First Bank
Q3 2018 Earnings Call Transcript

Published: 23 Oct 2018

[Operator:]

Good morning, and welcome to the First Bank Third Quarter 2018 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 Patrick Ryan, President and CEO. Please go ahead, sir.

[Pat Ryan:]

Thank you. I'd like to welcome everyone today's First Bank third quarter 2018 earnings call. I am joined today 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.

[Pat Ryan:]

Thanks Steve. So the third quarter of 2018 was a very good quarter in fact our best ever. From a financial highlights standpoint we had very good core operating results with loans and deposits both growing nicely during the quarter. Year-to-date our net organic loan growth excluding the impact of the Delanco acquisition is about 120 million. That puts us just a little bit behind plan from organic growth standpoint but we believe we are well positioned to finish the year strong. Deposit growth picked up nicely in the quarter. Year-to-date organic deposit growth is 110 million with the big chunk of that coming in the third quarter about 65 million. Growth in commercial deposits led the increase during the quarter. The margin held up pretty well but we did get a nice payoff from a problem loan that boosted the yield during the quarter. Steve Carman will provide some additional detail on the impact from that payoff later in the call. We continue to show good operating leverage in comparing link quarters, with net interest income up almost 7%, compared to just over 3% growth in noninterest expense when you exclude the impact of merger-related costs in prior quarters. Good growth steady margins strong operating leverage and some additional what I'll call good news events all led to very strong earnings of 5.4 million in the quarter or $0.28 per share on an adjusted or quarter-on-quarter core basis, that’s an improvement of $0.08 a share, or 40% over the prior year. In terms of strategic update the integration of BCB and Delanco are basically complete we expect to meet or slightly exceed our cost savings projections on both deals. Our new branch in West Chester PA is doing well. The lending team as many of you know has been in the market for a while and performing well. And we're excited to have deposit gathering services to complement those lending efforts now. Our Bensalem location is going to be consolidated into our Trevose office which is just a couple of miles away at the end of October. We should see some additional good cost savings and we hope or expect that it will have minimal deposit runoff, given the proximity of our Trevose location. So some of you may have seen we had an exciting announcement earlier in the month we hired a new Chief Deposit Officer, Emilio Cooper, he has been there for a few weeks now, he has hit the ground running and already had some great ideas about initiatives to help drive continued deposit growth in 2019. We recently finalized a in depth project to review our IT core system contract we ended up going with the Fiserv premier system. The conversion is in the early stages and we expect to be completed in the spring of 2019. The new system should provide improved operating performance and functionality, along with cost savings associated with being able to negotiate better terms this time around. And finally we saw a continued improvement in asset quality, not only did we get some payoffs and pay downs on some problems loans but overall levels of delinquency and non-performers continue to move in the right direction. At this time I'd like to turn over to Steve Carmen to discuss the financial results in more detail.

[Stephen Carman:]

Thanks Pat. As Pat discussed earlier we had a very strong third-quarter. While there are a few one-time type items for the quarter reflected in our press release, we continue to experience the following. Consistent core operating earnings growth, led by consistent net interest income growth, a strong asset quality profile, effective management and non-interest expense growth reflected in our efficiency ratio of 53.02%. Net income for the third quarter of 2018 was 5.4 million or $0.29 per diluted share, compared to 2.5 million or $0.16 per diluted share for the third quarter of 2017. Net interest income growth was 3.9 million or 36.6% higher for the comparable third quarters for 2018 and 2017. Just a couple of brief comments regarding contributory factors for our strong third-quarter results. Payoff of the nonaccrual loan, which resulted in recouping about $448,000 in interest income. We did sell off some residential loans related to the Delanco acquisition, which resulted in a gain of $136,200. We had gains on recovery of the legacy BCB and legacy Delanco loans totaling 258,000. We had a one-time loan fee of $117,100 and we have net gains on sale of OREO of about $53,000. Net income for the nine months ended September 30, 2018 was 13.5 million or $0.73 per diluted share compared to 6.4 million or $0.47 per diluted share for the same period in 2017. Net interest income growth was 13.4 million for the first nine months of 2018 or 48.8% higher for the same period in 2017. Last quarter, I discussed two items, one of which all banks are focused on the net interest margin and the other specifically related to New Jersey banks and the new tax legislation passed on July 1st. Here's an update on these two important items beginning first with our net interest margin. Our tax equivalent net interest margin for the third quarter of 2018 was 3.60%, an increase of 2 basis points compared with 358 for the prior year quarter. As mentioned earlier, the addition of 447,000 to interest income from the payoff of that non-accrual loan contribute about 11 basis points for our margin in the third quarter. Compared to the linked quarter of June 30, 2018, our margin was down 3 basis points. If you take a look, at the nine-months comparison our tax equivalent net interest margin was 362 up 28 basis points from 334 for the nine months ended September 30, 2017. As we've discussed, there are several factors that affect our margin, which include the shape of the treasury yield curve, which is now relatively flat affecting both loan and deposit pricing the level of prepayment penalties, which were a normal part of our business. Purchase accounting associated with our acquisitions and further Federal Reserve rate increases to name a few factors. The challenge we continue to face from a margin perspective is the rising cost of interest-bearing liabilities, particularly deposits. For example, the average rate paid on interest-bearing deposits for the three months ended September 30, 2018 was 1.34% which was 27 basis points higher than the average rate paid of 1.07% for the same period in 2017. With projected loan growth our funding cost will continue to move higher in our very competitive deposit markets, particularly if the Federal Reserve continues to raise the federal funds rate. While our tax equivalent margin has been relatively stable specifically, when looking at our quarterly financial highlights. We are expecting a moderate decline in our net interest margin in the fourth quarter and into 2019 based on the expectation that the Fed will continue to raise rates. The other item I discussed last quarter was our effective tax rate. The beneficial impact to our 2008 earnings was the earnings was contributed by Federal Statutory income tax rate which decreased from 35% to 21% and also we did have some new tax legislation on July 1 from state of New Jersey. As a reminder New Jersey imposed the tax surcharge on corporations of 2.5%, also, the new law reduced the dividends received deduction for certain dividend income retroactive January 1, 2017. Our effective tax rate for the nine months ended September 30, 2018 was 19.28%, based on current state tax planning strategies and discussion with our tax experts we are expecting our effective tax rate for 2018 to be approximately 20.5%. So the tax surcharge and reduction of the dividends received deduction for 2018 is expected to have only a minimal impact on us. However, we do not expect that to be the case as we look at 2019. New Jersey's adoption of combined tax filings for corporations that are part of affiliated group are expected at this time to negate state tax strategies we have in place today. We are currently estimating that the impact of the New Jersey tax legislation will start effective tax rate in the range of 28% to 31%. As we move towards the end of 2018 and look to 2019, we expect continued growth in core operating earnings led by commercial loan growth and a subsequent increase in net interest income. Our recent expansion into Westchester and other new markets is expected to be beneficial in generating new business and to the bottom line. Couple that with an expected strong asset quality profile and we remain well-positioned to increasing profitability and shareholder value moving forward. To further discuss our results on lending is Peter Cahill our Senior Lending Officer. Peter?

[Peter Cahill:]

Thanks Steve. As was mentioned earlier, loan growth in the third quarter was around $41 million, most of which was organic growth. Loans for the nine months were up 184 million, some of which includes loans acquired from the Delanco acquisition. We are down a little bit from what we did organically in the first two quarters but our pipeline is stronger than it's ever been. One issue we continue to be faced with is loan prepayments. In the third quarter we experienced extraordinary loan repayments of around 32 million, a significant amount a little less actually than what we saw in the first two quarters. As described in the earnings release, we did over approximately $277,000 in prepayment penalties as a result of these pay offs in the third quarter, if really we tied to negotiate prepayment penalties into loans where appropriate and we've been seeing results. Thus far in the first nine months of the year we've earned prepayment penalties of $814,000, which is 42% greater than total amount earned in 2017. This certainly helps the bottom line in periods where we're experiencing large loan prepayments. Organizationally the lending teams are in good shape all open relationship management positions in each of the teams were filled earlier in the year and RMs are staying active with their clients, as well as prospects in their respective regions. During the quarter, we did hire experienced construction lender to manage construction lending here, while not large in comparison of total loans, construction lending has been slowly growing we've had no issues in the portfolio from a credit quality standpoint, and as we continue to grow. We believe now it's a good time to have someone oversee that specific concentration. As Pat mentioned, we also announced during the third quarter the opening of a full-service office in Westchester, Pennsylvania. This is the home base for the three-person commercial relationship management team, we've had operating in that region for almost a year now. In addition to their efforts, the Westchester office is also staffed by a branch manager and related staff, who we think will be very successful in finding deposit business as well as generating small business lending relationships. Last quarter, I mentioned that we unveiled a new product and office underwrite small business loans officially and helps to drive deposits associated with this kind of loan. Business express uses a credit scoring system which is the same the SBA uses with small lines of credit. So far, one quarter in the results have been very good and we are now working on a plan to offer through the branches we get some even greater efficiencies using that network that we already have in place. Regarding the makeup of the loan portfolio, as I've mentioned in previous quarters there's been no significant changes in the types of loans we're doing. We continue to stress the need for healthy mix of both C&I loans and investor real-estate loans. An important ratio looked at by our regulators is the ratio of investor real estate loans to capital at quarter end we were at 333% right in line with the second quarter better than the first quarter and exactly where we started the year. I mentioned earlier the strong pipeline that 930 was very strong higher than it's ever been from the standpoint of dollar volume of loans and just a couple of loans less than a high point in number of loans that we experienced last year. At quarter end we were up 20% over the level at the end of the second quarter. As we've discussed in previous quarters pipeline levels do move around a bit and the strong level that we have as we head into the fourth quarter is due in part to a number of loans not closing and funding at the end of the third. So based upon this I think that despite having only a decent third quarter from the standpoint of loan growth I think we'll finish strong with a very good quarter and the year. Lastly, I usually touch upon asset quality, we've discussed the number of times that it's asset quality is our main focus from seeking business we haven't waivered from that, things at the end of the third quarter continue to be in very good shape and it is pointed out in the earnings release recoveries exceeded charge-offs again for the quarter. Non-performing loans as a percentage of total loans fell a few basis points compared to last quarter. Other than that things continue to be very good. Delinquencies are few in line with previous quarters. Now that's it for the year third quarter reports from lending I'll turn it back to Pat Ryan.

[Pat Ryan:]

Thank you, Peter. At this point I'd like to turn it back to the operator to open it up for any Q&A.

[Operator:]

[Operator Instructions] And our first question will come from Nick Cucharale of Sandler O'Neill.

[Nick Cucharale:]

So first I saw the cash balances were up significantly at an average and the period basis is the plan for some of that excess liquidity to roll off the balance sheet?

[Stephen Carman:]

Yes, I mean you know some of it timing related certainly as we grow. I think we are going to want to keep more cash on hand than we have in the past just to deal with the fluctuations, but I think if you look at the average for the quarter we are probably we are up a little higher than where we would be going forward. So I think the short answer is probably a little bit of a margin impact from some excess cash in the quarter but I'm not sure if it was it, a large impact.

[Nick Cucharale:]

And then secondly just to clarify on the future margin trajectory. You're referring to further pressure from the 360 reported level or 349 which removes the payoff?

[Stephen Carman:]

Well, I think the question is I think about it is where is it going from here so if you look at the 360 look 349 I think the trends over the last call it four quarters when trying to control for some of the larger one-time events you saw earning asset yields up plus or minus 12 over 13 basis points and funding costs are closer to 25. What that looks like going forward, obviously, the big question mark is what the Fed does and ultimately the shape of the yield curve. But if we have a another 12 months like the prior 12 months then I think we could expect some similar slight compression quarter over quarter as we move forward.

[Nick Cucharale:]

And then you mentioned a few initiatives affecting expenses concerning the branch consolidation and the core system conversion plan for the spring. Could you help us quantify the impact of those items and more generally how you're thinking about expenses as we head into 2019?

[Pat Ryan:]

Well, answering the second question first. I think generally our goal is to continue to grow core revenue in excess of expense growth given acquisitions and given the need to add staff incrementally as we grow, we do think expenses will continue to move higher. We have tried to target revenue growth on an annualized basis in the -- call it 10% to 15% range and then expense growth may be in the 5% to 10% range those are pretty big windows I understand but it’s a little hard to get more precise rolling forward just because some of the impact of the acquisitions as, we realize the cost saves that also make future investments. Specifically in the branch, our typical branch costs are in the plus or minus 500,000 range. I think this branch might have been a little bit less expensive from a lease standpoint and personnel, but figure it should be at least 400 pretax and cost savings to come from that as we move forward once the lease expense roles offs. And we are constantly looking at things on the expense side too Nick you know we understand we need to add staff in certain areas as we grow, but we also take a look at where we have resources and as things change we make adjustments where we need to make sure we keep expense growth under control.

[Nick Cucharale:]

And then Peter just one for you when you look at the pipeline as the geographic distribution change very much or is the growth pretty based?

[Peter Cahill:]

It's very broad based almost, it's kind of amazing when you look at it it's all the teams are doing equally well I mean there was a slow start in the Delanco not the Delanco the Doylestown team from the Books County bank merger we had some turnover there that we talked about, I think last quarter, but those positions have been filled business is starting to get generated there and all the teams are contributing to the pipeline.

[Operator:]

The next question comes from Bryce Rowe of Baird.

[Bryce Rowe:]

I guess couple of questions here. Obviously you've hired the Chief Deposit Officer and noted it in the prepared remarks just curious what exactly will be Emilio's goals in terms of is it a deposit mix, capacity growth type numbers. Just curious how you guys are thinking about that?

[Pat Ryan:]

Yes, I think a good question Bryce. I mean we're in the early stages of our three-year financial planning process, with an obvious focus on 2019 at this point, we have finalized numbers but it's fair to say our organic loan growth goals over the last couple years have been plus or minus 200 million and it is certainly our goal is to try to fund as much of that, if not more that that with deposits than any other alternative funding sources so that gives you a rough idea of overall dollar growth. And then second part of your question will there be mix goals tied to that the answer is absolutely yes. When we look at mix we look at it at a couple ways we look it at broken up by type of customer. So we'll have specific goals for commercial deposit growth or consumer growth and the municipal as well as the three main categories and then separately, by type of products so we're going to have growth goals related to non-interest-bearing related to transaction account growth and overtime our hope and attention is we will drive our ratio of core higher and like I said, I think where already looking at some good initiatives that should help us on that path moving forward.

[Bryce Rowe:]

Great that's helpful. I wanted to shift gears talk about the core system upgrade and obviously that's a process that will be ongoing here for the next few quarters. But how do you think about First Bank's capacity from an asset or balance sheet perspective with the upgrade and does the upgrade puts you in a better position to acquire I noticed the comment in the press release about you guys looking like an attractive candidate for other smaller banks that are looking to partner so just curious if you're if you're seeing an influx of conversations questions from some other smaller banks.

[Pat Ryan:]

So couple of things in their related specifically to IT and we didn’t really have a capacity issue per se we sort of continued to grow on our prior platform, but I think the new system has some good functionalities specifically on the commercial side, both within commercial lending, as well as commercial deposit gathering which I think will make us a little more competitive or make the process a little smoother for our customers. So we are hopeful that that'll be a positive. But the other thing when you just look at the landscape part of our research and researching vendors who is triggering out which players had greater market share, and specifically within the universe of banks that we think could be a short medium or long-term M&A opportunities and Fiserv's market share within our broad geography was significantly better significantly more penetration and you might say we are why does that matter and I think specifically it matters in two ways. One is the cost to convert is significantly better or less if you're converting Fiserv bank into Fiserv but also the customer and the user experience from the partner bank side the amount of time and training that's required to get them up to speed if they already have familiarity with the system is a lot less. So there's a few ways that indirectly we think that can help from an M&A standpoint. And then to try to address your question on M&A I think this continues to be an active market. I think there is a lot of folks that view us as being in the later innings of an economic growth cycle. And I think there are many of them that are thinking about whether they want to have to deal with another recession. And if they don't that could be fueling their desire to at least want to look around and see if there is good partnership opportunities out there. On top of the fact that one of the key in this industry issues within community banking is the prior generation of management as moved up, there is and always a good succession plan in place. So I think those issues together continue to create an active market for conversation whether or not things will happen, especially with the recent downturn in bank stock prices will time will tell there. But I think there is an appetite on the other side. So we'll see how it plays out.

[Bryce Rowe:]

Excellent and then maybe one last one from me on loan pricing. If I exclude the interest recovery and the prepayment fees in the quarter I'm showing a relatively flat loan yield second quarter to third quarter just curious what you're seeing from a pricing perspective? And if there's an opportunity to see some loan yield expansion ex prepays over the next quarter or so with Fed moves?

[Stephen Carman:]

Well, I'll start and I'll let Peter to jump in. but again I think listen the Fed moves late in the quarter so the 20% plus of our balance sheet that reprices the right away we should absolutely see an impact from that in the fourth quarter, but not much of an impact in the third quarter. As it relates to fixed rate loan pricing you started to see the longer the curve move a little bit in the last couple months and that certainly flowing through right. I mean most banks tend to price off of either FHLB or treasury, with the spread and so with both of those benchmarks moving higher I think that will translate into better loan pricing going forward, but Peter if you want to jump in and…

[Peter Cahill:]

Yes, I mean there is not too much to add to that. The benchmarks increase I think it was some pressure from certainly from the borrowers standpoint but also from some competitors to keep rates low, which kind of compressed margins for us. But you know, as each week goes on and I think it's easier for us to get back to kind of the normal margins and as we look back and we price the loan over the benchmark. So I'd like to believe that those spreads will improve as we move forward.

[Operator:]

[Operator Instructions] I'm showing no additional questions, I would like to turn the conference back over to Patrick Ryan for any closing remarks.

[Pat Ryan:]

Okay, well, like to thank everybody for taking the time to listen in and we appreciate your interest in the First Bank and we look forward to getting back to folks early in '19, with an update on the last quarter, but we're hopeful it will be good one. So thanks everybody.

[Operator:]

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