First Commonwealth Financial Corporation (FCF) Earnings Call Transcript

[Audio Gap] [Operator Instructions] I will now hand the conference over to Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Jonathan, and good afternoon, everyone. Thanks for joining us today to discuss First Commonwealth Financial Corporation's third quarter financial results. Participating on today's call will be Mike Price, President and CEO; Jim Reske, Chief Financial Officer; Brian Sohocki, Chief Credit Officer; and Mike McCuen, Chief Lending Officer. 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 have also included a slide presentation on our Investor Relations website with supplemental information that will be referenced during today's call. .. Before we begin, I need to caution listeners that today's call will contain forward-looking statements. Please refer to our forward-looking statements disclaimer on Page 3 of the slide presentation for a description of risks and uncertainties and 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. A reconciliation of these measures can be found in the appendix of today's slide presentation. With that, I will turn the call over to Mike.

Thank you, Ryan. Good afternoon, everyone. Core earnings per share totaled $0.45 for the third quarter. There were 2 unrelated offsetting financial events this quarter. These results included $4.7 million of onetime energy tax credits equivalent to $6 million on a pretax basis. These tax credits helped offset provision expense that came in at $14.2 million. The provision figure includes $3.5 million associated with the unfunded loan commitments reflective of strong production this quarter in committed lines. The other $10.7 million represents provision for loan losses, driven principally by approximately $7.7 million of specific reserves associated with 3 previously identified credits. Nonperforming loans increased, but the increase was also concentrated in a limited number of previously identified relationships rather than broad-based portfolio deterioration. Beyond those 2 events, the operating trends of our core businesses are strong. The net interest margin increased to 4.1%, supported by a decline in deposit costs to 1.67% and the impact of the Fed's latest hike on our variable rate loan portfolio. Additionally, consumer and commercial loan origination throughout the third quarter increased year-over-year. Loan payoffs also slowed for the first time in 5 quarters, leading to annualized loan growth of 2.6% in the quarter. Together with current backlogs, these trends support the outlook for loan growth within our mid-single-digit guidance. A 3 principal areas of focus for the near term include better credit performance, generating profitable growth and controlling expenses to create positive operating leverage. The latter becomes vital to investment in the future of our company. Our 2027 investment plan includes opportunities in technology, talent, marketing, fraud prevention and improved banker productivity, lead generation and financial analysis. Lastly, we believe a mission-driven community bank of our size remains important and relevant to our customers, communities, employees and investors. And with that, I'll turn it over to Jim.

Thanks, Mike. Mike provided the broad brush strokes of our financial performance this quarter, including credit. So I'll spend my time drilling down into our results to help you get a better understanding of the long-term run rate of our financial performance. The credit story is important, but I don't want to overshadow positive trends in our net interest margin, spread income, balance sheet growth and our fee income trajectory. Before I walk you through those things, however, I want to spend a moment addressing the impact of the tax credits and the buyback on the quarter. First, the tax credits. We have, for many years, purchased credits against our income tax but this was our first foray into federal energy tax credits. We started looking at these tax credits in the second quarter this year, and we purchased just over 50 million in credits in the third quarter. Those credits will be applied towards our federal tax liability for tax years '25 and 2022. That resulted in the recognition of $4.7 million in tax benefits in the third quarter. We intend to purchase credits going forward, including for tax year 2026. And with that purchase, we will purchase additional credits that we can carry back to 2023 and 2024. Once that's done and assuming the laws affecting the transferability of federal renewable energy tax credits don't change, will let it settle into a rhythm of purchasing tax credits like this every year. We think this could bring our effective tax rate down by approximately 1 to 2 percentage points, which might be worth about $0.02 per share per year, but it's heavily dependent on the terms of each deal. The other major event of the quarter we're talking about was the full execution of the previously announced $75 million buyback program. We came into the quarter with about $13 million of share repurchase authority from our previous program. Combined with the new authorization, repurchased approximately $88 million of stock during the quarter at an average price of $21.18. That helped rightsize the tangible common ratio from 9.9% last quarter to 9.2% this quarter. That, in turn, contributed to the expansion of our core return on average common equity to 15.90%, up 24 basis points from last quarter despite the elevated provision expense this quarter. We are also pleased to announce that our Board has authorized an additional $25 million in repurchase authority. We intend to recommence share repurchases next week once we come out of blackout. Beyond the tax credits and the buyback, however, there are positive fundamental trends in our revenue that are worth talking about. Our net interest margin or NIM expanded by 10 basis points from 4.01% last quarter to 4.1% this quarter. We were able to decrease deposit costs by 7 basis points last quarter. The September rate hike came too late to have much benefit on loan yields in the third quarter. But loan yields in the third quarter were held back by the reversal of accrued interest on nonaccrual loans, which created a drag of approximately 4 basis points of NIM in the third quarter. Looking forward, with no further changes in rates, which means no hikes and no changes in the shape of the yield curve, we would expect our NIM to rise to around 4.20% in the fourth quarter and continue to rise into the mid-420sin 2027. We all those estimates are give or take 5 basis points as perusal. I'd also point out that if not only NIM that is a good story for us, but our net interest income increased as well by $3.9 million last quarter, an annualized rate of approximately 13.7%. Fee income was unchanged from last quarter, but that's only because real progress in core fee items such as wealth, mortgage and back-to-back interest rate swaps was offset by the loss of $1.3 million a second quarter onetime gains we didn't have this quarter. Our previous guidance for fee income to range from $24 million to $25 million per quarter remains unchanged for the fourth quarter. Expenses were up to quarter but were impacted by several discrete items. We incurred a $0.6 million write-down on the extension of a long-term lease, but it will save us money in the long run. In addition, we received a $0.5 million reimbursement from the vendor last quarter that we obviously didn't have this quarter. Those 2 items together accounted for about $1.1 million of the quarter-over-quarter swing in expenses. The other major increased expense items included incentive accruals primarily related to increased loan production and our FDIC assessment costs. Looking ahead, our previous guidance of $74 million to $76 million per quarter remains unchanged for the fourth quarter. We will provide updated noninterest income and expense guidance for 2027 in January as we have done in the past. With that, we'll take any questions you may have.

[Operator Instructions] Your first question is from the line of Kelly Motta from KBW.

This is Megan Mens on for Kelly Motta. So your deposit costs trended lower, very good trend. And so I was just sort of wondering how sustainable you guys thought this was in a higher rate environment and with any competition? And last rising rate cycle, your deposit beta was just under 40%. So any thoughts on what you thought that was going to be in the next set of hikes?

Jim, you start.

Yes. I'll just offer a couple of thoughts on that. One is we do see deposit competition heating up and our long-term goal is to grow our deposit base commensurate with our loan growth. So we look for mid-single-digit loan growth, we would like to fund that consistently with deposit growth to keep our loan-to-deposit ratio where it is now in the low 90s. And that means we have to pay market rates for those deposits with the competition heating up in a rising rate environment, we expect our beta to be consistent with the way we calculated our historical beta of 25% with CapEx that are nonmaturity deposits, interest-bearing deposits, not including time deposits. We do a lot of -- we actually pay outside vendors to look at our deposit base to kind of accurately assess where our deposit betas have been in the past, so we can have a good estimate for the future, but that's the estimate we're using about a 25% deposit beta. So hope that please answer some of your questions on Mike, you want to add?

It's a bimonthly exercise. Every other week, we are getting together as a team and trying to understand the texture of exactly what you're talking about. And where we might attract some money and also how we might manage that for margin. It's a fun conundrum.

Okay. That was helpful. And then I also -- like you had very strong noninterest-bearing deposit growth and time deposits came down. So can you sort of provide more detail on the drivers of that as well as upcoming maturities in CDs in the next quarter and the rate they're maturing versus the new offering rate?

Yes. A couple of thoughts. We do the last 18 months or so, we had CDs at shorter-term maturities, but every bank was doing that. So nothing really new there. We're kind of keeping a term short and that was working. Earlier this year, we started going a little bit longer. We had some doubts whether a 15-month CD would attract customers and balances because customers simply don't like to go beyond 12 months, but it worked very well for us. And that was probably because we had a very strong customer perception of a falling rate environment. So if you saw a good rate at a longer term, it will be on 12 months, we are able to gather funds in those accounts. Now there's a shift in the customer sentiment towards a rising rate environment, so it's harder to get customers to do that. But the way the structure we have -- a number of CD maturities coming up soon. I wouldn't call it a cliff or anything that's unmanageable. But because those rates were short now, a lot of those seeds are maturing, and we're dealing with that as they come. Our CD retention rate has been fairly consistent over time. We're -- I don't think it's that different industry averages. We're able to retain about 80% of the CDs that mature. The 20% that don't generally tend to stay with the bank, they go into money market accounts or something else on as those rates are close. The 80% of do stay, about half of those will want the current special rate, whatever that is, and the other half will roll to the retention rate we're offering them. That whole process works, and that's a lot of the way we manage the rate cost -- the deposit cost of the bank, that's worked well.

Yes. I'd just add that the texture of our depository on the noninterest-bearing side is about 2/3 commercial. And so a lot of that might be more seasonal. And it's really overall though, about 2/3 consumer when you consider time and noninterest-bearing and now. And that's really at an average size, it's much smaller. So it just doesn't have -- it has a little less pressure there, and that's really good for us. So we have really a consumer-oriented granular depository that's really served us well through the last 2 cycles.

Okay. And then just 1 more. You were active on the buyback this quarter, and I know you said that you were going to resume them next week. Could you give any like color on the run rate or put in numbers to it? Or is that all we get?

Yes. I just -- we announced because our Board authorized did a $25 million authorization. And then 1 of the reasons we do it in $25 million chunks like that, unlike the 1 we did last quarter with the $75 million is that, that allows us to do the repurchase just due to the amount of retained earnings we have after paying a dividend to shareholders. So we don't want to telegraph in advance because we don't always know in advance. And even if we do, we wouldn't want to say it is the precise timing of when we do those kinds of buybacks. I just can tell you that we'll be back in the market next week and so we'll be active in the buyback.

Your next question comes from the line of Daniel Tamayo from Raymond James.

Maybe just starting on the credit side, if you can just kind of touch on your thoughts on the path of resolution for the increase in the NPLs and the classifieds?

Yes. I'll turn it over to Brian, but I would just share with is, we had 3 identified credits that made up the bulk of the reserve -- specific reserves this quarter, they were identified. We still have probably about 20% of our criticized is really from our entree into Central Pennsylvania. So that's outsized, and we continue to work that down. And the complexion of that is probably about $60 million of $300 million or so criticized. There's just 1 larger loan in there that's about 10 and probably 1 over 5. And then after that, it's pretty granular. Brian, what would you add?

No. That's your good comments, Mike. And Obviously, the classified increase specifically this quarter. It was the result of the migration of 2 of the larger loans that moved into NPL. And generated reserve. The third loan was already a nonperforming loan that had some incremental reserve. So if you look at the increase, it was specific to these identified credits. To your question specific to the future, obviously, the resolution of those is our key focus, and that will drive the classify the nonperforming and the reserves moving forward. To Mike's point, importantly, we're not seeing broad-based deterioration with new credits moving into the category. As you drill down into criticized loans and watch loans, our OAEM actually decreased by $25 million this past quarter, while the classified increased by $26 million. It's there where you really see the transition, the migration from the criticized into the classified. And when you drill down further into the watch loans, we're down over $100 million year-to-date. So we're seeing good portfolio performance on the front end. And our focus here over the next coming quarters will be resolution of the nonperformers. At quarter end, we felt that the reserve was appropriate based on the collateral valuations. Each of those loans, as you would expect, is in different stages of collection and resolution and that will be our short-term focus.

Okay. And then I guess my follow-up would be just on the C&I loan growth side. We had, I guess, an inflection in growth this quarter. Just curious your thoughts around ability to continue the trend there as we look forward.

Yes. We feel like we're turning the corner. I would say that in fairness, some of that does include our equipment finance group, which has slowed down a bit. But we do have traction in our regions. And a focal point is C&I lending, both larger, all down small business and business banking. And it also remains a focus because those are cornerstone relationships that have a repeat with household value. So that is where our ground game is focused. And is a key for our growth. However, that being said, as we look to the future, we have 6 lending buckets. We have HELOC -- loan out of the branches. We have mortgage, we have indirect auto. On the commercial side, we have CRE, C&I and then equipment finance. And we really want broad-based growth across all of those 6 categories and relationship value where we can get it. And so we're not looking for 8% or 10% growth in some category to pick it up. We've had years here. We had 2 or 3 years where we grew every region and every product line. And that's ideally how we'd like to grow it.

I appreciate that, Mike. And then maybe lastly, just on the on that loan growth topic again and probably more on the CRE side, but feel free to answer for any of the buckets. Just curious your thoughts on higher rates, kind of where we are and where we could be into next year, the impact that could have on the demand side?

I think it will dampen demand. Mike, if anything you want to add?

No. You're right, Mike, it will dampen demand. What it comes just to that question.

Yes. And it will dampen demand, particularly on the commercial real estate side, I mean, half point a full point is going to just make some projects unfinanceable and/or maturing loans that much tougher. That being said, Jim, we have if rates do continue to go up, there's a beta on the short end and also on the longer end of the curve and replacement rate provided the volume can stay up there. Anything you would add?

Yes. No. I mean, I think just on that topic, any -- what you're asking about, but the rate environment is a real goal to lock for us right now. It does allow us to continue to be pricing up for the fixed rate loans. So even if there's no if you don't meet our loan growth targets mid-single digits, and they've always been pretty modest. So we think they're achievable. That's what we're planning on now. But if we can, we see we price up for the book, which just works in our favor.