ESCO Technologies Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
January 26, 2024

There are 12 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the BankUnited Financial 4th Quarter and Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised today's conference is being recorded.

Operator

Would now like to hand the conference over to your speaker today, Susan Greenfield, Corporate Secretary. Please go ahead.

Speaker 1

Thank you, Kevin. Good morning and thank you for joining us today. On the call this morning are Raj Singh, our Chairman, President and CEO Leslie Lunak, our Chief Financial Officer and Tom Cornish, our Chief Operating Officer. Before we start, I'd like to remind everyone that this call may contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflects the company's current views with respect to, among other things, future events and financial performance. Any forward looking statements made during this call are based on the historical performance of the company and its subsidiaries are on the company's current plans, estimates and expectations.

Speaker 1

The inclusion of this forward looking information should not be regarded as by the company that the future plans, estimates or expectations contemplated by the company will be achieved. Such forward looking statements are subject to various risks and uncertainties and assumptions, including without those relating to the company's operations, financial results, financial conditions, business prospects, Growth strategy and liquidity, including as impacted by external circumstances outside the company's direct control, such as adverse events impacting the financial services industry. The company does not undertake any obligation to publicly We update or review any forward looking statements whether as a result of new information, future developments or otherwise. A number of important factors could cause results to differ materially from those indicated by the forward looking statements. These factors should not be construed as exhaustive.

Speaker 1

Information on these factors can be found in the company's annual report on Form 10 ks for the year ended December 31, 2022, and any subsequent quarterly report on Form 10 Q or current report on Form H-8 ks, which are available at the

Speaker 2

Thank you, Susan. Good morning, everyone, and thank you for joining us for the earnings call. About 9 months ago, Right after March Madness, the Q1 earnings, we kind of laid out for you what our short term strategic imperatives are. And they roughly were we would summarize them by saying improve the balance sheet to then improve the P and L and improve the balance sheet MACE. On the left side of the balance sheet, it relied less on resi and bonds and more C and I and CRE growth.

Speaker 2

On the right side of the balance sheet, rely more on core funding, defend DDA. And if we did all that, margin would expand and of course, keep expenses in check and keep credit front and center given that we're in uncertain times. So over the last couple of quarters, we kind of laid out for you how we did against those stated goals. I'm happy to announce the Q4 of 23 was the continuation of that story. Deposits grew nicely, dollars 426,000,000 despite the fact that includes a couple of $100,000,000 of brokered coming down.

Speaker 2

So excluding brokered, our deposits grew $604,000,000 NIDA was down versus a seasonal adjustment, literally happened in the last 2, 3 days of the quarter. Average EDA were actually down only $28,000,000 but period end, we're down more. And on Wholesale funding came down as it did last quarter. FHLB brokered, everything was down. And on the left side of the balance sheet, Just like last quarter, resi loans came down $172,000,000 bonds also came down 100, But we have growth in our core segments, C and I and CRE as well.

Speaker 2

I was actually at the beginning of the quarter, I So seeing like it might be a flat quarter for CRE, but it also grew. So total between C and I and CRE, we grew $476,000,000 On credit by the way, all this led to margin expansion again. So margin expanded from $2.56 last quarter to $260,000,000 And if we keep doing this margin, we'll keep expanding, and we'll talk about next year in a little bit. Let me just go through the rest of the Q4 first. NPAs, on the credit side, that's an NPAs tick down from 40 basis points to 37 basis points.

Speaker 2

And if you flew SBA loans and it's actually at 25 basis points. The NPAs are getting to a place where they're so low that it will be harder to drive them down. Charge offs, 9 basis points for the year. If you compare that to last year, I think we were 22 basis points, if I remember right. So charge offs for the full year have been fantastic.

Speaker 2

And we build reserve again a little bit this quarter. I'm sorry, I still keep calling it reserve, I mean ACL. Yes. So 82 basis points, it was 80 basis points last quarter. Chris, I think, assets did increase this quarter as you would expect this time in the cycle.

Speaker 2

But overall, in credit, with charge offs being where they are, NPAs where they are and our reserve for ACL being where it is, I'm sleeping very well at night. Capital is robust. SEK1 is now 11.4 percent and TCE to TA also is now at 7%. Unrealized losses in the securities portfolio improved by over $100,000,000 and AOCI net of tax improved by 50,000,000 So and our liquidity position stayed strong. So that's almost become a moot point at this juncture.

Speaker 2

So by the way, there were a couple of sort of notable items in the P and L, which we highlighted in the earnings release. The FDIC assessment, which You guys all knew about $35,000,000 And also, we sold some railcars this quarter, and that was a $6,500,000 charge. This actually helps us avoid some expenses in the coming quarters, which the $6,500,000 is significantly less than the expenses that we avoid if we had not sold these railcars. So some retrofitting So I'm happy about that as well. So what are we seeing in the marketplace?

Speaker 2

The marketplace, dare I say, we're seeing A soft landing where we're seeing sort of the perfect sort of thing, which we're all worried that the Fed will never be able to achieve, but they might be actually Achieving that. On Main Street, we're not seeing a slowdown. We're not seeing a slowdown in either loan demand or in margins. We're not seeing concerns in the credit beyond sort of the day to day concerns that we always have. So we're seeing a pretty decent economy, especially in Florida.

Speaker 2

We're seeing a pretty strong economy and beginning to feel more optimistic than even 3 months ago. With that in mind, I would say that for 2024 guidance, What we will say to you is given what we see the economy and the rate environment, it feels like This year, the strategy is going to stay the same by the way. It's to improve the left side of the balance sheet like I just described, we've been doing over the last couple of quarters, the last three quarters and also improving the right side of the balance sheet. So we finished our planning for the year just a couple of weeks ago. And what it comes out to is high single digit growth in deposits, not including brokers.

Speaker 2

So brokers would actually want to take down Consumer take down FHLB. And on the lending side, again, on the C and I, CRE front, high single digits growth. Resi will continue to shrink probably similar to the amount that it shrank this year, give or take. And NIDDA is where the focus will remain. And we'd like NIDDA to get back over 30% Probably it's hard to say when that will happen, but we certainly are gearing the whole company up to shoot for that to get back over 30 over time.

Speaker 2

It may not happen in a year, it may happen in a couple of years, but that still will be the most important thing we'll be chasing. Margins should continue to improve. I mean the Q1 will probably be flattish, give or take, 1 or 2 basis points. But after that, margin is a steady increase up into all of this year and into next year. And expenses will be mid single digits in terms of expense growth.

Speaker 2

Am I missing anything? You can fill in if I'm not seeing anything else. And in terms of capital, at least this is the question that will come up, the very first question, so I might as well answer it. So for the time being, we stay on the sidelines with share repurchases. At the February Board meeting, we'll talk about it again with the Board.

Speaker 2

I think Short term, that's going to be our stand. In the medium term, it will probably change. But we need to see a little more time before we get back into capital repurchase. There is a dividend discussion that is coming up in February, and I do expect the Board to act positively at that. With that, let me turn it over to by the way, I'm recovering from a cold, so I tend to lose my vocal cords after a while.

Speaker 2

So If I speak less, it's not because I don't want to. I love speaking. But just as a disclosure, I may have to stop. But Leslie, I'll turn it over to you.

Speaker 3

Okay. Thanks, Raj. So

Speaker 4

first off Let's get off there, Raj.

Speaker 3

Yes, I got a little confused there. I'll start a little bit on the deposit side. So as Raj mentioned, we were up $426,000,000 for the quarter in non brokered. Total deposits were growing by 604, excluding the non broker piece. The overall pipeline for deposits still continues to look Very robust.

Speaker 3

Our near term pipeline is about $1,000,000,000 which is heavily dominated by Operating account business and NIDDA business in line with Raj's comments about continuing to emphasize That business, that pipeline has remained strong for a couple of quarters now, and I think it looks very good as we head into the 1st part of 2024. On the loan side, overall loans grew by $277,000,000 for the quarter. As Raj outlined, consistent with strategy, resi did decline by $172,000,000 CRE was up by 77,000,000 For the quarter, we were happy with that growth. The C and I growth across all segments, lines, geographies, specialties was up almost $400,000,000 $399,000,000 for the quarter. So that was an excellent quarter for us in the C and I area.

Speaker 3

And mortgage warehouse was also actually up a bit for the quarter. We're starting to see some recovery in that sector as rates trended down and we saw a bit more activity on the residential side. As Raj indicated, franchise equipment and admissible finance were down modestly and those will probably continue to trend in that direction for 2024. We're optimistic about the growth of Core C and I and CRE For the year, we are, I think, blessed to be in excellent markets and excellent individual geographies. I think we've got great talent, groups of people in the right places in the specialties in Florida, the Southeast, our office in Dallas now, In many parts of the company, we're just seeing very, very good growth opportunities on the C and I side.

Speaker 3

We have an extremely robust C and I pipeline in all areas of that corporate banking, commercial and the small business unit, we're just good quality opportunities across the franchise. We do think as we look towards the latter part of the year, we did have CRE growth for the year, I think we're pretty well positioned from a CRE perspective as we head into the year given that Our overall numbers in the CRE portfolio are fairly modest at 23.6 percent of total risk based capital Of loans, I'm sorry, total loans

Speaker 2

and 13%

Speaker 3

of construction on total risk based capital. So We've got plenty of opportunities in the future. The market now at rates where they are is a bit muted, but also as we talk to clients looking towards the latter half of the year, we do see opportunities with clients that have capital at play and I think compared to other banks that have much larger pre and construction exposure issues. I think we'll be in a good position to selectively take advantage of some good quality opportunities as we get to the second half of the year if the rate market performs the way it's expected to perform. So with that, let me spend a few minutes on the CRE portfolio.

Speaker 3

You also have greater detail in Slides 12 through 14 of the supplemental deck where we've provided additional disclosure. So the CRE portfolio does remain modest at 23.6 percent of total loans. CRE to total risk based capital is 169%, well below the regulatory guidance threshold. At December 31, the weighted average LTV of the CRE portfolio was 56% and the weighted average debt service coverage ratio was 1.80. About 16% of the CRE portfolio matures in the next 12 months and about 8% matures in the next 12 months in its fixed rate.

Speaker 3

Everybody's favorite topic is office. So let's talk a little bit about office. Specifically, we have just a little under 1,800,000,000 Of office exposure, majority of that is in Florida. Within that, a little over $300,000,000 is medical office building so that we think that asset class will perform differently. It is in a much stronger position than kind of office sort of nationwide.

Speaker 3

So our overall traditional office portfolio is around $1,500,000,000 During the quarter, we had payoffs totaling $88,000,000 In the office portfolio, including what had been our largest office loan in the overall portfolio that went to the CMBS market at the end of the year. Our total office exposure was down $78,000,000 for the quarter. It was also down in the 3rd quarter by $30,000,000 So we're down $108,000,000 in the last two quarters of office exposure, which is significant as a percentage of the overall. Consistent with the prior quarter, the weighted average LTVA of the office portfolio was 65%. Weighted average debt service coverage ratio was 1.7 at December 31st.

Speaker 3

We've provided some of the breakdown of those numbers by geography on Slide 12. Substantially all of the portfolio was performing and 92% was pass rated at December 31. Overall, the portfolio continues to perform well is characterized by strong sponsors who are supporting underlying properties generally with low basis in the underlying properties and we do not expect much in the way of loss content from the office portfolio. As I mentioned, 60% of the office portfolio is in Florida, where demand in demographics continue to be generally favorable substantially all of the Portfolio is suburban. There's some charts on Slide 14 that give you some further geographic breakdown of Florida and the New York Tri State portfolios by the submarket.

Speaker 3

Just as a side story, I was in West Palm Beach last week visiting a private equity client in their office building at Downtown West Palm Beach. I pulled into the building and could not find a parking space and had to leave the building and go find public parking somewhere else. So I thought that was pretty good indicator of the health of the office market in that particular geography that we're in. With respect to the New York Tri State portfolio, 42 percent is in Manhattan, which totals approximately $180,000,000 Our Manhattan office portfolio has 96% occupancy in a 12 month lease rollover of 3%. The remainder is in Long Island and the boroughs and the surrounding tristate area.

Speaker 3

Overall, rent rollover in the next 12 months is a small portion of the portfolio at 11%. Dollars 146,000,000 of CRE office were rated below pass at Twelvethirty onetwenty 3. This compares to $90,000,000 at ninethirtytwenty 3, an increase of $56,000,000 Most of this increase is a result of tenants vacating space In some buildings, which is putting pressure, at least temporarily, on cash flows and increased insurance cost and interest rate costs are part of it. There is in most office buildings today, there is a phenomenon even if you re lease The space you have a concessionary period of time and generally unless it's a very short period of time, 90 days or less, we don't count That cash flow, even if we have an investment grade tenant signed up to replace that. So we are seeing some of this turnover in the portfolio and we'll work through parts of this.

Speaker 3

With that, I'll turn it over to Leslie for more details on the quarter.

Speaker 5

Okay. Thanks, Tom. So net income from the total was $20,800,000 or $0.27 per share, obviously impacted by the FDIC special assessment that was $35,400,000 pretax. We also sold or in some cases entered into agreements to sell some railcars at VFG for a loss of $6,500,000 that compares to a gain of $4,200,000 on similar transactions last quarter. So you see a pretty big $10,000,000 swing in fee income quarter over quarter, but it's pretty much all related to those railcar sales.

Speaker 5

There may be some more of this over the next few quarters, but we don't expect it to net out to anything material in the aggregate in terms of gains and losses, although it could be, it won't be. NIM was $2.60 for the quarter compared to $2.56 last quarter. Earning asset yields went up from $5.52 to $5.70 The yield on securities increased $5.48 to $5.73 there were some coupon resets in there. Some of these things only reset quarterly or annually. So we're still seeing coupon resets through the portfolio and some retrospective accounting adjustments.

Speaker 5

The yield on loans was up from 5.54 to 5.69. Cost of deposits was up 22 basis points to 2.96. I'll mention that that 22 basis point increase this quarter compares to a 28 basis point increase last quarter. So for the last several quarters now, we've seen that rate of increase slow quarter over quarter, which is a good sign. Average cost of SHLB advances was pretty much flat, but the average balance was down almost $500,000,000 and that also contributed positively to the margin.

Speaker 5

A little bit more about 2024 guidance following up on what Raj said. We do expect the NIM to overall in 2024, although Q1 will likely be flattish, maybe down a little, maybe up a little. I do want to say, I know there's a lot of curiosity about this. NIM expand the forecasted NIM expansion is a result of what we're doing on the balance sheet. It's a result of the transformation that we're doing on both the left side and the right side of the balance sheet.

Speaker 5

It actually doesn't have much at all to do with whether there's 2 cuts, 3 cuts, 6 cuts. That's not going to change the picture. The static balance sheet is pretty neutral. It's very, very modestly asset sensitive, but hopefully the balance sheet isn't going to be static. And that's what's going to drive The NIM is balance sheet composition, not what the Fed does.

Speaker 5

Our forecast does have forecasts in it, 1 each quarter, but that's not really the driver. And we see NIM getting into the high 2s by the end of 2024. We're projecting a mid single digit increase in net interest income along with the increase in the NIM, even though we expect the total balance sheet to remain relatively flat. Provision this quarter was $19,000,000 and the ACL to loans ratio increased from 80 to 82 basis points. The ratio of the ACL to non performing loans increased to 160 from 143 and the main drivers of this quarter's provision commercial production and the remixing in the portfolio and some increase in criticized classified assets.

Speaker 5

There's a waterfall chart in the deck that shows you all the things that drove the change in the reserve for the quarter. I would say for 2024, we do expect the ACL to continue to build as a percentage As the portfolio composition shifts more towards commercial versus residential loans and the commercial loans obviously generally carry higher reserves. The other thing I would make a point of saying is our pre reserve is almost 3 times our historical lifetime recycle loss rate. I get this particularly with respect to office, we're living in a little bit different world now than we have been historically, but that is a lot of cushion. Non interest income and expense, we already talked about the FDIC special assessment in the railcar sale.

Speaker 5

The increase in comp compared to the prior quarter, we're very happy about because it's related to the impact of the increase in our stock price on the value of RSU and PSU awards. So we don't wish that away. I don't think there's anything else of note to talk about in non interest income and expense. The ETR was low this quarter mainly because of state RTP true ups and the outsized impact they have on the ETR in the quarter where the pretax earnings number is a little lower. Excluding any discrete items, I would expect ETR for next year to be around 25.5%.

Speaker 5

And that's all I have. I'll turn it over to Raj for Any closing remarks you want to make? So listen,

Speaker 2

given where we're coming from over the next few months, this is a pretty good place. The progress that we've made, when I couple that with the momentum I'm seeing in

Speaker 4

the business and the health of

Speaker 2

the economy, which we don't control, but we're certainly very grateful for. And it impacts our bottom line. So when I look to 2024, I haven't felt this optimistic in quite some time. So it's a good place to start the year. I'll open this up for Q and A.

Operator

Our first question comes from Will Jones with KBW. Your line is open.

Speaker 6

Hey, great. Good morning, guys.

Speaker 5

Good morning, Will.

Speaker 6

Hey, so I wanted to just start that back on the margin guidance. Let's say that was really great color you gave just in terms of the margin really benefiting more of the balance sheet composition that's going around as opposed to what rates moving forward. But I guess the question is, the loan side is in process of changing. You guys have really done a lot of heavy lifting on On the side, is the lift really coming from more one or the other or is it a combination of both? This is really important for you.

Speaker 6

Yes, go ahead.

Speaker 2

Yes. I mean, we haven't we can't tell you mathematically like what part of it comes from one side of the other. It's both the work needs to be done on both sides. And the comment that Leslie made about the Fed moves in our base numbers, we just use whatever the forward curve was, which was 4 cuts.

Speaker 5

When we put $10,000,000

Speaker 2

Right, exactly a month ago when we put $10,000,000 on our budget. But if it was 2 cuts or 3 cuts or 4 cuts or 5 cuts, it doesn't really matter. That's how the balance sheet is structured right now. Now if it's something really out of less deal of their day. If they go down 10 cuts or something, something silly like, oh, it could raise rates 4 more times or then it will be a different thing.

Speaker 2

But within an extra cut or 2 or less, it doesn't really matter to the guidance we're giving. It has more to do with our ability to keep doing what we've done in the last three quarters.

Speaker 5

And I will say, Will, the expansion that you've seen over the last couple of quarters has been more related to funding mix. But going forward, we're really starting to get some good traction on the C and I and CRE core growth. So I think it's both going forward, not more one than the other necessarily.

Speaker 6

Yes. No, I absolutely think both sides are But just in terms of the loan remix you guys are doing, rolling off resi and adding on C and I and CRE, Where do you see that trade off in yields on the portfolio as you kind of roll off some lower yielding stuff and then add on This is some of the newer loans.

Speaker 5

I mean today, Will, the C and I increase that is coming on around 8%, give or take, maybe a little more. The resi stuff that's rolling off is I mean the resi portfolio has an average yield in the mid-3s. That's a big pickup. And we're also seeing by the way even Still and I don't know how long this will last, but at least for now, the spreads that we're putting on new commercial production are wider than

Speaker 2

the spreads on commercial loans that are rolling off, even

Speaker 5

if it's all floating rate product. And some loans that are rolling off even if it's all floating rate product. And some of that is market conditions and some of that is that we're just doing a slightly different kind of business. We've moved away from some of the SNCs and things that we were doing and doing more bilateral relationship based business, which also tends to come on at a little bit wider spreads.

Speaker 1

If you

Speaker 3

look, for example, at this year where we finished out, if you looked at every core lending group, corporate, commercial, Small Business and CRE, the internal spreads that we measure each group for the entire year finished with better spreads than they did in 2022. So We see incremental margin improvement in each of the lending teams.

Speaker 5

All of that is happening.

Speaker 2

And that's what the pipeline looks like. At some point, maybe spreads will come back tighter, but we don't see that yet.

Speaker 6

Yes. Okay. That makes sense. And Raj, I'll ask because I feel like this is an important moment for you guys. It feels like there's quite a bit of optimism as to where the margin could go by the end of the year.

Speaker 6

It feels like this is really one of the first years where in a while that you guys are kind of Maybe pulling back a little bit on expense growth, is this the year where we start to see some operating leverage really play out, especially in the back half of twenty twenty four?

Speaker 3

Yes.

Speaker 2

I know in terms of expenses and operating leverage, I'd rather achieve that through The revenue side than from the expense side. We had done a fairly large expense takeout exercise just before the pandemic. And I'll tell you that something you cannot do every couple of years, otherwise you won't really have much left. So you really have to invest. So we are continuing to invest in the markets, our core markets and the new markets that we have talk to you about over the last couple of years.

Speaker 2

And operating leverage should really come from expanding margin. At some point, we'll come talk to you about growing the total balance sheet as well. It may not be in the next 2, 3 quarters because it's still a Transforming balance sheet is a story. But Leslie is kicking me into the table because I'm not talk about 2025. But if I was to take a wild guess, I would say that 2025 and beyond, I think you go back to the normal world of growing the balance sheet rather than just transforming it.

Speaker 6

Yes. Okay. Great color. Last quick one for me. The gains and losses that you guys see selling the operating lease equipment, Is that ordinary course of business for you guys or were those really kind of more one time?

Speaker 1

I think

Speaker 5

We're trying to pare down on asset classes that we don't think are core to the future of our business. So you'll probably see some more of that over the course of the next several quarters. I wouldn't call it one time, but it's not something we've done forever either. But you should expect to see some more of that. Although it will be lumpy, I don't expect it to be net net material over the course of the next year.

Speaker 5

Got you.

Speaker 6

So all else equal, I mean, maybe that lease financing business, maybe it's not we don't see much growth there this foreseeable?

Speaker 5

No, it should shrink.

Speaker 2

It's been shrinking for the last 3 years. It will continue to shrink. The growth will come from Our core footprint business, C and I, CRE Small Business, not from the what we call BFG, which is the Bridge Finance business, which Franchise Finance and Equipment Finance, both of those businesses, we have them in rundown.

Speaker 3

Yes. If you went back 3 years ago, our UPB would have been $2,000,000,000 Today, it's about $650,000,000

Speaker 5

That won't grow.

Speaker 6

Okay. Well, that's super helpful. Thank you,

Speaker 2

Thank you.

Operator

One moment for our next question. Our next question comes from Timur Braziler with Wells Fargo. Your line is open.

Speaker 4

Hi, good morning.

Speaker 3

Good morning. Good morning.

Speaker 4

Looking at deposit beta assumptions, I'm just wondering what your expectations are here over the next couple of quarters assuming no rate cuts in the immediate near term, how much additional creep is there expectation is for deposit betas on the way down and if the competitive Florida market might increase that lag effect on betas on the way down or if you think the Florida deposits are going to reprice similar to what you might see elsewhere?

Speaker 5

So I'll address that at a high level. I mean, there's a lot of very granular modeling that goes on there, and I'm not going to try to dive into all the details of it. The beta through the cycle thus far has been about 54%. We're still modeling high-50s in the aggregate by the time repricing up stops. As far as on the way down, while I think we'll be quite proactive in bringing deposit costs down as rates down, you have to remember that on the way up, the marginal cost when rates are coming down, the marginal cost of New business is going to be higher than the market with the total cost of the back book.

Speaker 5

So on the way up, Maybe not so much. The back book on the way down, you are going to have the marginal cost of new business still being a little bit higher than the cost of the back book because the cost The back book doesn't equal the marginal cost. So in the aggregate, when you look at it altogether, because of that phenomenon, it will appear to be a little slower.

Speaker 2

We do have one more quarter of CVV pricing, significant CVV pricing, which is the quarter we're in right now. So after that, when we look at our CE maturities, it just drops off pretty significantly after March. Last quarter, Q4 was pretty big and this quarter is also big. And then second quarter is really, really small and through the rest of the year. So that's one element of it.

Speaker 2

But I think the second element obviously is new money that is coming in Compared to where the average book, back book is today, new money is still coming in pretty high until the Fed cuts. But the existing book repricing should start to basically that That phenomenon should be over in about maybe 8, 4 weeks.

Speaker 5

Yes, agreed. And that receding repricing phenomenon is one of the reasons We didn't guide to margin expansion in the

Speaker 4

Q1. Got it. That makes sense. And It's encouraging to hear that non interest bearing migration in 4Q was more so seasonal in nature. I'm wondering, do you think that the excess liquidity and the risk of kind of additional non interest bearing flight is done here?

Speaker 4

And if that's the case, can you maybe just talk us through what the seasonal factors are throughout the course of the year and how those balances should move along with that?

Speaker 2

Yes. I mean our title business is has grown very nicely, and we're very happy with it. That's where most of that seasonality is coming from. It's basically mortgage origination, mortgage banking related deposits. And they do they follow a pretty team cycle, they're always weaker in the middle of the month, middle of the quarter.

Speaker 2

They're always stronger at month end and quarter end with one exception, which is year end. Year end, that business kind of shuts down and does very little activity. Nobody is closing a mortgage on December 31 or close to it. So we've looked back over the last 3 years very closely at this data and we see the same trend last December and the December before. It's just a little more pronounced as the business has gotten bigger.

Speaker 2

So that will start building up. Summer is when business is the hottest and these things build up over time. But also within a month and within a quarter, we see that cyclicality and now We have a pretty good handle around this. So most of that happened in that business. There was a little bit of outflow from some accounts, but I would call that sort of ad hoc if stuff like that happens.

Speaker 2

Sometimes they're inflows, sometimes they're outflows. But I'd say 75% of that outflow really was mortgage related and it happened pretty late in this quarter, which is why on average now, Do you see hardly any change, but period and balances was a significant drop?

Speaker 5

It's a regular December 31 phenomenon.

Speaker 4

Got it. And then just a couple CRE related questions. It looks like Office LTVs ticked up a little bit quarter over quarter in New York. Maybe just talk us through some recent appraisals that you've had in New York, primarily Manhattan and what you're seeing as far as

Speaker 5

Let me say a couple of things about that. Some of that's reappraisal, some of that is modeled because when we don't have a new appraisal, we our models actually take commercial property forecast at the submarket detailed submarket level and adjust the LTV. So some of that is modeled and some of that is actually reappraisal. Tom, do you have anything to add?

Speaker 3

Yes. I would say, our when you say New York City, everybody Obviously, specifically means Manhattan, the number of office loans we have in Manhattan is fairly It's a fairly small number. It's about 12 loans in total. The only maturities that we've seen actually paid off. So we were not looking at new appraisals.

Speaker 3

And I would say the information we hear kind of anecdotally not related to our specific portfolio because we just don't have a large enough sample and didn't have enough maturities to say that. I would say it's largely going to point towards valuations being down maybe 20%, something in that kind of range, but it's very much also a building by building issue depending upon the occupancy and debt service coverage and debt yields and things in that building. There's not like all real estate, it's building by building. But in general, those are the kinds of valuation changes we're hearing in the market. But given our fairly limited portfolio and lack of maturities, we don't have a whole base of information internally to go off.

Speaker 5

And I will say, The LTVs remain very strong, a lot of cushion still there.

Speaker 4

Great. And then just Lastly, New York City multifamily, what portion if any is rent regulated and what portion is 2019 or earlier vintage?

Speaker 5

We have $121,000,000 worth of New York City rent regulated exposure. It's insignificant at this point.

Speaker 4

Thank you.

Speaker 3

Yes. I'd also come back on the loan to value issue in New York. Loan to values are important, but also investor basis in the property is extremely important. And when you have our client base is a traditional generational owned client base and when a lot of these buildings were acquired At extremely low valuations, the tax basis issue matters a lot in terms of how they support buildings. If there's any short term swings in occupancy and debt service coverage ratios and things of that nature.

Speaker 4

Great. Thank you for that color.

Operator

One moment for our next question. Our next question comes from David Rochester with Compass Point. Your line is open.

Speaker 7

Hey, good morning guys.

Speaker 2

Just a

Speaker 7

point of clarification on the expense guide. That's off of expenses ex the FDIC special or is it including that? Excluding it, right?

Speaker 5

Yes. Thank you for making that point.

Speaker 7

Okay. Sure. I just want to make sure. And on the margin guide, that sounded In terms of the high-2s, I was hoping you could maybe put some finer parameters around that because high-2s can be a pretty decent range, pretty big range.

Speaker 5

I know and I'm a little bit hesitant to do that because there are just so many factors that could move that a few basis points in one direction or the other. So I'm a little hesitant to give you a point estimate because whatever point estimate I give you is going to be wrong.

Speaker 7

Got you. Whatever gets you to mid singles on NII?

Speaker 5

Yes.

Speaker 3

Yes. Okay.

Speaker 7

And just on the railcar sales, it sounded like you may have more of those coming. Is the bulk of that book underwater at this point? If you just maybe make a comment on that? And then what do all the sales mean for that income stream going forward? What's a good run rate on that going into the Q1?

Speaker 5

The income stream is going to come down, but the associated expenses are going to come down Well, and net net to the bottom line, that's going to be a positive. I know you don't that depreciation of operating lease equipment will come down as well. And there are other expenses that you don't see because they're not broken out in the P and L of running that business that are going to come down. So while that fee income line will come down net net, this will be a boost to the bottom line.

Speaker 3

Yes, I would agree with that.

Speaker 8

Got you. In terms of

Speaker 7

the magnitude you guys are I mean should that get cut in half over the next year or how are you thinking about the trend down?

Speaker 5

The fee income line, it will probably run $800,000 $9,000,000 a quarter.

Speaker 7

Okay. And maybe one last one. I know you already addressed this on the buybacks. It seems like you're speaking positively about loan growth. The C and I and CRE outlook is positive.

Speaker 7

You're talking about a soft landing, credit trends are contained. Why not take advantage of the discount to tangible here while you still have it?

Speaker 2

Maybe I'm just being too conservative, but I kind of still feel there's more time that's needed To pass, there's still a possibility of a recession or a slowdown. I think there's just I'd rather deploy as capital, honestly. I don't think it's into loan growth. I know we're not talking about total growth this year as much, but into next year, we are thinking about that. Even the bond portfolio, as an example, which we've been shrinking at some point this year, it will stop shrinking.

Speaker 2

So overall, we're also gearing for balance sheet growth in the out years and also looking at There's still uncertainty in the system. So put that all together in a very short term, I think we'll stay on the sidelines. But don't want to speak for the Board. Eventually, it's the Board's decision, but we do have this as a discussion point at every Board meeting starting in February. We have that on the agenda again to discuss.

Speaker 2

My guess is they will probably defer it into probably the second half of the year. But we can change. We do actively discuss it at every board meeting. I wanted to come back

Speaker 3

on one point on your railcar question as it related to the comment about underwater. It's not so much that were underwater from a residual to NOV kind of analysis perspective. It's that these Assets will require future investment to continue to keep them marketable, and this is not a business line that we want to be in, in the long run. So when we have opportunities that we can continue to move out of these Sometimes relatively small gains, sometimes relatively small losses, it fits the long term strategy of the company.

Speaker 7

Great. Sounds good. Thanks guys.

Operator

One moment for our next question. Our next question comes from Jon Aschner with RBC. Your line is open.

Speaker 2

Hey, good morning.

Speaker 5

Good morning, John.

Speaker 8

I think Dave had all my questions just lined right up, but I do have a few more. How much more is it to do in the residential runoff? I mean Raj, you alluded to it, it might be similar. So question 1 is, do we assume down another I guess, a little under $1,000,000,000 And how long does this continue to go?

Speaker 2

I think you should expect this year $700,000,000 to $800,000,000 more this year. And we're not giving guidance for next year, but I think that trend is sort of will kind of continue because that's I still think we're way over allocated to resi. Despite it being a very safe asset, it just doesn't have yield and the spread. So yes, I think we did something I forget the exact number this year, but it will be a similar number. In 23, It will be a similar number at 24 in terms of production.

Speaker 8

Okay. Have you ever shared an optimal percentage for resi?

Speaker 2

I'd say kind of what it used to be before the pandemic. So I think there's a way to go a couple of years ago before we did it.

Speaker 8

Okay. Okay, good. You referenced the 30% is where you'd like non interest bearing to go and I think the term you used was gearing up To get back there, how do you do that? What is the strategy to do that?

Speaker 2

Well, find it out. How much time do you have?

Speaker 8

No magic wand.

Speaker 2

We were over 30% a couple of years back. Obviously, that was in a very different monetary environment that we're in today. But at the beginning of the year, we often come up with of a slow business for the company to sort of rally behind everyone. The company is rallying behind. And I point with the idea of pulling that up and say that's what we're going to do.

Speaker 2

So there's no magic to a 30%. It's just that if we were at 32%, 33%, and I know certainly commercial banks that are even higher than that, We should strive for a 3 handle. So but there isn't a sort of a well thought out sort of logic to this is why you get there. What we will say is the pipeline that we now track closely than anything else from the company with the treasury pipeline, account by account, which we spend hours every week focusing on, is pretty decent. It's very robust.

Speaker 2

And that gives me the confidence to say that I think that is attainable goal. It may not happen in the next 2, 3 quarters, but it will certainly, something which we can achieve in the next couple of years.

Speaker 3

I would add to that since I'm generally in the middle of the battle every day on this. It kind of comes down to 3 things. Number 1, you have to have the right talent in the right places who are driving value at the client level and can make people change from Ex bank to our bank, you have to be focused on market segments that are predominantly more deposit rich than others. There are some industries that drive significant deposits and some that don't. So we have over the last few years, altered our strategy to be very focused on the types of industries where you do tend to drive significant deposit levels.

Speaker 3

And the third is just back to something Raj alluded to is intense focus

Speaker 2

Got it. Yes. You do have to pick your spots based on where the money is or where the industry is, then go in and actually look at where the pain points are in those industries, in those little spots that you pick. And it generally takes a multiyear effort to solve those pain points through a combination of technology and process. And then you hit the market and you're able to gather market share.

Speaker 2

That's been the formula for success. It doesn't happen in a year. A lot of these things take multiple years. But when they do work out, it's hard for people to replicate. And that's how this entire business has been built.

Speaker 2

And there are things in the pipeline that we're working on even now that we don't talk about openly because it's too early to talk about But they are about solving those pain points that bigger banks or even sometimes banks our size are just not focused on And we don't

Speaker 3

if you're a football fan, it's 4 yards in the cloud of dust every day.

Speaker 8

Yes. Okay. I thought it was 3 yards, but I'll give you 4, Tom.

Speaker 5

I bet you have.

Speaker 8

Yes, okay. You're better than that. The Dolphins, they run, they don't They throw, they don't run is what I should say, yes. Just one more on Slide 6. It's interesting looking at 2016 and 2017, those two slides because, obviously the economic forecast had a huge impact on the reserves

Speaker 3

for the year, but you actually had

Speaker 8

a little better economic forecast. But I'm kind of circling that risk migration and specific reserves. Is that mix or is that true risk migration or what's behind that build? And then how material of a build do you expect this going forward as the mix changes?

Speaker 5

Yes. What you see there this quarter corresponds to the increase that you saw in criticized classified assets. And one moment that we put a specific reserve on this, not really material enough to go into details about. It's hard to say where that goes in the future to be honest with you. I think credit is normalizing.

Speaker 5

NPL levels are very low, net Charge off rates are very low and I think across the industry we're seeing some normalization of credit and I think we'll continue to see that. There's nothing Like for us, as we're not leaving sleep over credit, that you will continue to see some normalization of credit. So there'll probably be a little

Speaker 3

bit of that. But it also includes

Speaker 2

The shift from revenue

Speaker 1

That's not net

Speaker 2

column. Yes. In general, yes. Yes. As the C and I build CRE builds and revenue ends up, you should expect the 82 basis points.

Speaker 2

All that will happen. All that will happen. It will go up. It will go up, yes. Because we just against C and I, we have

Speaker 3

higher Yes.

Speaker 5

If nothing else happens, if everything else stays constant In terms of the economy and specific reserves and risk rating and all of that, the reserve will still go up because of the compositional shift. That's to be expected. I mean, you can see right now, we've got 1.53% reserve on C and I and a 0.09 reserve on residential. So

Speaker 2

Yes. I was going to

Speaker 3

say we have a very well disciplined and thought process around risk rating.

Speaker 5

Yes.

Speaker 3

And we risk rate loans, what they are at this exact moment, not what we think they'll be 6 months from now. And if you have a building that loses a tenant and you have a new lease in place from an investment grade company, but the cash flow does not start to kick in for 6 months. We grade it based upon the cash flow today, not the cash flow 6 months from now. So that will change. We'll see some of that happen, but we risk rate, I think very conservatively, inappropriately.

Speaker 8

Okay. All right. Thanks for the help. I appreciate it all.

Operator

One moment for our next question. Your next question comes from Ben Gurlinger with Citi. Your line is open.

Speaker 5

Hey, good morning everyone.

Speaker 1

Good morning, Gooden.

Speaker 2

Just wanted to circle back.

Speaker 9

I know we've thrown out a lot of guidance and ranges. I just want to I had everything correct. So kind of mid single digits on NII expenses, mid single digit growth off of the core numbers, let's call it just around $600,000 give or take on the full year of 2023. Leslie, I think you said lease finance should be around $9,000,000 a quarter roughly.

Speaker 2

So, A, so roughly what's is

Speaker 9

it fair to call it around 20, 21 ish On a normalized basis?

Speaker 5

2021 what, I'm sorry.

Speaker 9

$1,000,000 I'm sorry for total non interest income.

Speaker 5

I don't know. I think you'll see a slight trend up in deposit service charges and fees on the back of NIDDA growth. I gave you the number for lease income. Probably the other will trend up a little bit too. I don't have that number right in my head.

Speaker 9

Sure. Yes, no big deal.

Speaker 2

Okay, sounds good. I think I felt like I got mostly guidance right then. So

Speaker 9

when you guys just think from the kind of lending and philosophical perspective,

Speaker 2

you said you guys are getting

Speaker 9

a little bit better rate, especially on even floating rate. Are you potentially introducing credit risk Or is it just other lenders backing out that gives you that better yield. And if they come back in, the odds are that probably will start with rate, which is kind of annoying from a competitive perspective, but like is that embedded in some of your guidance that rates probably will come down if the economy is better than expected?

Speaker 2

Yes. I think it has everything to do with the fact that The Fed is shrinking the amount of money in the system. So there is the cost of money has gone up. Spreads are wider for that reason. By the way, they're wider on the deposits line too.

Speaker 2

So we're just kind of the conduit to pass that on to the borrowers, the same credit, same risk rating, same names, something that is coming up for renewal, you will get wider spreads in this market than 18 months ago. So it is not about that we're Going down the credit spectrum, it is that the market is in a different place than it was competitively for borrowing than a year ago. That's what is driving wider spreads. But like I said, we're also paying up on deposit side. That's why if it is only on the lending side that we're getting wider spreads and deposits was in a happy place like a year and a half ago, our margins would be way wider.

Speaker 2

That's not the case. So now it's not about credit selection, it's all about the market dynamics. There's less competition.

Speaker 9

Got you. Okay. That's fair. And then when you think about kind of the holistic approach to Expenses, I know there's some there's a cadence kind of with the seasonality, some years just more pronounced than others. I was just curious if you can just quarter to quarter like where might the high point be or how should we think about

Speaker 2

the back half of the year?

Speaker 5

We don't really try to provide quarter by quarter guidance. I don't know when certain things are going to hit the P and L. You typically have a little bit higher payroll In the Q1, everybody does because of the front loading of payroll taxes and 401 contributions and HSA seating and all of those things. Beyond that, we don't spend a lot of time trying to figure out which quarter expenses are going to hit the P and L.

Speaker 2

All right. That's fair. I appreciate it. Thanks, guys.

Operator

One moment for our next question. Our next question comes from Steven Alexopoulos with JPMorgan. Your line is open.

Speaker 10

Hi, good morning. This is Alex Lau on for Steve.

Speaker 5

Hey, Alex. How are you?

Speaker 10

Hi, good. Starting off with the margin, How much was the impact of CD repricing to the NIM in the 4th quarter? And what can we expect for the Q1? Also, what were the rates of the old CDs running off and the new rates that CDs were coming on at? Thank you.

Speaker 5

So I don't have all of those details in front of me Q4. I know there's a little bit shy of $1,000,000,000 coming due in the Q1 that's probably going to reprice up on average by about 50 basis points.

Speaker 2

In terms of new money coming in, and I don't recall exactly where the pricing is right now, but I do know that we backed off on deposit pricing on CD pricing right around Thanksgiving. So we may have done it actually twice right after Thanksgiving and then once again in December. So we did get we did lower meaningfully what our Promotional rates were for 12 month money, which is sort of our lead product. But I don't have the exact numbers in front of me. But I do remember making those decisions back then.

Speaker 2

Number of course. Yes, high 4s I think is where we are.

Speaker 10

Got it. Thank you for the color. Moving on to deposits, Which business segments or industry did you see the growth of the $600,000,000 in non brokered deposits in the quarter? And what level of rate are you paying on these new deposits and how much of this is new DDA?

Speaker 3

Yes. I would say if you look at the deposit growth, it was pretty much across every business line. So it would be it's across all segments. It would be I wouldn't have the detail in front of me to give you like a SIC code by SIC code breakdown of what industry segments it was, but it was pretty broadly based across kind of all lines of business, which is what We're seeing from what's in the pipeline when we look at it. I mean, it's hundreds of opportunities across all of our business units.

Speaker 10

Great. And can you also comment on your ability to convert those treasury deposit pipelines in the 4th quarter and has this ability to convert been improving with customers more willing to move balances now that March Madness is close to a year ago now. Thanks.

Speaker 3

Yes. I would say when we track the pipeline through various stages, I would say our pull through rates, once we get to proposal rate are pretty high from my kind of historic Viewpoint, I mean, normally when we look at the pipeline, once we make a proposal, generally our pull through rate is probably in the 80% range. So obviously before proposal, when something is in dialogue, then it's less. But once we get to proposal stage, our realization rate is pretty high.

Speaker 2

By the way, somebody just texted me or our team, our 12 month CD price currently is 4.5%, And we have a 9 month promo at 5%. That's been the rate for the last few weeks.

Speaker 10

Okay. Great. Thank you for that. And then just one last question. What are your expectations for ratio to trend in 2024?

Speaker 10

And when do you think that this ratio can get back to the historical, call it, low 50% range? Thanks.

Speaker 5

We're probably not that focused on the efficiency ratio to be honest. We're more focused on expenses to assets and those types of things. I our guidance is a mid single digit increase in expenses and we don't spend a lot of time thinking about the efficiency ratio to be honest with you.

Speaker 10

Thank you for taking my questions.

Speaker 5

Yes, not the efficiency ratio. There's just so many components to that. The rate environment is going to affect that. The balance sheet transformation is going to affect that. So we'd rather just focus On the components, yes.

Speaker 10

Got it. Thank you.

Operator

One moment for our next question. Our next question comes from Zachary Westerlund with UBS. Your line is open.

Speaker 11

Hi, everyone. It's Zach on for Brody. Most of my questions have been answered, but so I just had a couple of quick ones related to the margin. The securities yield, you guys had some nice increases in that over the past three quarters. I was just curious what's driving that and What's the trajectory looking like over the next couple of quarters?

Speaker 5

I think what's been driving it is coupon rate increases for the most part. That's probably about done. So the trajectory is probably more likely down than up, particularly if we get rate sets.

Speaker 11

Got it. Thanks for that. And then on the deposit costs, the 4.20 spot rate, how do you expect that to trend over the first half of the year?

Speaker 5

I think next quarter is going to be up because we're still we've got the CD repricing. We still haven't Adding rate cuts, if the forward curve comes to fruition, it will start trending down over at least the back half of the year, Maybe as soon as the Q2 depending on what the Fed does.

Speaker 11

Awesome. Appreciate it.

Operator

I'm not showing any further questions at this time. I'd like to turn the call back over to Raj for any closing remarks.

Speaker 2

I'll close by saying after a fairly difficult 2023, We're starting the year 2024 on a very positive note. The business is it's got momentum in all the right places that we worked so hard on and the economy and the things that we don't control are also favoring us, especially in the markets that we're in. So all that gives me a lot of hope for what 2024 will be. It is still a lot of work for us to do, And but the team is energized to hit the road and keep the link through 2024. Thank you all for joining us.

Speaker 2

If you have any questions, of course, you could reach me, Leslie, directly. We'll talk to you otherwise again in 3 months. Thank you. Bye.

Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.

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Earnings Conference Call
ESCO Technologies Q4 2023
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