First Bank (FRBA) Earnings Call Transcript & Summary

Thank you all for joining. I would like to welcome you all to the First Bank Earnings Conference Call Fourth Quarter 2022. [Operator Instructions] Now let me turn the call over to Patrick Ryan, President and CEO. So Patrick, you may begin.

Thank you. Good morning, everybody. Welcome to our fourth quarter earnings conference call. I'm joined today by Andrew Hibshman, our Chief Financial Officer; and Peter Cahill, our Chief Lending Officer. Before we begin, Andrew, can you please read the safe harbor statement.

The following discussion 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, 2021, filed with the FDIC. Pat, back to you.

Thank you, Andrew. I'll start with some high-level comments on the quarter and the year. I'll turn it over to Andrew to give a little more detail behind the numbers, and then he'll turn it to Peter to give a little more background on the lending side. I'd say, overall, I think it was a decent finish to a very, very good year. Unfortunately, in Q4, the NIM expansion that we achieved in Q3 was eroded and we ended up back at margin levels more in line with where we saw things in the second quarter. But despite the margin erosion, we did have overall profitability levels that remain very strong, and we achieved tangible book value per share growth of $0.46, which was meaningful book value growth during the quarter. Our asset quality remained very good. We saw net recoveries during the period, and our levels of outperforming loans for very low. Our return on average assets was down a little bit from the third quarter, but remained very healthy at 1.35%. We continue to bring in high-quality new bankers. So only deposit generators were also brought in on the sales side during the year, and we're excited about the prospects for those teams as we move forward. And we think we'll see continuing operating leverage opportunities as we continue to scale our operations and also look to integrate the Melbourne merger later in the year. I'd like to highlight strong performance metrics. While they were down from Q3, I think they still show very, very good performance, especially relative to peers. Our return on tangible common equity was 13.5%. Our efficiency ratio was below 50% for an eighth straight quarter. Our pre-provision net revenue return on assets was 1.95%, just a little bit below 2%. And -- our net interest margin has been over 3.5% for the past 8 quarters. Our nonperforming assets to assets remain very low at 23 basis points. And overall, our allowance covers our nonperforming loans by over 4x. On the lending side, we saw $74 million in loan growth during the quarter, with over 70% of that new production coming from C&I. We have very strong asset quality with low delinquency. We're building out our capabilities in small business and asset-based lending to continue to move our ratios a little higher on the C&I side, further diversifying down a little bit from the investor real estate category. And we've seen gradual evolution of the organization as we continue to layer in attractive C&I lending niches, really building the franchise out from a traditional real estate focused community bank into more of the middle market commercial bank. On the deposit side, we obviously had some challenges. Overall, deposit growth was strong, but we did see a significant increase in our cost of deposit some of that was related to the way the timing of events played out during the quarter. As I mentioned, we had significant C&I lending opportunities. We actually had a reduction in payoffs and paydowns that we normally see on the commercial real estate side. Those 2 things together put a little pressure on funding, which caused us to have to increase the rates on our money market. Now the good news is we were able to bring in over $100 million in the deposits and deposit growth during the quarter, but we also saw a lot of excess noninterest-bearing balances move out of the noninterest-bearing accounts into interest repairing accounts here at the bank, which gave us the liquidity we needed but obviously had an impact on our cost of funds and on the margin. Now we were expecting some movement out apparently although it did happen a little bit quicker than we expected. We think some of that, again, was a timing issue related to the need to bump up our money market rate in order to make sure we have the dollar disease to fund the good C&I loan opportunities. But all in all, we've made a lot of good moves to make sure that we can continue to drive core deposit growth. We did actually see an increase when you look at just new noninterest-bearing accounts opened during the quarter, we actually brought in more new money and new accounts than we saw money leading and closed accounts. So again, there was a lot of money moving out of noninterest-bearing into interest-bearing, which impacts the margin, but in terms of retaining customer relationships, our team did an excellent job. So in summary, despite some headwinds emerging in Q4, we had a very good and profitable year in 2022. We realized top quartile performance across key metrics like return on assets, return on tangible common equity, pre-provision net revenue and tangible book value per share growth. In fact, our tangible book value per share grew 10% during the year despite a lot of challenges on the interest rate side. And we achieved good high-quality loan growth and improved asset quality profile. Furthermore, we have reason for optimism as we work our way into 2023. We've been able to attract several key bankers that will help us drive core deposit growth moving forward. We've got some nice new C&I lending niches, which will help drive both portfolio diversification and an improvement in our overall commercial deposit balances, which will put less reliance on higher cost sources of funds. We're doing a nice job enhancing our digital banking capabilities to make sure that we remain competitive in that space. And we're continuing to see fallout in opportunities from M&A within the New Jersey banking market that we think will create great opportunities for both customer acquisition and banker acquisition as we move into 2023. And finally, the exciting opportunity with the Malvern acquisition to integrate that, really drive some size and scale and improve profitability within our PA franchise and also drive overall improved scale benefits across the entire franchise. So certainly challenges as we look out to 2023, but also reasons for optimism as we look to continue to build and grow shareholder value here at First Bank. So at this time, I'll turn it over to Andrew to give me to the numbers. Andrew?

Thanks, Matt. For the 3 months ended December 31, 2022, we earned $9.1 million in net income or $0.46 per diluted share, which translates to a $1.35 return on average assets or $1.40, excluding tax-affected merger-related expenses. The final factors contributing to the quarterly results were historically strong but slightly declining net interest margin, strong credit quality metrics and effective management of noninterest expenses. Net income declined $1.1 million from the linked third quarter but was up $1.3 million compared to the fourth quarter of 2021. Strong commercial loan growth continued in the quarter. Loans were up approximately $75 million, excluding the small decline in PPP loans compared to an increase in non-PPP loans of $36 million in Q3, $84 million in Q2 and $65 million in the first quarter of 2022. Total deposits were up $104 million during the fourth quarter of 2022, with interest-bearing deposits up $184 million and noninterest-bearing deposits down approximately $80 million. We continue to maintain key relationships. However, they have become more rate sensitive, resulting in movement of funds. We did a detailed analysis of the declining in noninterest-bearing bearing balances during the fourth quarter. A very small percentage of the decline related to accounts that were closed and left the bank. But during the fourth quarter, we did experience several large relationships that maintain significant noninterest-bearing deposits moved into interest-bearing products, and we saw some normal end-of-year fluctuations. The growth in interest-bearing balances was due to new money CD and money market promos we initiated during the quarter, coupled with the movement of funds I just discussed. Due to the shift in the deposit mix, the repricing of certain existing customer balances and the new money promo during the fourth quarter, our total cost of deposits increased 7 basis points compared to the linked prior quarter. Primarily due to this increase in the deposit costs, offset somewhat by the increase in the average rate on loans, our tax equivalent net interest margin decreased to 3.69% for the quarter ended Q4 2022 compared to 3.97% in the previous quarter. The decline in the margin in the fourth quarter was exacerbated by low PPP fee income and prepayment penalty income during the fourth quarter of 2022. Excluding PPP fee income and prepayment penalty income, the margin would have been approximately 3.67% in Q4 versus 3.89% in the third quarter of 2022. Our asset liability management approach continues to be conservative, but we have taken steps in the fourth quarter and plan to continue to shift our balance sheet to a more liability-sensitive GAAP position. In the current rate environment, we expect continued pressure on the margin in the short term, but we believe the quarterly decline will not be as severe as the decline was in the fourth quarter of 2022. Liquidity levels increased slightly during the fourth quarter due to our deposit gathering initiatives. We were also able to slightly reduce borrowings and broker deposit balances during the fourth quarter. As we have mentioned in our previous calls, our strong organic loan growth has lowered our liquidity recovers, but has also contributed to our investment portfolio being relatively small when compared to peers. The size and low-risk nature of our investment portfolio has limited our unrealized losses compared to some of our peers. During the first 3 quarters of 2022, unrealized losses increased, but unrealized losses actually declined slightly during the fourth quarter. Due to our strong net income, we were able to increase our tangible book value per share by $0.46 during the current quarter. Based on net recoveries during the quarter and a strong asset quality profile, we maintained our allowance for loan losses as a percentage of loans to 1.09% at December 31, 2022, compared to the same percentage at the end of September. This was supported by only a very slight increase in nonperforming loans compared to the end of the third quarter. And we are also currently finalizing our CECL calculation and expect our allowance as a percentage of loans to increase by approximately 5% to 10% upon adoption during the first quarter of 2023. In the fourth quarter of 2022, total noninterest income increased to $1.4 million from $934,000 in the third quarter of 2022. The increase from the third quarter of 2022 was primarily due to an increase in loan fees, which was principally related from this latest onetime loan fee. Our SBA loan activity and pipelines continue to be strong. However, sales activity has been slower than expected, primarily due to the rising interest rate environment, which has reduced the premiums earned on sales. And in most cases, we are attaining the loans on our balance sheet. Loan swap activity also continues to be slow. While noninterest income levels may continue to fluctuate, we do not expect a significant increase in noninterest income over the next several quarters. Annualized Q4 2022 noninterest expenses were 1.84% of average assets or 1.78%, excluding merger-related expenses compared to a peer average of 2.1%. The -- in total, noninsurance expenses were $12.5 million in the fourth quarter of 2022, up $728,000 or 6.2% compared to the third quarter of 2022. The increase was primarily due to merger-related expenses associated with the merger agreement we finalized in December and higher salaries and employee benefits. Excluding merger-related expenses, noninterest expenses increased only 2.4% compared to the linked third quarter. With a difficult interest rate environment, we continue to be laser-focused on expense control, but we do anticipate our quarterly expenses will continue to increase slightly from the core Q4 2022 levels as we continue to add this stat and inflationary pressure continues to affect other expense items. While we believe the current interest rate environment will continue to put pressure on our margin, we are still generating historically high levels of net interest income and operating efficiency results. We believe we can continue to generate core loan and deposit growth and combined with very strong credit quality metrics and effective management of noninterest expenses, we are well positioned to continue our strong core profitability trends in 2023. At this time, I'll turn it over to Peter Cahill, our Chief Lending Officer, for his remarks. Peter?

Thank you, Andrew. I'll try to provide some additional information not already covered by Pat or Andrew. From a lending perspective, 2022 was pretty clean from the standpoint of noise in the numbers. My comments will focus only on organic results, PPP loans, as you mentioned, are about done with slightly over $3 million or so remaining in their payments agreed. Regarding the fourth quarter, I think the results were excellent. Approximately 29% of our growth for the year took place in Q4, just slightly behind Q2, our largest quarter, up nicely from the third quarter, which was the slowest. Total loan growth for the year, again absent PPP, was around $260 million. This exceeded our total loan growth goal of $200 million by 30% and overall kept us in double-digit loan growth for the year. Loan generation continues to be good in all areas of the bank. One thing of interest was that new loans closed and funded during the fourth quarter declined from an average of $126 million in the first 3 quarters of the year to $83 million in Q4. There are a number of factors at play here. First, we are well ahead of plan throughout the year, which meant we could be a bit more selective. Also, through the first 6 months, loan growth was weighted towards investor real estate loans. So again, we were selective about what we pursued in the second half of the year and for the fourth quarter. Then with the impact of the economy on interest rates helping cool loan growth on the investor real estate side a bit, we experienced a reduction in loan payoffs that I think both Pat and Andrew mentioned during the fourth quarter. All of this resulted in good growth in the C&I side of the portfolio for the quarter, which brings in, as you know, more floating rate loans as well as relationship deposits. Payoffs in the fourth quarter totaled only $14 million compared to $177 million or a quarterly average of $59 million per quarter during the first 3 quarters of the year. In the total for the year, C&I into a much lesser extent, consumer made up 47% of all new loans closed and funded and investor real estate made up the difference. The positive news we saw moving into the fourth quarter was that the percentage of new loans coming from C&I rose to 70% of total loans closed and funded. Looking at the reason for loan payoffs. In Q4, 62% of payoffs reduced to the underlying asset being sold and 25% of total payoffs were refinanced by another bank. The entire year, the kind of "refinance outnumber" was higher at around 38%. At this point, I'll talk a little bit about our loan pipeline, which continues to look good. The numbers we discuss here are based upon probable funding, which means we project first year usage and multiply that by a probability factor based upon where we are in the approval process. That means, for example, loan that's already approved, will have a much higher probability of closing if there on just underwriting. At December 31, our loan pipe stood at $233 million, down slightly from $240 million at the end of Q3. The total number of individual loans in the pipeline rose, however, from 211 at the end of Q3 with $222 at year-end. The average pipeline finger for the 12 months this past year was $244 million. So December -- at December, we were around 4.5% off the average for the year. Factors that impact the monthly number is include the number and size of loans that have already closed and funded and therefore get moved off the pipeline. For example, we closed and funded $45 million in loans in December. This is above the average month and those deals steam off the pipeline at 12/31. Overall, I'm satisfied with what we're seeing in the pipeline. Things seem to have slowed a bit, but we're still seeing a lot of activity based upon economic uncertainty that we see, it change every day. We're taking a cost approach to underwriting new business, especially in investor real estate and construction lending as well as with any new prospective customer coming in for the bank. As loans move through the pipeline, it eventually hit our projected loan funding report, which we've talked about here before, this report looks at 60 days and projects funding and prepayments for Andrew's team in finance. Our review of loan funding report over the next 60 days shows continued good activity right in line with previous quarters. Regarding asset quality, there's not much more to say beyond that Andy's comments and what's in the earnings release, things from my perspective, continue to look very good. Credit metrics are solid, loan delinquencies, which were at roughly loans at the end of Q3 or even low in December. That's my recap in the fourth quarter in 2022. We're planning on continued growth and meeting our goals and objectives going into 2023 from the lending side, we have a number of priorities, some of which we have previously announced, but which really haven't had a chance to positively impact performance yet. Obviously, number one on our list is the pending merger with Malvern that's the top priority when we discussed that on previous calls. We have a new regional office and opening up in Westchester, Pennsylvania right before the end of first quarter here. Right now, we're running that market out in a very small space on the 1st floor of a building downtown. In a few weeks, we're going to the full service bank branch in Westchester, which will provide room to grow as well as be a better retail location drive up et cetera. Similarly, in Northern New Jersey, we've located a new Northern regional office in Essex County. We are tentatively scheduled to have our relationship management team in the new space by the end of the quarter with retail space to follow in Q2. Late last year, we announced our equity fund banking initiative, lending to private equity funds in our market. This team is doing well, and that's a strong pipeline. Pat and Andrew mentioned SBA lending. I'm satisfied with the results the team had in 2022 despite the impact on sales of the guaranteed portion of 7(a) loans. We expect even better performance this year in SBA, and we're looking to add to staff there if we can find the right people. I'm also happy to report that we've recently hired seasoned banker to build out and develop an asset-based lending team that made reference to that in his comments. This person has many years of experience in asset-based lending and in our market and will add to our product set. We expect the team to be up to running by early second quarter. So we're excited about all these projects, each in its own way will enable us to continue to grow successfully in 2023 and years to come. And that concludes my report for lending. I'll turn things back over to Pat for some final comments.

Thank you, Peter, and thank you, Andrew. At this point, I'd like to open it up for the Q&A session for the call.

[Operator Instructions] The first question we have on the phone line comes from David Bishop of Hovde Group.

Pat, question for you. I think you noted you exited the year a little bit flush with cash. Was there -- and obviously noted the decline in DDA balances. Was there any [indiscernible] aggressive maybe sort of prefund some of the loan growth in 2023 and trying to get ahead of the market further rate increases and just be a little bit more aggressive to position yourself from a liquidity perspective of kind of 2023?

Yes, listen, I think there's always a variety of reasons why certain actions are taken. I mean, the practical reality is you put a product out there or you tweak a rate and you don't know exactly the extent of the activity it will generate. And I think as we were taking a look at our product design and setting our rates, and we thought there might be an opportunity if we were going to err on the side of one or the other, we wanted to maybe bring in a few more dollars than not enough dollars. And that's ultimately how it played out. I think we put out rates that at the time were decent rates. I think they've subsequently been surpassed by competitors based on subsequent Fed moves, but it did give us an opportunity to retain business that was getting competitively corded, if you will, and then also bringing some additional dollars. And listen, to your point, will we love highest margin possible, you don't want to play gains on the liquidity front. You have to make sure you're dealing from a position of strength on the liquidity side. So yes, that obviously plays a role.

And I'm just curious, Pat or Andy, when you look at the overall cost of deposits maybe from -- I don't know if there's a way to quantify or are you seeing maybe that trending to over the next couple of quarters and what you're seeing in terms of average loan yields under production.

Yes. I mean, great question. Obviously, we have visibility into rates that are currently being offered and what's that generating in terms of new business. The piece that's a little harder to forecast is money that's been sitting on the sidelines, folks that maybe don't need it in their operating accounts that when yields were low, they didn't want to bother making the move over. Now those folks are looking to put some of that money to work either with us at a higher rate or into the market. And I think we saw a fair amount of that happened in Q4. Our hope is a lot of the money that was looking to move, made the move and that what we'll see going forward will be significant reductions in that shift out of NIB into interest bearing. And at least so far in January, the noninterest-bearing balances are holding up. So a little hard to say with a lot of certainty, but we think every bank will reach a point where depending on their liquidity position, they may need to make a move. And when they make that move on the rate side, it will cause a short-term jolt, but then things will normalize. And I think we believe, based on the efforts we're making on the quarterfinal generation side that jolt came for us in Q4. And that's not to say deposit costs will continue to move higher, but we're optimistic they'll move higher at a much slower pace.

Got it. And then just one final question, and I'll hop back into the queue. Outlook for loan growth. Just curious, I mean, you're double digit this year. It sounds like a decent pipeline you think there's enough demand and bankable credits out there to support that or consider little bit from the low double-digit range.

Yes, sure, David. I think given some of our new initiatives and given what we're seeing in terms of significant slowdowns in terms of prepayments and payoffs I think hitting our plus or minus $200 million loan growth goal will be manageable. It will likely be done with less new business, right, maybe not as much churn as in prior years. And certainly, we expect it will be done a lot more with C&I and floating rate commercial deals and a little less on the commercial real estate side. But I just think because we'll see fewer payoffs and pay downs, achieving a net growth goal of in that $200 million range I suspect we'll do what we have.

Our next question comes from the line of Manuel Navas of D.A. Davidson.

Could you give a little bit more color on kind of the NIM trajectory? And I know you had your deal closing too and just kind of -- you have a little bit less pressure this coming quarter, what's kind of thought process after that?

Yes. Great question. I'd love to have better visibility than we do. Obviously, there's a lot of moving pieces right now, and it's a little tough to predict. I think we expect there'll probably be some continued pressure on the margin. We're sort of targeting a margin over the next couple of quarters is somewhere in the 3.50% to 3.60% range. We're going to or like to try to get it up closer to the higher end of that range, but that's sort of the best I could predict at this point. And then when you look out to the back half of the year, largely because of the idiosyncrasies of merger accounting, will almost certainly see a sizable margin pickup on the back end because of how you take the upfront marks and you accrete back into income. I don't know, you have anything you want to add there, but I know based on some preliminary numbers you are showing the margin. So in up quite a bit on the back half, but more a function of the merger accounting than anything else.

Yes, that's right. I mean, obviously, a lot will depend on the shape of the yield curve and what happens. It seems like the Fed is going to move a little bit more gradually here over the next couple of meetings, and we'll see what happens there. But yes, it's going to get a little complicated later in the year with all the purchase accounting. But we'll make sure to do a good job of disclosing the impact of the different purchase accounting things that are flowing through the margin. So you'll see that. But I think Pat's got kind of guidance on the margin coming down slightly again early in the year. And then hopefully, we get a little bit of a better yield curve over the back half of the year, and hopefully, we can kind of maintain that kind of core margin. And then with the Malvern integration, you'll see some significant fluctuations because of those interest rate marks that get accreted back into interest income.

That's really helpful. I -- you kind of talked a little bit about deposit costs in a big picture. Are you targeting certain data for the year? And anything that can kind of help with seeing where they're going to go? Or is it just such a moving target at the current moment.