First Commonwealth Financial Corporation (NYSE:FCF) Q4 2023 Earnings Call Transcript

First Commonwealth Financial Corporation (NYSE:FCF) Q4 2023 Earnings Call Transcript January 31, 2024

First Commonwealth Financial Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. My name is Aaron, and I will be your conference operator for today. At this time, I would like to welcome everyone to the First Commonwealth Financial Corporation Q4 2023 Earnings Conference Call. All lines have been placed on mute to prevent the background noise. And after the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn our call over to Ryan Thomas, Vice President of Finance and Investor Relations. Ryan, please go ahead.

Ryan Thomas: Thank you, Aaron and good afternoon everyone. Thanks for joining us today to discuss First Commonwealth Financial Corporation’s fourth quarter financial results. Participating on today’s call will be Mike Price, President and CEO; and Jim Reske, Chief Financial Officer; Jane Grebenc, Bank President and Chief Revenue Officer; and pinch hitting for Brian Karrip this quarter will be our Deputy Chief Credit Officer, Brian Sohocki. As a reminder, a copy of yesterday’s earnings release can be accessed by logging on to fcbanking.com and selecting the Investor Relations link at the top of the page. We’ve also included a slide presentation on our Investor Relations website with supplemental financial information that will be referenced during today’s call.

Before we begin, I need to caution listeners that this call will contain forward-looking statements. Please refer to the forward-looking statements disclaimer on Page 3 of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Today’s call will also include non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to and not as an alternative for, our reported results prepared in accordance with GAAP. Reconciliation of these measures can be found in the appendix of today’s slide presentation. With that, I will turn it over to Mike.

Mike Price: Thanks Ryan. I will begin with some fourth quarter highlights. We are pleased with our fourth quarter earnings per share of $0.44 with a 1.56% core ROA, a 1.91% core pretax pre-provision ROA, and a 53% efficiency ratio. Average deposits for the quarter grew 1.6% annualized and loans grew at 2.8% annualized. The loan growth was decidedly commercial with equipment finance leading the way. Our margin fell to 3.65%, lower than we had expected, driven by our customers’ expectations on deposit rates in our markets. While we are always focused on deposit acquisition, we’re just as focused on deposit retention. Still, our quarter-end cost deposits at 1.65% and remains strong relative to peers and the quarter-over-quarter increase in the cost of deposits slowed each quarter of 2024.

We had a constructive credit quarter with a $1.9 million release of reserves due in part to improvement in qualitative reserves and release of unfunded reserves. Net charge-offs totaled $16.3 million, however, all but $4.4 million had earmarked specific reserves that had been previously provided for. A good portion of the charge-offs were former Centric loans, stemming from our acquisition, which closed on January 31st, 2023. Essentially, our reserve levels ended the year roughly where they began in January of 2023 at 1.31% of total loans. Our non-performing loans fell $8.5 million to $39.5 million or 44 basis points of total loans and are back to where we started the year. With 2023 behind us, let me turn some time now over for year-over-year highlights.

We made $1.70 in core earnings per share, backing out merger-related items with a core ROA of 1.56%, a 2% core pre-tax pre-provision ROA a net interest margin of 3.81% and a 52.91% efficiency ratio. Tailwinds included well-controlled credit expense or organic deposit and loan growth, a bigger balance sheet due to the Centric acquisition, and higher interest rates. The latter three tailwinds drove a 24% or $73.6 million increase in net interest income to $386.9 million for the year. Headwinds included markedly higher deposit rates for the year and flat fee income. As we reflect on the year, we had good expense control and drove some additional cost savings through acquisition, which also helped operating leverage. We grew average deposits for the year at 12.5% and loans at 17.6%.

Excluding acquired Centric deposit and loans, Loans grew at 5.5% and deposits grew at 7.6% compared to the fourth quarter of 2022. Like many in our industry, our checking and basic savings balances fell, the growth in higher cost money market and CD balances more than offset the downdraft. However, the lower cost accounts did not attrite in number nor did the mix of deposits change meaningfully between the consumer business and public funds categories. Also, our business deposits outperformed our expectations. In our regional approach to deposit gathering and lending, we had a good year and carry momentum into 2024 in our three largest regions. Importantly, we navigated our sixth M&A opportunity, which we now call the capital region and are excited about what lies ahead for this market.

As we look through the year and into 2025 thematically, we will wake up every day and think about live the mission every day at all levels of the organization, grow our deposit funding and lending businesses commensurately and at the appropriate spread, improve in every region, line of business and support unit every year, become digital in every facet of our business, continue to invigorate talent, leadership and culture. and remain focused on operating leverage and efficiency. We had a strong 2023. We’ll continue to build on that success in a few important areas. Three of our regions are performing very well. The three other regions are just beginning to find their stride. Also, as the employment market has cooled some, we are continuing to attract some very talented bankers for key positions.

Given our talent offerings and leadership, we can grow C&I relationships. We’ve built solid offerings in our fee businesses and can create partner introductions. And lastly, our business mix drifted towards commercial banking this past year and we can do an even better job of gathering deposits in getting appropriately compensated for lending activities. The list could be longer, but the point is that effectiveness in the trenches with our core banking is really all about will in execution, and we’re enthused about the opportunity in front of us. Lastly, we continue to build out our core digital capabilities to include back-office efficiencies and customer-focused online and mobile banking enhancements for both consumers and businesses. In 2024, we will allow customers to aggregate their third-party bank accounts on the summary view within their first Commonwealth online banking profile.

This complete view of finances across institutions supports our core mission of helping our customers improve their financial lives. And with that, I’ll turn it over to Jim.

Jim Reske: Thanks Mike. Mike has already provided an overview of the year and a few financial highlights for the fourth quarter. So, I’ll just try to drill down into some detail on the margin and try to provide some additional guidance for you. Net interest income was down $2 million from last quarter, but our net interest margin or NIM came in at 3.65%, which compares quite favorably to peers. Looking back at the quarter, loan yields actually performed quite well and in line with expectations. New loans came on the books at 7.80%, which was 162 basis points higher than the loans that ran off. That increased loan yields by 10 basis points over last quarter, but that wasn’t enough to offset a 24 basis point increase in the cost of funds.

The increase in deposit costs was mostly due to continued movement of customer deposit balances into higher-yielding money market and CD accounts. The good news is that the pace of increases in the cost of funds continues to slow down. The 24 basis point increase in the cost of funds in the fourth quarter is lower than the 32 basis points increase in the last quarter, which is lower than the 48 basis point increase in the second quarter and the 51 basis point increase in the first quarter. We expect that slowdown to continue. And even with last quarter’s increase in the cost of deposits, our total cost of deposits in the fourth quarter was 1.65% and our total cost of funds was 1.94%, still in inviable position amongst our peers and a source of competitive advantage for us.

Our cumulative through-the-cycle beta to this point is only 36% in part because we started this cycle with a total cost of deposits of only four basis points. To sum up, we believe that our net interest margin has been holding up well and that our margin will come through the cycle in a strong competitive position. Looking ahead to the first half of 2024, the continued upward repricing of the loan portfolio is expected to roughly match the increase in the bank’s cost of funds. Even so, we expect net interest income to improve year-over-year compared to 2023. We would caution, however, that we expect a wider range of potential margin outcomes than usual due to the unpredictability of both rate movements and deposit behavior. Fee income was off by about $0.5 million from last quarter, mostly due to mortgage gain on sale income that was down by about that much, along with trust income that was down by about $400,000 due to tax receipts last quarter.

These were offset by SBA gains that were up by about $600,000 from last quarter. We expect fee income in the first quarter to be in line with the fourth quarter and for the year 2024, we would expect fee income to be roughly equal to 2023 as growth in SBA and other sources offsets the impact of losing approximately $6.2 million of interchange income due to the Durbin Amendment. As I mentioned, net interest income was down $2 million from last quarter, but that was neatly offset by a $2.2 million decline in expenses. The improvement in NIE was driven by a $1.2 million positive variance in the Pennsylvania share tax for the reversal of an over accrual of taxes we had accrued for the Centric acquisition. Our advertising spend was also down from last quarter by $472,000, but that’s mostly just timing.

We did, however, experience a $308,000 positive year-end adjustment to BOLI due to higher discount rates. In sum, we expect non-interest expense to run at about $68 million to $69 million a quarter in 2024, which is in line with consensus estimates. We provided some information on credit and charge-offs in the earnings release, but I wanted to provide some additional color on the call. We had $16.3 million in total net charge-offs $12 million of which have been provided for in prior periods. Of the total net charge-off amount of $16.3 million, $8.3 million was from loans acquired in our last acquisition and that group of loans had specific reserves from prior periods of $8 million, not the $6 million figure shown in the earnings release. The $16.3 million net charge-off total also included a $4.3 million charge-off of an individual commercial real estate credit, which is not an acquired loan and that loan had a $4.1 million specific reserve from prior periods.

Of our total $39.5 million of non-performing loans on the balance sheet, $14.6 million are acquired loans and those acquired loans at $4.6 million of specific reserves held against them. In fact, that $4.6 million of specific reserves represent the lion’s share of the $5 million of specific reserves left in the entire bank. We thought this additional detail might be helpful because charge-offs were elevated this quarter. However, given our business mix, our long-term view of a “normalized” net charge-off rate of around 20 to 25 basis points hasn’t changed. Turning to the balance sheet. Loan growth was augmented by securities purchases in the quarter, which brought up the yield on the securities portfolio. You may recall that we’ve been holding excess liquidity since the Silicon Valley Bank crisis in March, at which time we borrowed $250 million from the Federal Home Loan Bank and part — in cash.

We deployed some of that liquidity into securities in the third quarter and the rest of it in the fourth quarter and yield a little over 6%, Fortunately for us, just before yields started to fall. Capital grew by $73.7 million in the quarter as AOCI improved by $42.3 million in the quarter, and we retained $31.4 million in earnings after dividends and some buyback activity. We only bought back $978,000 in stock in the quarter, buying whenever our stock price dipped below $12.50. The combination of the strong capital growth and moderate balance sheet growth had a positive impact on capital ratios. Our tangible common equity ratio grew from 7.7% to 8.4%, while our CET1 ratio grew from 10.9% to 11.2%. Perhaps more importantly, tangible book value per share improved by 9% from $8.35 a share last quarter to $9.09 per share this quarter.

And with that, we’ll take any questions you may have. Operator, questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Daniel Tamayo with Raymond James. Your line is live.

Daniel Tamayo: Thank you. Good afternoon guys. We start first on just your NIM and net interest income guidance, Jim. I guess, first, what was the accretion in the quarter or purchase accounting accretion and just to make sure we’re on the same page, the guidance you gave is for stable is a stated NIM guidance, including accretion?

Jim Reske: Yes, this state including accretion. The accretion was 9 basis points in the fourth quarter, and we’d expect that to fade out by 1 to 2 basis points per quarter next year.

Daniel Tamayo: Okay. So, it’s coming off 1 to 2 basis points per quarter. So, you’re expecting really the margin to expand then over the next couple of quarters based on that?

Jim Reske: Yes, I mean the guidance is more for stability in the next couple of quarters, and that’s driven by the fundamentals of the change in the cost of funds in the yield on loans, which we think are going to roughly match. You can never pin it exactly and we’re just trying to give guidance within an appropriate range, but the larger factors or the cost of funds that the yield on loans are going to drive it much more than the fadeout of the yield on the purchase accounting.

Daniel Tamayo: Understood. And then, I guess, just following up on that. Just curious how you expect rate cuts to impact the margin when it would happen?

Jim Reske: Yes, so the rate cuts will affect us. We remain asset sensitive. Some of it depends on the timing of the rate cuts and the speed of the rate cuts. So, think of it this way. The portfolio we’ve disclosed we talked about this all the time, but the loan portfolio is about half fixed and half variable. So, when the rate cuts happen, they hit the variable portfolio right away and then the fixed portfolio ex is an offer. But the fixed portfolio, that’s been repricing upward and has been repricing upward even without rate hikes for the last half of last year. So, that’s — when I disclosed in the prepared remarks, the 162 basis points of positive replacement yields that’s largely a fixed portfolio repricing upward because the variable proposal is already repriced.

So, with 162 basis points of upward repricing in the fixed portfolio, you could probably have a few cuts and still have upward repricing in the fixed portfolio which we like as a buffer on the way down and an offset to some of the impact of the rate cuts on the variable portfolio, but those are to offset each other. But generally, we are still — we disclose asset sensitivity in our regulatory filings on — based on parallel cuts. But we’re still asset sensitive. And at some point, the cuts will overtake the pricing on the fixed side of the portfolio. Just one more comment, if I can. The other side of it, of course, is the liability side of the balance sheet and the deposit behavior. And without any cuts taking place yet, just the threat of cuts in the handouts, we’ve already seen some easing up of competition in our market.

So, some relief on the deposit pricing side. And — but that takes some time to bring the cost of deposits down. So, hopefully, that gives you a little color on how to play.

Daniel Tamayo: Understood. No, that’s helpful. I mean, so you don’t have a kind of an explicit budget or thought into how much the margin would move for cut, I guess, putting everything that you talked about in terms of variable rate loans and deposit repricing together. I get that it would be steeper at the beginning and then there’d be some kind of catch-up on the funding side. But is there like an all-in type of NIM compression that you think it would be useful in modeling?

Jim Reske: Yes, we used to say rule of thumb 5 basis points per cut, but that was when deposit behavior was much more stable as it is now. So, I’m not sure that rule of thumb holds very well. And given where we are in the cycle and I think there are other dynamics at play that the rule of thumb doesn’t really hold that well anymore. Our own internal forecast is not blind to rate cuts. We’ve put in from based on forecast we purchased blended forecast that has the Fed funds rate end of the year at 4.25%. I think that was 4.25% at the time we did our budgeting exercises. And if you get it today to be 4%. So, we anticipate declines. We just think give us some stability because of all these offsets going on for the first half of the year. But if the Fed funds rate goes ends the year at 4.25% by the end of the year, there will be NIM compression.

Daniel Tamayo: Okay. All right. I appreciate all the color, you taking my questions. Thanks Jim.

Jim Reske: You bet. Thanks Daniel.

Operator: Thank you. Thank you for your question. Our next question comes from the line of Karl Shepherd with RBC Capital Markets. Your line is live.

Karl Shepard: Hey good afternoon. Maybe to start again on the margin. Jim, could you just talk a little bit about your level of confidence in the cost of funds increases slowing? I know you mentioned competition easing a little bit. But just kind of what are you seeing that makes you a little bit more confident this quarter that we’re getting to the end of it?

Jim Reske: Well, so looking at the pattern of decreases over the past, it’s kind of rattle them off during the prepared remarks, it’s just been coming down. So, I think that next quarter as the cost of deposits should will still be increasing even if rates cut, but that should slow down to the 10 or 15 basis point range. So, 10 to 15 basis points of increase — continued increase in the cost of deposits, even with easing up of pressure in the market, even with rate cuts still some increase in the cost of funds is more deposits seek higher rates. But that’s the slowdown that I’m anticipating and kind of the reason why. And that roughly matches what we anticipate 10 to 15 basis points increase on the benefit of increasing loan yields even in that kind of rate environment.

Part of what helps us is that we’ve already kind of tried to structure the maturities and the deposit look fairly short. About two-thirds of the CD book will reprice in calendar year 2024. And we have money market specials like everybody else. There’s six months max on money market specials. So, there’ll be opportunities for us to reprice the deposits downward. So, all that is baked into the thinking. I hope that helps a little bit.

Karl Shepard: Yes, definitely. And this is probably more of a Mike question, but you sounded pretty optimistic. Can you sketch out some of your loan growth expectations for the year? And do you think it will be commercial-led again?