and throughout the completion of our core banking software system conversion. For the second year in a row, we've been named a Newsweek Magazine's ranking of the best banks which recognize those institutions that best serve their customers' needs. This great accolade follows one we received a few months ago where we were named, for the third consecutive time, one of the world's best banks on customer satisfaction. These recognitions are a testament to the hard work and dedication of our employees, our focus on our better banking pledge to deliver superior customer service and our efforts to provide our customers with high-quality products and services and the ability to access them when it best meets their schedule, whether in person or through our full range digital platform. I would also like to congratulate our community development team led by LaReta Lowther for the receipt of the ABA Foundation Community Commitment Award for Community and Economic Development. This prestigious national award is for their strong performance in outreach with our new market loan program as well as recognition of our strong community banking routes. Through our New Markets Loan Program and other innovative programs, our goal is to promote meaningful community-driven investments and fund a wide variety of business providing critical and social commercial services to low-income communities. Lastly, on August 2 we completed the conversion of our core banking software system to FIS's IBS platform. This was an important project that involved hundreds of employees across our organization to ensure its success. This dynamic platform provides improved operational efficiencies, capabilities for growth opportunities, including partnerships with fintechs and enhanced products and services for our customers. Just some of the digital enhancements include the national person-to-person payments network, Zelle which we are now on; enhanced security measures; robust personal financial management tools to allow account aggregation; budgeting and spending targets; and the ability to stop or release payments online. As I said before, I firmly believe that during the last couple of years with our investments in Kentucky and the Mid-Atlantic region and our new core operating system, we have solidified our evolution into a strong regional financial services company that is supported by several unique competitive advantages. I'd now like to turn the call over to Bob Young, our CFO, for an update on our third quarter financial results and the current outlook for the fourth quarter of 2021. Bob?

Thank you, Todd. Good morning. I have a bit of a cold. So I'll try to stay focused here but you might hear a bit of a raspy voice. During the third quarter, we experienced a continued low interest rate environment, negatively impacting our margin and we retained significant amounts of excess liquidity. And that was somewhat mitigated by continued strong residential mortgage origination volumes and discretionary expense controls. We continue to make important growth-oriented investments and also experienced improvements in both the macroeconomic forecasts and qualitative factors utilized in our CECL accounting standard for the allowance for credit loss calculation. As noted in last night's earnings release, we reported improved GAAP net income available to common shareholders of $41.9 million and earnings per diluted share of $0.64 for the three months ended September 30, 2021. Excluding restructuring and merger-related charges, results were $0.70 per share for the quarter as compared to $0.66 last year. The nine months ended September 30, we reported GAAP net income available to common shareholders of $180.5 million and earnings per diluted share of $2.71. Again, excluding restructuring and merger-related charges, results were $2.79 per share for the current year-to-date period as compared to $1.14 last year. Also, pretax pre-provision income and related returns have been very strong on a year-to-date basis, although somewhat lower for the quarter due to our reduced net interest margin, affecting net interest income and somewhat higher expenses. Total assets of $16.9 billion as of September 30, 2021, increased 2.1% year-over-year due mainly to growth in the securities portfolio from excess liquidity related to higher cash balances from our customers' receipt of various stimulus program benefits as well as higher personal savings. Total portfolio loans decreased 9.8% year-over-year to $9.9 billion, due primarily to forgiveness of $940 million of SBA Payroll Protection Program loans, $278 million of which occurred during the third quarter as well as a higher level of commercial real estate loan payoffs. Excluding PPP loans, total loans decreased 4.9% year-over-year and 1.8% sequentially, reflecting the previously noted commercial real estate payoffs, continued lower commercial line of credit utilization and the impact of selling the higher percentage of 1-to-4 family residential mortgage originations into the secondary market. The unusually high CRE payoffs impacted total loan growth by approximately two percentage points and the residual impact of the sale of a higher percentage of residential mortgages through the first few months of 2021 was almost another two percentage points. Strong deposit growth continues to be a key story as total deposits increased 10% year-over-year to $13.4 billion due to the previously mentioned stimulus-related program funds received by our individuals and business customers and continued higher levels of personal savings. Total demand deposits were up 16.5% year-over-year. Furthermore, reflecting the strong growth and the resulting available excess liquidity, we've continued to strengthen our balance sheet by reducing higher cost certificates of deposit, Federal Home Loan Bank borrowings and short-term borrowings which declined 20.7%, 73.7% and 60.1% year-over-year, respectively, for a total higher cost funding reduction of $1.2 billion. Key credit quality metrics such as nonperforming assets, criticized and classified loans and net loan charge-offs as percentages of total portfolio loans have remained at low levels and favorable to peer bank averages, as measured with those with total assets between $10 billion and $25 billion in recent quarters. Further, we have experienced very low annualized net charge-offs to average loans of just one basis point on a year-to-date basis. The net interest margin of 3.08% for the third quarter of 2021 increased 23 basis points year-over-year, primarily due to the lower interest rate environment as well as the mix shift of securities to approximately 23% of total assets versus 17% last year. The investment securities portfolio increased $1.1 billion year-over-year as a result of the higher cash balances from our customers' higher personal savings, creating extra liquidity to invest. And this additional cash liquidity negatively impacted the net interest margin by approximately eight basis points for the quarter and a similar amount year-to-date. Reflecting the significantly lower interest rate environment, we have reduced all posted deposit rates, including certificates of deposit throughout the past year which helped to lower our deposit funding costs 12 basis points year-over-year to 14 basis points for the third quarter of 2021 or nine basis points when including noninterest-bearing deposits. Across a number of fee income categories, we are seeing the benefit of organic growth and a return to a more normal operating environment. Noninterest income for the quarter ended September 30 was $32.8 million, a decrease of 5.4% year-over-year, primarily due to lower mortgage banking income, down some $3.9 million to $4.6 million from the record level recorded in the prior year period which was primarily due to selling a lower percentage of loans to the secondary market this particular quarter as well as lower gain on sale spreads. During the third quarter, we sold about 40% of loans into the secondary market versus 75% last year on total originations of $382 million and about 60% of that was either purchased money or construction. We pivoted to holding more mortgage loan originations during the second quarter and portfolio loans were up during the quarter as compared to the second quarter as a result. Reflecting new team hires and overall higher demand, we have now experienced the sixth consecutive quarter of above $300 million in mortgage loan production. We also continue to see nice organic growth across our wealth management businesses, including trust up 13.4% for the quarter, securities brokerage up 13.9% for the quarter and private banking, all of which are benefiting from the current market environment as well as unrestricted access to our financial centers to hold one-on-one client meetings. Finally, BOLI was up 27.2% due to additional mortality benefits of about $700,000 as well as an additional tranche of purchased BOLI which added an additional $200,000 for the quarter. Total operating expenses remain well controlled as demonstrated by a year-to-date efficiency ratio of 57%. While we continue to focus appropriately on expenses, we have redeployed some of the savings from our various efficiency and optimization efforts to make the necessary investments in our technology and digital banking platforms as well as our employees to support future growth opportunities. Excluding restructuring and merger-related expenses, noninterest expense for the three months ended September 30, 2021, increased $3.9 million or 4.5% to $90.2 million compared to the prior year period, primarily due to $2.6 million of settlement costs with respect to the pending resolution of a lawsuit included within other operating expenses as well as higher salaries expense. When excluding the settlement costs, our operating expenses for the quarter were $87.6 million which included an additional $1.4 million in health care costs as compared to the second quarter. Salaries and wages primarily increased year-over-year due to higher short-term incentive and stock-related compensation expense which somewhat offset lower salary expense from a lower base of full-time equivalent employees as branch closures and back office savings were realized. We have successfully balanced the management of full-time equivalent employee counts with necessary annual merit increases as well as the recent increase in base hourly wages. As of September 30, 2021, we reported strong capital ratios of Tier 1 risk-based capital of 14.18%, Tier 1 leverage of 10.10%, CET 1 of 12.91% and total risk-based capital of 16.38% as well as the tangible common to tangible assets ratio of 9.12%. During the third quarter, we repurchased approximately 2.1 million shares of our common stock on the open market for a total cost of $71.3 million. And as of September 30, approximately 2.96 million shares remain for repurchase under the existing share repurchase authorization. I might mention that since the end of the quarter through last night, we have repurchased an additional approximate 0.7 million shares at a total cost of about $24 million. Well, let me just provide some wrap-up thoughts on our current outlook for the fourth quarter. As an asset-sensitive bank do remain subject to factors expected to affect industry-wide net interest margins in the near term. We continue to believe that our GAAP net interest margin will decrease a few basis points during the fourth quarter due to lower purchase accounting accretion, lower PPP net fee accretion and lower earning asset yields on new loans and securities. While we anticipate some continued reduction in deposit and borrowing costs as CDs reprice and borrowings are paid off, transaction costs are at relative floor levels. So there just is not as much room to lower overall liability costs. As previously announced, we did pay off $25 million of acquisition-related subordinated debt in the third quarter and have recently announced our intention to pay off another $35 million in the fourth quarter which was inherited from the Old Line Bank merger in 2019. And total savings from these two payoffs will approximate $2.8 million annualized. In general, we continue to anticipate similar trends in both core noninterest income and noninterest expense, absent the settlement costs as we experienced during the third quarter of 2021. Based on the quarter-end pipeline, residential mortgage originations should also remain strong during the fourth quarter and we continue to intend to place a relatively higher percentage of these loans into the residential loan portfolio as compared to earlier in the year. The provision for credit losses under CECL will mostly depend upon changes to the macroeconomic forecast and qualitative factors related to hotels and the COVID-19 pandemic as well as various credit quality metrics, including potential charge-offs, criticized and classified loan levels, delinquencies as well as other portfolio changes. But in general, continued improvements in macroeconomic and other noted factors should result in a continued reduction in the allowance for credit losses as a percentage of total loans over time with lower levels of provision releases as compared to earlier this year. Share repurchase activity will depend upon pricing levels and volume restrictions under existing SEC guidance as well as current remaining repurchase authorizations. Lastly, we currently anticipate our effective full year tax rate may between 20% and 21%, subject to changes in tax legislation, deductions and credits and taxable income levels. We are now ready to take your questions. Operator, would you please review the instructions?

[Operator Instructions].The first question comes from Brody Preston of Stephens Inc. Please go ahead.

Good morning, Broderick.

Good morning, everyone. Can you hear me?

Yes.

All right. Great, thanks taking my questions. I'll try to be brief here. Just wanted to get some additional color on the C&I paydowns. Was there a common theme among them in terms of geography, industry and customer profile?

No. I would say too - we're pretty generous in terms of how we categorize C&I. You notice we talked in our prepared remarks about $250 million worth of commercial real estate loans go into the secondary market. A lot of that is showing up in the C&I classification line item because of the way we categorize things. The C&I line usage actually was up a little bit during the third quarter and net loan balances in the C&I was actually up a little bit in July and August, a couple of million dollars. So it's those C&I loans that we categorize as more commercial real estate based upon percentage of ownership and things like that but it's really the commercial real estate loans going to the secondary market or properties just being sold out right because of the cap rates. That's what's driving that number as opposed to maybe some of our peers would categorize C&I primarily as lines of credit and equipment loans and owner-occupied and stuff like that. So, we're going to look at that for future reporting periods but that's really the commercial real estate that's going to the secondary market showing up in that number.

Okay, great. And then, the core loan yields are actually holding up fairly well. But when I look at the roll-on, roll-off delta that you guys provide on the commercial side, it's about 60 basis points. So how do you see core loan yields kind of trending for the book yields going forward? And how are kind of new origination yields in the month of October coming on just given the leg up in the 10-year and the belly of the curve?

Sure. I'll pass that to you.

Yes. Sorry, I just want to get off mute there. At this point, that 60 basis points, as you referenced, I think is going to be lower than that. We've already seen a pretty significant leg down in terms of repricing. And while we do have a lot of loans, as I've indicated in the past that have floor rates and so there's some opportunity there for repricing as well as renegotiation of some of those rigs. I do believe that 60 basis points delta will come down for two reasons; one, what's repricing in the portfolio is at a lower rate, number one; and number two, as you point out, Brody, new loans are going on here in the fourth quarter at slightly higher rates. So that number that's in the PowerPoint is a combination of new loan pricing as well as loans repricing in the existing portfolio. And if you have something repricing 250 over LIBOR or the new SOFR spread, then you are going to get something less than 3%. But relative to new loan pricing, our target remains between 3% and 3.25% for new loans.

Got it. And if I could just sneak one more in before I hop back into the queue. You referenced how well you've taken down the FHLB borrowings, Bob, of the 200 or so that you have remaining, what is the maturity schedule look like? And would you look to kind of get rid of the rest of the horse moving?

There really isn't that much for us to do an early redemption. I do note that we have the Old Line sub-debt coming off, I think, between that and the old YCB sub debt that we paid off in September. Those are two critical payoffs of relatively expensive debt. They had repriced in the 460 area, 470. So that certainly will be helpful going forward. But in terms of the Federal Loan Bank borrowings, there's another $25 million in the fourth quarter and there's about $125 million in all of 2022. And then just some residual borrowings that reprice in '23; so not much after '22.

Thank you very much taking my questions.

Thanks.

The next question comes from Casey Whitman with Piper Sandler.

Hey, good morning. Maybe turning to expenses. So if we call core expenses, $88 million or so this quarter. Sounds like that might be a pretty good run rate for you going forward? Or do you think there's a possibility when you get back to the mid-80s just due to lower health care costs or savings in the core conversion? Or is this $88 million sort of the run rate?

Yes. I'll let Bob dive in and provide some more color. It does - we kind of hit the pandemic low point, I think, in the second quarter with regard to expenses and there were a lot of onetime things that went in our favor on that. So I think what you're seeing with the health care cost being the $1.4 million in the third quarter, that's a big number. I'm not sure that's going to repeat itself but we got another $0.5 million or so worth of the salary increases and stuff that we did that would start to flow through. So I think we're back close to kind of what we were at kind of pre-pandemic in that $88 million range or something like that. We'll see how that plays out but that's - I don't think that's probably - upper 80s' not a bad number to look at. Bob, do you have any more color to that?

Well, I just would say that we did experience throughout the year, higher equipment and digital software costs, digital banking costs, I should say, related - not necessarily related to core conversion but prior to the core conversion as people pivoted to using more mobile and internet banking solutions. And that's true for the industry, not just for us. Of course, there were obviously hard costs related to that. Also, the PPP program itself generates a lot of costs upfront which we defer. And so that's part of net deferred fees but there are also back-end costs on the forgiveness side for every loan that's forgiven, we pay something like $125 through the fintech platform that we use and so that's part of that as well. And just higher electronic banking usage, Visa debit card usage, all of that goes into that higher digital banking cost. But we do have all of that priced into the FIS charge on a monthly basis going forward. And we do anticipate that as compared to the way we paid that bill in the past, we run a different core system still with FIS that we will see some savings just in terms of how much we're paying on a monthly basis for each account process. Almost all of these digital and internet banking costs other than Visa are included in one month-late charge per account. So, I think there was a fair amount of that, that came through expenses here in the second and third quarter, although we did reclass some of it into merger-related and restructuring I should say. And so, I think Todd is right; we would be guiding particularly with the salary increase and the hourly wage increase to that $87 million, $88 million number here in the short term.

And would a reasonable expectation for growth off of that in 2022 be for like the-low-single-digits? Or is that a reasonable outlook?

Yes. Just from my perspective, if I look at it, we don't - as you know, we don't give guidance out in future years and things to kind of focus more on ratios and things like that. But we got two things, one thing working in our favor, one thing may be working against a little bit. Bob mentioned the kind of the ability to scale at a lower cost because of the new FIS system that we're on, IBS and the per customer charge versus asset size charge. So that will help us over the longer term, keep expenses down. But we are investing, right, on the revenue side. So I want to make sure that we're really well positioned to resume the loan growth and get to that mid to upper single-digit loan growth number. That's something we're extremely focused on. So the addition of another 20 or so hires, things like that, we're going to invest in the franchise in order to get the growth that we want to get at in the markets we're in. So that will add a little bit of expense but at the same time, I think the core operating system will bring some expenses down over time as well.

Okay. And the last question for me but the $4.5 million restructuring charge, is that mostly related to the core systems conversion? And are there any sort of other nonrecurring charges we can expect, I guess, in the fourth quarter? Or are you pretty much done with those?

No. Bob, you might jump in on that but that's really it. There are a lot of the contract termination costs and things like that associated with switching the core but that should be in the third quarter.

There were branch lease cost determinations, Casey, from the six branches that we closed in July but the bulk of that is related to the core conversion and is over.

The next question comes from Russell Gunther with D.A. Davidson.

Good morning, guys. So it sounds like you have some visibility into next quarter. The paydowns are going to remain elevated here. I'm just curious if you guys can extend that at all in the next coming quarters. Any confidence that you'll return to that $85 million more normalized rate in the first half of next year.

Yes. I mean that's what our anticipation is right now. It's hard to project out quarter-to-quarter. I mean we did not see the high level of commercial real estate payoffs in the third quarter. We knew it was going to be high but we didn't know it was going to be as high as it was. I think a lot of other banks have made the same comments in terms of things that went to the secondary market. Right now, looking at the fourth quarter, we don't see huge numbers there but we didn't see huge numbers there at the beginning of the last quarter either, right? So I would expect that some of the aggressiveness I'm seeing, particularly with Freddie and Fannie, I mean they're doing - it's amazing. I don't know if you heard this from others but I mean we've seen 5-year interest only on loans that are 75% loan-to-value, 10 years interest only on loans that are less than 70% loan-to-value. We've seen projects taking not just before stabilization. We've seen them taken during construction. So we're kind of competing against the government here as an industry and they're doing some things that we just don't think makes sense. So I don't know how long that's going to continue. There's a lot of liquidity there but maybe not as much where I would say, kind of - you've heard a number of banks talk about protecting the integrity of the balance sheet. And I think that's the important thing to be doing right now but it's - there's just some crazy things that are going on out there and fixed rates for a long period of time under 2.5%. So we're trying to be prudent about what we're doing but with the high cap rates that are out there, you can't blame customers from just taking a property and just selling it outright and liquefying and then turning around and investing it somewhere else down the road. So, I don't blame the customers for doing what they're doing. I think it's smart but at the same time I think that it's temporary, it's short-lived, just don't know whether it's this quarter or next quarter or when it's going to stop. But at some point in time, I think it will return to a more normalized level. So I really looking hard at the new construction loans that we're booking that will be funding over the next 12 to 18 months. And we have $400 million, $500 million worth of construction loans on the books that have not completely funded yet. So we've got that dynamic working for us but we also have a very aggressive secondary market that seems to want to get into the construction business. So, I think that's going to be interesting to see how that interplay works out.

Understood. That's very helpful, Todd. You reiterated the longer-term goal of a mid to upper single-digit loan growth number. And I'm just curious, given the bolt post of adding 20 commercial lenders in existing and adjacent metro markets, do you think that type of production added is enough to kind of get you to the low end given the other headwinds that we discussed?

Yes, I think so. Because we're doing a number of things operationally to speed up our process and become more efficient. So we went through the PPP loan program, we used a company called Numerated that kind of helped us automate that whole thing and we're looking to use that on a broader basis throughout our company for noncommercial real estate-related loans. So we should be able to turn loans around really quick and that's going to be a huge lift in productivity for our existing lending staff. But I would also mention, too, that over the last 18 months or so, we did a core conversion with the bank Old Link. Our largest acquisition we ever made was over that - within that last 18, 24-month time period. And then we did our own core upgrade from a core that we ran for 45 years and in doing all of that remote and everything, I mean that's a heavy lift and it was a heavy lift for our employee base. So those are behind us now. So now we can kind of look forward in terms of, I think, increasing the productivity level of our existing people, not only because of the technology improvements that we've implemented but now we're able to focus them externally as opposed to you got to get through seven training classes before Friday type of thing that they've been dealing with for the last 1.5 years because of the new core conversion. So the 20 people, that's - if we can find more, we'll do more. But I think that will be a part of it but the big part of it is going to be just the productivity lift that we would expect to see out of our existing staff.

Thank you for your time. I will jump back in the queue.

The next question comes from Catherine Mealor with KBW.

Hi, Catherine

Hey good morning. We're going to just circle back on growth and it looks like the residential mortgage portfolio inflected a little bit this quarter. We saw modest growth. Do you think we've hit a bottom in the residential mortgage portfolio and you'll start to see more growth there which I think may help just kind of ,at least kind of, support the loan portfolio, given that we still best pay down from the commercial real estate at least next quarter?

Yes. We - actually, third quarter was our second best production quarter ever in residential mortgage lending and pretty close to our first best. I think it was a year earlier. So we feel like we're doing a really good job on the residential mortgage side. With the production level and Bob mentioned, we're holding a little more on our balance sheet now and that's to provide a little more growth orientation as well, too but we've continue to invest. I mean, of the 30 or so - 35 or so people that we hired over the last year in revenue producing roles, 16 or 17 of those were mortgage loan originators. The rest were commercial bankers. And then, I think what I mentioned in my prepared comments in Northern Virginia, that team that we bought on, did about 5% of our overall mortgage production. We would expect to continue to invest in the business and to continue to grow it but I feel good about the performance that the team has had.

Great. Then I would assume, with that you'll have - you continue to have lower levels of residential mortgage fee income, as you keep more on the balance sheet and still less than secondary market. And so - but as an offset to the lower mortgage and fees and perhaps service charges, it feels like that had a really nice boost this quarter. And what's the kind of normalized level that you think we can return to on service charges? Is it fair to look back? I mean, I guess we've got Durbin but is it fair to kind of look back at 2019 and kind of adjust to those levels? Or how should we think about normalized service charges and banking fees?

Yes. Bob and Dan might have color on that, too. The pandemic - well, first of all, you're right on the residential mortgage side. The more we put on our books, the less in secondary market fees that we would have but the pandemic changed a lot of things. The acceleration of digital was very significant. Fortunately, for us, Durbin was far enough in the rearview mirror. It was a couple of years ago. So it's not in any of our run rates or comparisons in terms of comparing to pre-Durbin but the acceleration and just the digital usage by the customer base has been really positive for us. I think the other thing to think about longer term and what we're really trying to invest in with our insurance product and having that be digital and fee income associated with that is, I think banks in general, we're going to be facing this changes in overdraft's fees going forward. You see some of the big players and even big players, some of the larger regionals or mid-sized regionals now that are coming out in and kind of attacking that with the different programs and things. And I think that's something we got to think about, maybe not over the next year or two but definitely over the next five, six years. What's the kind of the fee income sources that are going to offset that and we think insurance is a big part of that but digital adoption is something that we think is going to continue. It's not going to go back to the way it was pre-pandemic. I just - I think you may see some more branch visits than you had during the pandemic but so much has shifted online. We really think that's going to be the channel. Bob, Dan, what would you add to that?

I would just say that we were happy that service charges saw an increase this quarter because really, we've been saying publicly that with all of the liquidity that are in - that is in people's accounts, really, there hasn't been the propensity to use overdraft capability that our folks have to a greater degree. So it was nice to see that. And as compared to last year, we've really seen a nice growth rate and particularly, just since the first and second quarter of this year. And Todd did talk about electronic banking fees. That's both due to an adjustment to a new settlement provider as well as just higher usage here in the quarter. So I do think that both of those run rate going forward. And Todd didn't mention this but I did in my script, wealth management really has seen some nice growth and continued to experience that here in the third quarter as well. Of course, some of that's market related but really are seeing some good pull-through in our main wealth management businesses now securities, brokerage, trust and private banking relative to customer additions.

And maybe my last question is just a big picture profitability question. I'm sure that the efficiency ratio will suffer a little bit in the near term as you add on new lenders before they're fully ramped up and you kind of return to a better growth rate. So is there - what kind of band do you put on the efficiency ratio where you'll be comfortable bringing that up to? And kind of what - maybe what limitations you'll put on yourself with expense growth until you can start to see some better revenue growth?

Yes and it's a great question. How much the load - right to load into the expense column to get the revenue generation out of it. And Bob and I and Dan and I will be looking very closely at just positive operating leverage. We've always tried to drive that so that within the year that we're making the expense, we're getting a good positive operating leverage turn on that. You would expect to get that on lenders that you're hiring into the organization and whatnot, even if they've gotten non-solicits for a year. So they still ought to be productive and be able to grow. And I also think that the productivity lift that we ought to get because of the new system and being past the pandemic and all the trainees and everything is going to help us dramatically be able to keep the efficiency ratio down to a reasonable level. I think I look at it and say, we've always been in kind of the top third, best third, so to speak, in efficiency ratio. I'd like to continue to stay there. I don't know what the yield curve is going to do. I just don't have much of a clue for that. So it's hard to peg a number. We've always said, we wanted to stay in the mid-50s and we've been able to do that as we went up in over $10 billion and all that. So as the market continues to move forward, what's going to be the normalized good rate used to be mid-50s. Is that still what it's going to be? I think the yield curve is going to drive an awful lot of that. So it's hard to pick a number. But I would say, what we're really focused on, obviously, is the quality of the balance sheet which I think we've really done a good job with that. We pruned the portfolio over a number of years and that's impacted growth to some extent as we've kind of rightsized our indirect portfolio and multifamily and hotel and things like that. Those are behind us; so we don't have things that we're trying to shrink or anything like that going forward. Everything is kind of in the growth mode. And with the markets we're in now because of the acquisitions in Kentucky and Maryland, we're coming out of the pandemic in a much different situation than we were in six, seven years ago with regard to growth markets and people in growth markets. And the low-cost deposit base that we've got, well, it doesn't seem to add a lot of value right now because everybody's got rates to slow. If rates start rising, we've got sub debt three years ago in 2018. We really outperformed the market significantly because our deposit costs don't go up as rates start to go up and that all falls to the bottom line for us. And those deposit numbers continue to go up. I think natural gas is going to be the transition fuel for quite a while. I think we're all starting to see that. That bodes really, really well for this franchise in terms of - we don't lend into it but the deposit benefits, the wealth management benefits of it. So I look at all those things together and I feel really bullish about where we are in the future, particularly with the new core and everything that we've got. So those things that we can control, I think we're going to do a good job with but I just don't know where the long-term rates are going to be. We get the rates up over 2% on the 10-year and the spread between the two and the five-year to grow. Then yes, I think it's really possible to stay in the 50's. If the yield curve doesn't cooperate though, I'm not sure you're going to see many banks that are going to be there but we're going to continue to invest in growth and this is a growth franchise that we've been saying that for a long time. That's why we made the acquisitions that we made and we know that's what we got to prove. So we're not going to be penny wise and pound foolish. So a long answer but I thought I'd just get that out there.

That's great. Thank you very much.

Sure.

The next question comes from Steve Moss with B. Riley Securities.

Good morning, everybody. This is Steve's Associate sitting in for him today. Just a quick question on credit here. NPAs came down. Criticized loans came down as well this quarter but the reserves seem to still be holding strong. Sort of curious, what is the timeline there to get things back to that day one reserve ratio? And sort of what's the pathway to get there?

Yes. I think with the timing on reserve releases, everybody is kind of in different places on that. I think we released like $0.10 more in reserves in the second quarter than the market was thinking and maybe even more in the first quarter and less this quarter. So everybody's got their own kind of contour to this based upon their own CECL calculations and assumptions. So I kind of look at where you at from a loan loss reserve perspective and we're like 137 and the peer groups like 125 to 130. So we're right there with the peer group, even though how we got there and how they got there, it's all different. But we're all end up in about the same place right now. So we would expect, as credit continues to improve and continues to strengthen, I mean we're seeing the RevPAR on hospitality now in line with where it was in 2019. So that's good. That really - that bodes well for the future. We would expect that you would continue to have this contour - the trend in downward reserves. But I'm hopeful that the next year, we're also putting loan growth on and obviously, you want to reserve for new loan growth as well too; so how that all sorts out. I think we've said in the past is, not just us but the industry that maybe the end of next year, end of '22 or end of '23, you might see kind of getting back to day one CECL. But then you also got to look at what's the office portfolio going to look like nationwide and stuff like that. So there are things that will happen over the next 12, 18 months that maybe don't seem to be big issues but things people are going to keep their eye on. So I don't know when you get back down to that 10 or 11 number but we tend to think a year, 1.5 years from now, it'd probably be back to where we don't have anything unusual that's being reserved for because of pandemic or unusual losses.

Right, that's helpful. Yes, most of my questions have already been asked. So I'll ask my last one here on capital. You've already noted the - today's amount of share repurchases. I think I missed that number. I was curious if I could get that again. And I'm sort of curious if that run rate holds beyond this quarter into 2022 for repurchases as well?

Bob?

Yes. So, what I said in the script is an addition here in the month of October through yesterday was just under 0.7 - 700,000 shares, let's say that. And I would say, as the pace that's - in October, that's really a similar pace to what we experienced in the second quarter as we ramp that up. But here more recently is the price increase under our 10b5 program, it automatically dialed back the amount of purchases on a daily basis. As we move from blackout and out of 10b5 into the regular repurchase program, we'll be judicious relative to pricing levels against tangible book value opportunities for the internal rate of return on the repurchase program. And as I said in my script, volume going forward would depend upon the pricing and the opportunity in the market to buy back shares under the SEC limit. So that's as much as I would guide to at this point.

The next question comes from Steven Duong with RBC Capital Markets.

Hi, good morning guys. Just back on the service charges, the improvement, is that largely from NSF fees?

No. I believe that Bob jump in, provide more clarity if you want to but there are about 700,000 that was related to just timing associated with how things were collected in one core system versus the other as we switched over. So it was more just a recognition of income versus anything changed there and it will be at this run rate going forward.

Todd, that was the electronic - Steven, that would be electronic banking fee line item that Todd is referring to. As the service charges, there were really no significant rate increases as part of the conversion. There are some account movements back and forth. So there could be a little bit related to that. I think the overdraft product was used to a greater degree in the third quarter remains to be seen with people's liquidity, if that will hold true in the fourth quarter with holiday spending projected to be up quite dramatically over last year. So we'll see how that works out. But as I said in an earlier question, I think it was Catherine, we were encouraged by the increase. And at least for the next quarter to believe that, that should run rate.

Okay. And I guess does it - did it surprise you at all that the overdraft option, more of your depositors were taking that, given the level of deposits that there are that you guys have with them?

I was personally surprised, yes. So Todd, I think some of that is again a little bit to conversion to the new system and the applicability of artificial intelligence to the limit supply to each customer's account. But Todd, I might have interrupted you.

No. No, I think that's right. It's a more intelligent system, so to speak. So your limits are really based upon your experience with the bank versus everybody gets the same type of number. So I think it's really more of an advantage to the customers that they need to use it, that they get the amounts that they need versus amounts that might just be standard for everybody.

Got it. And the electronic banking fees, is that where you record your interchange fees?

Yes.

Okay, all right. And just on your margin, I guess, Bob, if we were to leave exclude the PPP impact, the purchase accounting and also just this excess liquidity, what rate hike level do you think would get your margin to be basically neutral stabilized?

Well, that's a $64,000 question.

Well, I had to ask that you - before you go off in the sunset.

I'm trying to get Dan on here so you can hear his voice but on the subject of the margin going forward. I think it's - first of all, we were down a few basis points from what we thought during the last earnings call, admittedly. And that's really just due to the additional liquidity we've experienced on the balance sheet. All of that is either going into lower yielding securities. That's down 75 to 85 basis points from what's rolling out of the securities portfolio to what's rolling in. On average, we were about 126 with new security purchases in the quarter. So stuff coming off at 2, 2.25, going into an average of 126 will have an impact on the margin. And so there was more of that, more amortization as well on existing securities from prior purchases premiums but just the additional cash. We saw an additional $300 million in cash quarter-over-quarter. That's at 5 basis points to 10 basis points, basically. And as I identified in the script, Steven, that represents about an eight basis point between that, the additional securities and the additional cash, about an eight basis point reduction in the margin. That's not much different than what others are reporting. But an answer to your question, it really depends upon what liquidity does going forward. We are encouraging some larger institutional customers if they have other opportunities to invest to take those opportunities to kind of shrink back, paying them 10 basis points versus us earning 10 basis points, no impact on - no value to the margin. I'm not suggesting that's going to have a large impact going forward but I do think in this low 280s area - again, depending upon customer liquidity, that is pretty much as low as I think the portfolio is going to go. We still do have some repricing in the loan portfolio from Old Lines portfolio particularly that had 5- to 7-year fixed rate loans. But we have offsets, as I mentioned during my script in the CD area in borrowings, whether they be the sub debt being paid off or Federal Home Loan Bank, that should offset that for the most part.

And I guess maybe just on the CDs, the cost is 49 bps this quarter. Just curious, what are you guys offering on average right now for your CD product? And is there an opportunity - I mean, given the level of liquidity that you guys have, can you just get down to, say, like it's 10 or 20 basis points and let the customer choose if they want to switch - move it over into a money market or a savings account?

Really have seen a lot of that over the last year. It's the only line item in deposits that's down. And really, that's - we've been below market on our posted rate offerings for some time with CDs just as we continue to see this influx of cash. And so a lot of customers are going short into money market or savings accounts and not reinvesting. You asked what those average rates are and they're in the 20 to 25 basis point range on average. It should be lower than that for six months CDs a little bit higher for, say, a 2- or 3-year CDs. So, I really do think there's $500 million or $600 million of repricing securities - I'm sorry, CDs, still an opportunity to see that line item. You can see how much it's come down over the past year in the margin in the press release. So still some opportunity there in addition to what I mentioned on borrowings.

Right. And I guess with the 20 bps to 25 bps that you're offering, are people rolling into the new CDs? Or they willing to go, say, I don't want to lock my money in for six months or a year and move it into your other products?

We experienced about 60% to 65% CD renewal. I don't think that's most different from the industry. So again, let's say 2/3 of our customers are back into the same CD, they're not really changing maturities. And then the rest are either taking it to other places or they're putting it in their money market or savings or checking account.

And the last questioner will be William Wallace with Raymond James.

Good morning guys. Most questions that I had have been asked but I did want to just circle back on expenses. Last quarter, you were suggesting, I believe, mid-80s run rate. So this quarter, talking about $87 million to $88 million run rate. It seems like, I don't know, kind of a relatively large bump up in one quarter. And so I'm just wondering if you could kind of tell me from your own position, what changed? Is it really all - is it just the salary increases? Or was there something else in there that you weren't anticipating?

Well, you're backing out the settlement cost, right? The legal settlement cost.

Right.

Well, about - I think we talked about $1.4 million was related to the health care increase which wasn't known at the beginning of the quarter but we think that was a big number. It may not be repeated. But then the hourly salary increase as well, too, was another $0.5 million. There's a couple of million dollars right there that kind of bridge that gap that was not anticipated at that time period. I think $85 million, yes, that's where we were at. Just kind of think going forward, as Bob mentioned, probably $87 million, $88 million because of the investment in people that we're going to make. But a lot of banks had to pivot during the third quarter with regard to people and just in order to retain them and be able to fill open positions and keeping everything function in the way you want it to function. You had to go out and raise salaries for people. So that showed up in the third quarter, not just the hourly raise but we did it for some other positions as well, too. So it's - I don't want to just chalk it up to inflation but there's a good chunk of it that's in there that was recognized during the third quarter that was stronger than what we would have expected at the end of the second quarter. Bob, you add anything to that?

Well, we do anticipate a little bit higher marketing spend here in the fourth quarter as compared to the last couple of quarters of run rate. We've been kind of guiding to that throughout the year but haven't really experienced it but do anticipate a little bit more here in the fourth quarter. And then related to discretionary expenses, we just anticipate that post pandemic, there are more meetings with customers. There are more opportunities for business meals and entertainment as compared to the last couple of quarters. So, we are anticipating that you'll see a little bit more return to 2019 run rate spend in terms of travel and other general administrative costs. But - and the FDIC insurance, remember, we had a pretty significant credit that we experienced there in the second quarter. And - so that was back to its normal level here in the third quarter at about $1.2 million. And miscellaneous taxes which are down in other operating experienced about a $900,000 reduction in the second quarter. We had some of that in the third quarter as well as we filed tax returns. So not anticipating that to continue here in the fourth quarter. Those are just two or three factors that I would add on additional detail to Todd's mention on the salary and benefit side.

Yes, there's about $2 million that showed up that because of the health care expense and the salary increases that I think had we known that at the end of the second quarter. We would have built that in, probably said something in the $87 million, $88 million range. I think - but we really try to address that in some other areas. I mean if we look at our pretax pre-provision kind of excluding the restructuring costs and the settlement costs and all that. So the pretax pre-provision excluding restructuring and settlement $60.2 million and that was pretty much right on overall consensus. So we felt that from a profitability standpoint, we met the overall consensus. So we - even with the higher expense level, I think we found ways to cover that through the growth in some other fees like trust fees and stuff like that to offset it. But that $87 million, $88 million is probably a better number to use going forward unless something really unusual were to happen one way or the other which we don't anticipate right now.

Okay. And maybe just to kind of re-ask a question that Casey had asked earlier. So some of these - some of the pressure that's driving this kind of higher guide is coming from the wage increases. Is it possible that you maybe have gotten ahead of some of the annual cola adjustments that you would have made earlier in the year and such that next year's growth rate could be maybe lower than your typical inflationary pressured growth?

Yes. I mean we've typically used a 3% merit increase rate across the board and tried to find ways to manage to that or better than that historically. That's increase is based upon performance being here but also inflationary expectations in that. I think as you're looking now, the whole question is, it's what we're seeing as a transitory or is it permanent, right? You get people at $1.50, $2 raise, you're not going to take it back. So there is a certain element of this inflation that I think is permanent and that's becoming permanent. But yes, it's something we'll have to look at as we get to the end of the year and first quarter of next year in terms of what are the inflation expectations, what is going on and do we stay with typical 3% that we've used for years. I think every bank I've been with for the last 30 years has used the same 3%. Or does that get adjusted? And I think a lot of it has to do with what are others going to do, right? So I mean, you're competing not just against other banks but McDonald's and RVs and gas stations and Walmart and everybody is out there putting bonuses out and raising hourly wages. And we'll see if that continues to the fourth quarter and into the first quarter. I don't have a lot of visibility to that right now but it'd be nice if we got ahead of the core adjustments a little bit but I'm not so sure at this point.

Okay, all right. And then on the legal settlement, I don't recall seeing any legal matters disclosed in the financials. Correct me if I'm wrong but I guess it's a relatively large settlement if there hasn't been a disclosure of the suit prior. Can you give us any - I understand you probably can't say much about it but any indications to the nature of the suit itself? And was it out of a relationship that was acquired or legacy?

No, I would just say, I want to be respectful of the process kind of where we're at with it. That's why we put it in as pending because we've got it all ironed out but we want to get everything signed and officially done and all that. But I would tell you that it's very typical of what you've seen with a lot of other institutions over the last year. I think, matter of fact, I think there may be several hundred institutions that are going through the kind of the same process. So it's nothing out of the ordinary or unusual with regard to that. What I will tell you is that the settlement is global and it's across all of our markets, right. So that would be the end of it. But I don't want to get into specifics but it's very typical of what you're seeing in a lot of other banks report.

Okay. And Bob, you said you're looking forward to Dan being on these calls but I think you're going to miss us as much as we're going to miss you. I'll stop there.

Thank you, Wally. I have - I will just say, I really enjoyed working with all of you over the years and I appreciate your kindness and I do miss seeing you in a live setting. So maybe there'll be opportunities for that down the road, I'm not sure but sending notes on the beach, so to speak.

And I do want to thank Bob for his 20-plus years of service. He's just done a great job for us and he's done a really nice job getting Dan ready as well, too. And Bob is still going to be around in a consulting capacity. We got a lot of respect for him at what he's done and what he is going to help us with in the future as well through during the transition. So I just wanted to make that comment. Hope we have the opportunity to see you all at an upcoming conference. It seems like more of these are being done in person which I'm very pleased about. I know we're going to be in Arizona next week at Itaewon [ph] and we've got others planned down the road. So, excited about getting the chance to see people face-to-face again. Thank you for your time today.

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