WSFS Financial Corporation (WSFS) Q3 2023 Earnings Report, Transcript and Summary

Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the WSFS Financial Corporation Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. I'd now like to turn the conference over to your host for today, Mr. Art Bacci, Chief Wealth Officer, Interim Chief Financial Officer. Sir, you may begin.

Thank you, Regina. Good afternoon and thank you again for joining our third quarter 2023 earnings call. Our earnings release and earnings release supplement, which we will refer to on today's call, can be found in the Investor Relations section of our company website. With me on this call are Rodger Levenson, Chairman, President and CEO, and Steve Clark, Chief Commercial Banking Officer. Before I turn over the call to Roger for his remarks on the quarter, I would like to read our Safe Harbor statement. Our discussion today will include information about our management's view of our future operations, plans and prospects that constitute forward-looking statements. Actual results may differ materially from historical results or those indicated by these forward-looking statements due to risks and uncertainties, including, but not limited to, the Risk Factors included in our annual report on Form 10-K and our most recent quarterly reports on Form 10-Q, as well as other documents we may periodically file with the Securities and Exchange Commission. All comments made during today's call are subject to this Safe Harbor statement. I will now turn the call over to Roger.

Thank you, Art, and everyone else for joining us on the call today. WSFS performed very well in the third quarter as we continue to demonstrate the strength and diversity of our business model. Core EPS of $1.23 and core ROA of 1.46% represented growth from the second quarter of 6% and 4%, respectively. Our performance was driven by loan growth across all our commercial and consumer segments. Deposits were essentially flat when compared to the second quarter, excluding the anticipated runoff of short-term transaction-related deposits in our corporate trust business. The net interest margin remained very solid at 4.08%, reflecting the impact of the Fed hike in short term rates in July, expected increase in deposit betas and very modest deposit attrition. Through-the-cycle interest-bearing deposit betas ended the quarter at 39% as the pace of growth continued to moderate. NIM was favorably impacted by about 5 basis points due to higher purchase loan accretion and maturity events in a few reverse mortgages. Core fee revenue grew 9% linked quarter and was a record quarterly high. Growth came from each of our major business lines including wealth and trust, Cash Connect, mortgage banking, capital markets, and the core banking business. The core fee revenue ratio increased to 28.60%. Consistent with the slowing economy and corresponding credit normalization, we did see a negative uptick in our asset quality metrics. Most of this variance was driven by two unrelated C&I credits that moved to non-performing status due to operating challenges specific to those businesses. Problem asset migration reflected downgrades in the commercial sectors, including office. Inclusive of these downgrades, the office loan portfolio has 6% problem loans, zero delinquency and less than $1 million in NPAs. Total classified loans to Tier 1 capital plus ACL stood at 16.11% or just under 3% of total loans. Credit losses were relatively flat to Q2 at 45 basis points or 19 basis points excluding NewLane leasing and Upstart portfolios. Our balance sheet remains strong, including significant liquidity capacity and regulatory capital levels that continue exceed well capitalized. On slide 14 of the earnings release supplement, we have provided an update to our mid-year 2023 outlook, incorporating Q3 results and commentary on Q4 ranges on NIM, PPNR, and ROA percentages. Overall, we remain on track to achieve the full-year outlook, which assumes no additional short term rate hikes and modest GDP growth in Q4. Consistent with our historical practice, we will provide a 2024 outlook when we announce Q4 earnings in late January. Thank you. And I will now turn it back to Art to facilitate the Q&A.

We will now open the line to answer any questions you may have.

[Operator Instructions]. Our first question will come from the line of Frank Schiraldi with Piper Sandler.

I want to ask about the loan growth here. Obviously, quite strong in the quarter. You reiterated your guide overall for 2023. But as we start to think about – you guys have – particularly given your low loan-to-deposit ratio, but also we're seeing maybe a tougher credit environment. So, how do you think about the opportunity versus potential risk here? Do you think we start to see some moderation in this loan growth going forward here? What are your thoughts in general?

Frank, this is Steve Clark speaking. So, I think the way we look at the loan growth is really about opportunity in the current macroenvironment and the current region we serve. So, on CRE, we continue to be very, very selective. We have focused on multifamily and residential, particularly at the beach and shore markets. But the real opportunity for us is C&I. That pipeline is relatively strong. It's the result of some of our competitors being distracted and some of the service issues companies are experiencing from their incumbent banks. So that creates opportunity for us. So we're very active in CNI calling and prospecting, very selective in CRE, but do have a tailwind of fundings coming from commitments that were extended last year and were underwritten in a higher rate environment and very sensitized to the rate environment. So that's kind of my perspective.

Just on credit, I think the coverage ratio, reserve coverage ratio was flat linked-quarter. Just given some of the downgrades on the problem assets, could you just maybe speak to that a bit? And was this credit migration kind of baked into the reserve already or just your general thoughts on reserving and the credit migration, particularly on the problem asset side?

Frank, this is Art. The ACL was flat at 1.28%. Remember, a good portion of that was because of just loan growth. So that was less impacted by any migration issues. This is something we will continue to evaluate throughout the quarter as we look at the economic outlook and the trends we're seeing. But at this point, we feel pretty comfortable with the coverage ratio where it is.

This is Steve. I would only add that the credit migration you referenced is – those assumptions are baked into the current ACL from both a qualitative and quantitative perspective.

If I could just sneak in one last one on the deposits. You guys mentioned the trust deposits that flowed back out, the transactional stuff. And I guess that was a driver of the non-interest bearing balances being down linked quarter. Just any thoughts on what you're seeing more generally there. Do you expect kind of a continued flow of leads in non-interest bearing balances in this kind of higher for longer rate environment?

This is Art. I'll take that. When you look pre-COVID, our non-interest bearing total deposits was around 27%, 28%. We're at about 31% now. So we're still above where we were pre-COVID. There may be a little bit more leads to go there, but I think we're kind of towards the bottom of it. On the trust deposits, there's an element of it that – there's really two components of our trust deposits. One is kind of a, I'd call it, right now $700 million to $800 million base that’s just recurring cash flow coming in from loan payments that we pass on to investors. Then there's a component where there may be certain types of trusts that are pre-funded with cash and we hold for a period of time. That's the lumpy component of it. And so, that's really a function of how the securitization market is going. We do have a pipeline that we're looking at that potentially have some more non-interest bearing deposits in Q4. But it's really driven by the capital markets and the securitization activity and the type of deals that are being done in the market.

Frank, this is Roger. I think the only thing I would add to it, just building on Steve's comments about the commercial loan business, with C&I being the largest segment, those deposits come with those relationships and with the overall focus more broadly on relationships, in addition to wealth. We have a strong focus on full relationships in the commercial space, which should give us some ability to offset, as I said, some of the lingering absorption of the excess liquidity in the consumer book.

Your next question will come from the line of Russell Gunther with Stephens.

Just a quick follow-up on the loan growth question earlier. Obviously, a good environment for you guys to continue to take share from competitors, given your positioning. How's the environment for taking commercial lending talent? Does that still remain an opportunity and any wins in the quarter?

Russell, Steve Clark. Yes, it remains an opportunity. No, there were no wins in the quarter. But we have active outreach and we're receiving inbound calls from relationship managers in the market who are interested in joining the WSFS team. So we have active dialogue, and we believe there will be some talent coming our way in future periods, but nothing to report in the third quarter.

With our competitive positioning, we're the natural landing spot for talented relationship managers, particularly from larger banks. And you've seen that as the relationship manager group has expanded over the last several years under Steve's leadership. The bar, though, is very high to join us at this point. Obviously, we want people who can move business with them joining us and we're also culturally consistent and have a same kind of philosophy around relationship banking. So we get a lot of inbound calls, but the bar for us is definitely higher in terms of the quality of people that we would bring over.

Russell, this is Steve Clark again. I need to correct myself. I have my quarters confused. So we actually did add to RM talent in the quarter one in the Philadelphia market. A long tenured relationship manager came to us from a large national bank. So he's housed in Philadelphia, and then a healthcare RM, long experienced RM in the market joined our healthcare vertical. So those two RMs did occur in the third quarter.

Just quickly, switching gears. From a margin perspective, cash balances came down quite a bit this quarter. Can you just remind us kind of where they stand today relative to maybe a base you'd like to remain at, but maybe relative to total assets?

I would say, Russell, that balances are within the range of kind of what our long term goals are. Remember, it fluctuates a little bit depending upon what's going on with Cash Connect, and the on-balance sheet, off-balance sheet business, and then overall liquidity planning. And right now we're within our liquidity goals. So it should stay in and around this range.

I know we'll get a full-year outlook in a few months, but as we think about your updated margin range for the fourth quarter, just bigger picture, how are you guys thinking about where that can ultimately trough even just from a timing perspective? We've seen competitors this quarter talking about trough in 3Q, 4Q. How are you guys generally thinking about the timing there?

Russell, assuming rates they're at, we're thinking somewhere second quarter next year we start to see a bottoming of the margin. There's still some opportunity with us to increase our betas lightly. We have some budget left in our beta where we do see some competitors increasing rates, and we certainly want to protect our relationships. And as Steve said, a lot of our new business comes with deposit relationships. But I think in the second quarter, we start to see a bottoming of the NIM.

Last one for me. On the net charge-off outlook, again, bigger picture, you mentioned core kind of 19 basis points ex NewLane and Upstart, just to have a general sense for your expectation for consumer charge-off trends in the near term.

The consumer charge-off trends have been pretty much within our expectations. The last two quarters, they've been consistent. So I think we're kind of normalizing at a pretty steady rate for – and those being mostly the Upstart portfolio and the NewLane portfolios, even though that's more of a leasing small business, but those seem to have kind of leveled out at this level.

Your next question will come from the line of Feddie Strickland with Janney Montgomery Scott.

Can you update us on expectations for earning and total asset growth as you allow the investment portfolio to run off? I think in the slides, it says you're targeting 18% to 24% today. And then, along those same lines, should we should we see the balance sheet relatively flat, or maybe even shrink from here in the near term, just trying to get a sense for where total assets could go?

I think we would see total assets pretty much remain flat. I think our mortgage-backed securities portfolio had been elevated because we had the excess liquidity over the last few years, and we're allowing that to run down to more traditional levels around 20% or so and that's going to take a few years. But we're seeing, as we said in the supplement, about $1 billion of runoff in that portfolio over the next two years to kind of look at that as $1 billion of runoff that can be redeployed into our loan portfolio and a nice pickup in yields on that transition and mix shift.

Just one more for me. Can we see overall fee income come down some in the fourth quarter, just given the guidance of mid-single digits for the year? And if so, was that driven by any business line in particular?

I would tell you that the fee income has a little bit of noise at times just because of the income we generate from some BOLI derivative cost. The core components of it – wealth, Cash Connect and the core banking fees – continue to have gone up. It's a range we've projected. We did have a strong quarter in our capital markets area, which helped drive up this quarter’s fee revenue. So that's why you see the 9%. I wouldn't expect it to continue to grow at 9%. I think back to our normal expectations of mid-single digit would be more appropriate.

Your next question will come from the line of Manuel Navas with D.A. Davidson.

Just circling back up to the loan growth expectations. I understand selectivity in some portions of the book and the opportunity in others. How do you include the expectations for a bit of that recession at the end of the year in your growth projections?

I would just generally say, as we mentioned, Manuel, most of our growth is coming from taking market share. And so, even if there was a contraction from the run rate when GDP growth – which is obviously what we would expect, we don't believe that would have, in the near term, an immediate impact on the loan growth. Longer term, it would depend on the path of the economy. But most of where we're seeing our growth is from taking market share and, to a lesser degree, expanding existing relationships.

And you talked about a pipeline of construction and there was some nice construction gains in the quarter. Can you just kind of talk about that a bit, just what trends you're seeing there?

Manuel, Steve Clark. Looking back over the past year, so into early 2022, when we approve construction financing for multifamily or for residential subdivision, equity from the borrower goes in first. And again, we're underwriting in the range of a 65% to 75% loan to cost. So that equity is significant, goes in first. And now, those unfunded commitments that we settled on, closed on last year are funding this year. So that is a tailwind in our loan growth. And again, those loans were underwritten in a higher rate environment and sensitized to an even higher rate environment to make sure the appropriate coverage would be there at completion of the multifamily project or interest reserve on a residential lot subdivision project.

I'm sure that tailwind is captured in the guidance. Can you quantify the benefit to 2024 from some of that?

Yeah, I can't quantify at this point.

I'll shift the questions. I understand we'll get an update next quarter. Thinking about that NIM bottom in the second quarter of 2024, is the expectation there that you'll see stability in the NIM? Or could even start to rise? And this is assuming no more hikes and kind of a flat Fed Funds environment?

Yeah, I think it would stabilize and we'd see some leveling for a period of time. But again, as the portfolio makes changes from the MBS over to the loan, we'd be picking up 450 to 500 basis points on that mix shift. So that would start to bring the yields up over some period of time. Obviously, it’s not going to be immediate. But, yeah, assuming all else equal, I would say, second half of the year, we'd start to see some lift in the NIM.

Kind of building on that, are we getting close to the peak of the loan yields? Could that still mix a little bit higher? Just looking at loan yields alone at around 6.80%, what are kind of thought of that progression, if rates stay the same, stay flat from here?

At this point, we have some originations that are coming in over 6.90%, into the low 7s. I think it really depends on the mix of loans we're bringing in. But the pricing, which is probably – assuming no change in rates, I look at Steve, I think we're pretty much – we’re comfortable where our pricing on the loan side is.

I would not expect a significant increase in yield unless the Fed raises interest rates. Our book is 55% variable, so we would benefit from a Fed increase, but I would not predict higher yields – significantly higher yields going forward after that.

But you're still going to benefit from the securities yields of 2.30% going to the loan yields over time?

Correct.

You made a comment about the – some room on deposit beta versus kind of your target. Seems like you're kind of outperforming in recent quarters. How are you thinking about using some of that leftover, higher beta target to kind of maybe protect your deposit flows. Just talk about that strategically? And I'll leave it there.

Our outlook committee looks at what the competitive pricing is, and we talk about it every month. We do see some competitors that have some higher rates. And again, to protect relationships, we will do exception pricing where it's necessary, and that's really left up to line of business leaders to determine that exception pricing. So we do believe we have the ability to, where necessary, increase some rates to manage a relationship. We're not doing it across the board to just go raise deposits. We're not in the position of needing to get additional liquidity. But, certainly, we've acquired some very strong relationships and those we want to protect.

Thank you. And with no further questions in queue, I'd like to turn the conference back over to Mr. Bacci.

Thank you again for joining the call today. If you have any specific follow-up questions, please feel free to reach out to me directly. Also, Roger and I will be attending conferences and investor meetings throughout the quarter and we look forward to meeting with many of you.

Have a good day. That will conclude today's meeting. We thank you all for joining. You may now disconnect.