First Bank
Q2 2018 Earnings Call Transcript

Published: 25 Jul 2018

[Operator:]

Good day, and welcome to the First Bank Second Quarter 2018 Earnings Conference Call. 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 Patrick Ryan, President and the CEO. Please go ahead.

[Patrick Ryan:]

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

[Stephen Carman:]

The following discussions may contain forward-looking statements concerning the financial condition, results of operations and business of First Bank. We caution that such statements are subject to a number of uncertainties, and actual results could differ materially, and therefore, you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described under Item 1A, Risk Factors, in our annual report on Form 10-K for the year ended December 31, 2017, filed with the FDIC. Pat, back to you.

[Patrick Ryan:]

Thank you, Steve. I'd like to start off with some general comments and then I'll be turning it back to Steve and Peter for some more detail around the financial results and the performance in the loan portfolio. I would say the second quarter was a good quarter both strategically and financially. On the strategic side, we closed on our acquisition of Delanco Federal Savings at the end of April and we completed our technology integration in early July. We now have three full service locations serving the South Jersey region and we believe that will give us a little more critical mass as we look to compete strategically in that market going forward. In terms of our Southeastern PA expansion, we did move into our loan production office in West Chester Pennsylvania. We have an application pending for a branch location at that site as well and we're hoping to hear back soon. In terms of early production from that team, I think we're off to a great start. We've seen strong loan demand and we also have a very active pipeline and the team continues to do well in terms of generating good deposit opportunities for us. So we feel real good about the early signs of that Southeastern PA expansion. We have had some success selling vacancies on our Bucks County market. I think we feel good about the quality of the team there and I'll let Peter provide a little bit more detail in terms of progress in Bucks County. In terms of our overall organic growth in our traditional markets, if you will, in Central New Jersey, we did open a fourth location at Pennington which is a formal Yargo [ph] national branch location, so location we know very well and we're very excited about hiring away the former Branch Manager from Hapeville Valley [ph], who is very well-known in that market and we're excited about that additional fourth branch location in Mercer County for us. Rounding out our comments on strategic side, we did enter the Russell 3000, which we're optimistic will provide some overall additional stock market liquidity and visibility and I'd also like to comment on the regional structure which we deployed about a year ago. I think we're seeing some real good results in terms of improved ownership and accountability within each of our key markets. From a financial standpoint, we had a great quarter core earnings. We're very good when we adjusted for the merger-related expenses. We did have good continued organic loan growth and I'll let Peter provide a little more detail there. We are pleased to see that our margin helps steady. I think we're up one basis point quarter-over-quarter. I'm not sure how long that will stay. As I'm sure, many of you know the operating environment is getting more difficult than in terms of not only sourcing new deposits, but also the cost of those funds, as well as the flattening of the yield curve are all creating challenges for us. We did see an improved deposit mix, commercial deposit team together with our RMs did a nice job so far. We're up approximately $30 million year-to-date in our commercial deposits. Our asset quality profile remains strong. That translated to core ROAA of 1.14% and ROAE of 10.13% and we also saw our commercial real estate to capital ratio drop down to 326%, which is a low point for us over the last couple of years. In terms of area of focus for the second half of this year, we'll have a strong emphasis on continued deposit growth. We are slightly behind plan. Some of that was related to what we would concert [ph] to be pricing discipline on the CD side. As you've seen, historically, CDs were a strong component of our growth and as we've held the line on CD pricing or tried to hold the line, we've seen less growth in the CD portfolio compared to years past. We're continuing to build out and add to our Commercial Deposits group. We do have a new person who is accepted who will be starting with us in September and we're very excited for them to join the team. In terms of the second half of the year, we're going to have opportunities for continued expense savings from the Delanco integration. We will continue to opportunistically look for M&A opportunities within our core markets and we continue to be focused on trying to grow organically while not loosening up credit standards in economy that appears to be picking up some steam as well as some competition which we've known as driving some pressure not only on loan pricing, but also loan structures. So to summarize, I think we're on pace for a record year in 2018. Good pipelines are continued organic growth opportunities within each of our markets. I think our discipline M&A strategy is bearing fruit in the sense that we've been able to drive cost savings and approves the economy's scale from our prior acquisitions and I'm pleased that our asset quality metrics remain very solid. As mentioned, we do have some headwinds in the second half as we look at the flattening yield curve in a competitive landscape, but I'm confident that we can continue to be successful with our discipline strategy within our New York City to Philadelphia quarter. At this time, I would like to turn it over to Steve to provide some more detail on our financial results.

[Stephen Carman:]

Thanks, Pat. Net income for the second quarter of 2018 was $4.0 million or $0.22 per diluted share, compared to $2 million or $0.15 per diluted share for the same period in 2017. Solid organic loan growth of $45.2 million for the second quarter 2018, not including the impact of purchased accounting with Delanco resulted in strong net interest income growth for the quarter. In addition, as Pat mentioned earlier, we've had significant loan growth over the last several quarters supported by a strong asset quality profile. Reported return on average assets and average equity for the second quarter of 2018 were 1.02% and 9.09% respectively. That compares to an ROAA of 72 basis points and ROAE of 7.54% for the second quarter of 2017. Not including certain merger-related items, we would have earned adjusted net income of $4.5 million whereas Pat mentioned from a core operating earnings standpoint an ROAA of 1.14%, the return on equity of 10.13% respectively for the second quarter of 2018. Net interest income for the second quarter of 2018 was $13.6 million, an increase of $5 million or 57.5% compared to $8.7 million in the second quarter of 2017. Average loan balances primarily commercial grew $405.1 million as a result of organic and acquired growth. Our focus as we continue to grow is to effectively manage in the level of non-interest expense growth. Our efficiency ratio for the second quarter 2018 was 55.64%, up slightly from 53.91% for the length of first quarter and lower compared to the same quarter in 2017 when our efficiency ratio is 58.21%. Our earnings for the quarter and year-to-date have benefited from the federal statutory income tax rate decrease from 35% to 21%. On July 1, New Jersey passed a new law regarding the corporation business tax. We expect the new state tax legislation will create additional New Jersey income tax expense starting in the third quarter of 2017 and into future periods. We are currently assessing the impact with our tax advisers. Looking at our net interest margin, at this time we have not changed our view. We expect our margin to be stable to modestly declining in the second half of 2018. There are several factors that will affect the margin, including the relatively flat treasury yield curve, which affects both loan and deposit pricing. Competitive deposit pricing pressures are clearly present in all of our markets. That said, the adding of lower cost commercial deposits and the addition of stable deposits from Delanco will assist to maintaining a stable margin. Our tax to equivalent net interest margin for the second quarter of 2018 was 3.63%, an increase of 40 basis points compared to 3.23% for the prior quarter. The increasing federal funds rate has contributed to higher floating rate loan yields and subsequently a higher overall loan yield. Prepayment penalties have also added to the stability of our net interest margin despite higher deposit cost. On a linked quarter basis, our margin for the first quarter of 3.62%. Led by net interest income primarily from loans, we expect continued growth in core operating earnings in the second half of 2018. Our expansion in the new markets, a strong asset quality profile and the benefit of the comparatively lower annual effective tax rate have all been beneficial to the bottom line. We are well-positioned after the first half of the year to achieve our financial goals for 2018. To further discuss the results on lending, here is Peter Cahill. Peter?

[Peter Cahill:]

Thanks, Steve. As Steve have mentioned earlier, organic loan growth in the second quarter, which would be exclusive of Delanco was $45 million, up from the $43 million in growth generated in the first quarter. You can get to this $45 million by taking the $100 million solid loan growth for the quarter; of that, Delanco was 78, but you got to back out $23 million reflected as home for sale and that gets you to the $45 million. Then that just puts us just about on plan with our annual growth goal from an average loan's standpoint. I'm happy with where we are right now from the standpoint of business generation, after the first quarter I mentioned the impact of staffing turnover in Bucks County, describing it as short-term pain, which return into longer term gain. I still believe that very much. Right now, all the replacement relationship managers we have reached agreements with the higher have arrived, they're on board and they're now up to speed with how we do things in around meeting existing clients and letting former clients know where they are. Growth in the market had halted for a while with the turnover, but things are now headed back in the right direction. Secondly, in the second quarter, we experienced extraordinary loan repayments approximating $42 million, up from the level in the first quarter where we reported $37 million in loan prepayments. As described in the earnings release, we did over approximately $232,000 in prepayment penalties as a result of these pay offs. Regarding the makeup of the loan portfolio, again as in previous quarters, there has been no significant changes. As it pertains to new business, we've done a good job increasing the percentage of C&I loans we do, relative to investor real estate and we hope to see continued progress in that area. We've set a target on our loan pipeline of around 50% for investor real estate loans, the balance being comprised of C&I and consumer loans. We continue to be right around that number which we view as very positive. One thing I could add here was that during the quarter, we went live with a new small business product we're calling Business Express. We're using what is a small business credit slowing system developed by Experian, which is basically the same one the SPA uses for small business loans. We're using this to approve C&I loans up for $500,000 in size. We've tested this for about six months and it allows us to be much more efficient in decisioning this type of credit. In addition to the efficiencies created, we hope that will help increase C&I loans for us, as well as commercial deposits. As far as the loan pipeline goes at June 30, 2018, it's pretty robust. At March 31, you might recall we were down 19% from the year-end in terms of dollars, but up slightly in terms of the number of the loans in the pipeline. On the previous earnings call, we said that we view that as an aberration and it turned out to be so. The pipeline at June 30 was up 38% in terms of dollars and 9% in terms of the number of loans. And as referenced previously, the loan mix is in-line with prior periods and spread out well among most of the relationship management teams. As things continue to get settled in the greater Bucks County market, I expect the pipeline to grow even further as that team gets acclimated and begins to produce new business. Lastly and in regard to asset quality, things at the end of the second quarter continue to look good. As pointed out in the earnings release, net recovery has exceeded net charge-offs for the quarter which is a good thing. Non-performing loans jumped up a few basis points but that was a result of one real estate secured loan going a couple of days under the 90-day mark. It has since made a payment and is back to performing. Other than that, things were good, delinquencies were few and we are near all-time loans as far as past due loans are concerned. That's it for the second quarter lending report. I'll turn it back to Pat Ryan.

[Patrick Ryan:]

Thank you, Peter. I appreciate the additional background and commentary. I think it's this time I will turn it back to the operator and open things up for Q&A.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] Now, the first question comes from Nick Cucharale from Sandler O'Neill. Go ahead.

[Nicholas Cucharale:]

So, first, I wanted to start on the expenses. A few moving parts here with the cost extractions from Bucks County and Delanco in your commentary last quarter with respect to some plan investments and people and locations in the back half of the year. How should we thinking about the expense run rate as we enter the back half of the year and into 2019?

[Patrick Ryan:]

I'll give that a shot and then let Steve jump in. But I think that the investments that we've discussed last time have at this point, largely been made. We did open up our new LPO. We've had the team in Southeastern PA for a little while, but obviously, we have now the actual physical location expense built-in as well as the new branch in Pennington. As we've grown, I think we've done a really good job holding the line on back office highers, but from time to time, there are needs to add as we've grown and so we've made some additions in couple places. But I do think a big chunk of the increasing expense is built into the numbers obviously with new locations and Pennington and West Chester, probably takes a year, a year-and-a-half to get those to profitability. So we've got a little bit of a drag for right now. But I do think other than those sort of one-off strategic investments, the core plan of trying to keep a lid on expense growth is still in place.

[Nicholas Cucharale:]

And then on the loan growth front, you mentioned you were on target for your full-year goal for average loans and just giving the resolution in Bucks County and what seems to be significant increase in the pipeline, it seems to be like loan growth in the back half of the year is going to be exceptionally strong. Am I right in assuming that? And what is your full year target for loans?

[Patrick Ryan:]

You've got to let us under-promise and over-deliver a little bit. Right? Steve, you could go ahead. I'll let you jump in.

[Stephen Carman:]

Well, we've reported over the past couple of quarters that we're right about on plan, so we're up $43 million in the first quarter, $45 million this quarter. The plan for the year is about $200 million and whether it's going to be tremendously more than the first half of the year, I doubt it, but it should be more than the first half of the year and it should put us right on or over the plan.

[Nicholas Cucharale:]

That $200 million is exclusive of Dclanco [ph]. Correct?

[Stephen Carman:]

That's correct.

[Nicholas Cucharale:]

Then lastly, just considering the LPO on West Chester, you continue to strengthen the Pennsylvania footprint -- just from a strategic perspective, what geographies are attracted to you that you want it or where the focus is filling in and adding scale to your existing markets?

[Patrick Ryan:]

Yes. I would say right now when we think about our regional structure, we got North Jersey, Central Jersey, South Jersey and then Southeastern PA which is Bucks County down through the city and Chester counties. I think that's a pretty big sandbox to be in for the moment. There are probably opportunities to expand some presence either up north or even in the Lehigh Valley, but I view those as sort of mid-to-long term opportunities if the right opportunity presents itself. For us, we're not looking to go denovo in the markets where we don't historically have a presence. So market expansion beyond where we are today is probably going to be driven by finding the right team, or teams, and/or M&A opportunities. But if you look at our historical core market within central, we'll probably will look for denovo opportunities there on a very selective basis.

[Nicholas Cucharale:]

Thanks for taking my questions.

[Patrick Ryan:]

Sure, thank you.

[Stephen Carman:]

Okay.

[Operator:]

The next question comes from Joe Gladue from Merion Capital. Please go ahead.

[Joe Gladue:]

Let me start out, just ask repeat one number I think I missed. It's just the amount of loan prepayment penalties in the quarter?

[Stephen Carman:]

The prepayments were around $42 million for the quarter and the prepayment value is around 232 [ph] that we showed.

[Joe Gladue:]

I guess to move into my next question, just on the net interest margin -- other than prepayment penalties, I assume that some accretion income that's going into that excess margin and just wondering how that plays into the guidance to reflect it down in interest margin. I assume first couple of quarters after Bucks and Delanco that you have a little bit higher accretion income and that that will go down. Is that included in the guidance?

[Stephen Carman:]

Yes, that is incorporated in, Joe. That accretion is part of what we look at. As you take a look at that guidance, taking a look at our deposit cost and it still appears as that we're in position to meet the goal of the stable to modestly defining market in a rising interest rate environment.

[Joe Gladue:]

I guess I'll just ask -- you mentioned I guess completing a technology upgrade and just wondering, are some cost saves available for matters that's just going to be sort of replaced by the investments to new locations and such?

[Patrick Ryan:]

I think, Joe, there are some good opportunities there. First and foremost, we had a group of folks that were retained through the end of this month to help with the transition in the conversion. So there will be some ruling off of folks that aren't staying long term and then we also had I think some significant savings through the discussions with our core provider that we're still negotiating around so I can't get in a lot of detail, but I do think there's going to be some nice cost savings, some are strictly IT-standpoint as well. I think we'll be in good shape to generate some good savings now that the conversion is complete, Joe.

[Joe Gladue:]

Okay. And are we completely through with the Bucks County costing and I guess what timeline on anything from Delanco?

[Patrick Ryan:]

Well, I would say I think the time line on Bucks will be pretty close to 100% of our goal by the end of this year. We're doing some things we're working on there to get the final pieces of the cost saves that we have originally projected and then I would say on the Delanco side, I would think by call it first quarter, second quarter of next year, we should be at or above what we thought we'd save in terms of cost from them.

[Joe Gladue:]

All right. That's it for me. Thank you.

[Operator:]

[Operator Instructions] And the next question comes from Bryce Rowe from Merion Capital. Please go ahead.

[Bryce Rowe:]

I wanted to just follow-up on some of the previous questions. Number one, Steve, on the purchase accounting impact, any way to quantify that on both the loan side -- loan and deposit side in terms of income and expense?

[Stephen Carman:]

I think it's somewhere the neighborhood of couple hundred thousand dollars for a quarter.

[Bryce Rowe:]

Okay. I would assume that the deposit side of that purchase accounting effect will play out more quickly than the loan side?

[Stephen Carman:]

Yes. It will, Bryce, but it's a much smaller piece.

[Bryce Rowe:]

Okay. You guys mentioned the impact of the new state tax and understand you're still assessing the impact. Is there a way to kind of take about what an effective tax rate could be form just a range of an effective tax rate as we look out into the second half of the year?

[Stephen Carman:]

Well, that's a bit of a difficult question, Bryce. When we put the plan together, we had projected an effective tax rate of 23%. It's been lower than that. I don't think some of the changes at the state of New Jersey are currently instituting the 2.5% surcharge in '18 and there would be some change to our dividends or necessarily on material for our effective tax rate. It will be what happens in 2019 that we're taking a very close look at which combined reporting and what that means to us.

[Patrick Ryan:]

Steve, let me jump in. You might want to clarify. You used the term change in dividends. I think you want to specify that you're talking about dividends from the Delaware Reed [ph], not corporate dividends.

[Stephen Carman:]

That's right. I apologize for that. Yes, it's obviously subsidiary dividends, dividends coming up from our Delaware Corporation up to New Jersey. Now we'll be viewed differently by the state and there's an exclusion to some of that dividend income, but it's rather minor in the first year.

[Bryce Rowe:]

And then I want to just maybe get a little more discussion around the commercial deposit group. I appreciate that you've seen some nice growth out of that group. I was kind of curious what the pipeline might look like and if you have a targeted balance for growth over the course of the year or the next couple of years.

[Patrick Ryan:]

Yes. I think Phase 1 was given the group off the ground and really working the existing commercial portfolio and I think we've had some early successes there. We are a little bit behind plan. One of the things that we want to ultimately do with that group is build it out a little bit so we've got more of a direct sales effort into cash-rich companies that may not have significant borrowing needs historically are commercial deposit focus we've led with lending and then try to back fell on the deposit side. I'd say our medium-term goal for that group is to get them built out a little bit more so we can do more in terms of direct sales into those what we'll call kind of cash-rich non-borrowing type niches. But for now, I think the group is doing well. We've been able to circle back through a number of clients and build out our deposits from those folks? I think the pipeline continues to build which is nice and I'm hopeful that the investment will prove to be a good one, but we're still I would call it in the early stages, Bryce.

[Bryce Rowe:]

Okay, that's helpful. Just to be clear, the effort so far has been geared at the current customer base and trying to maximize the relationship?

[Patrick Ryan:]

Exactly.

[Bryce Rowe:]

Great. All right. I appreciate it. Thank you, guys.

[Patrick Ryan:]

Thank you.

[Stephen Carman:]

Thanks, Bryce.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Patrick Ryan for any closing remarks.

[Patrick Ryan:]

Okay. Well, I appreciate everybody taking the time to call in. We appreciate the questions and that will conclude our call. Thank you very much.

[Operator:]

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