First Commonwealth Financial Q3 2024 Earnings Call Transcript

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Provided by Quartr
October 30, 2024

There are 11 speakers on the call.

Operator

Thank you for standing by and welcome to the First Commonwealth Financial Corporation Third Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. I'd now like to turn the call over to Ryan Thomas, Vice President of Finance and Investor Relations.

Operator

You may begin.

Speaker 1

Thanks, Rob, and good afternoon, everyone. Thank you for joining us today to discuss First Commonwealth Financial Corporation's 3rd quarter financial results. Participating on today's call will be Mike Price, President and CEO Jim Rieske, Chief Financial Officer Jane Grebenc, Bank President and Chief Revenue Officer Brian Tsaaki, Chief Credit Officer and Mike McEwen, our 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.

Speaker 1

Before we begin, I need to caution listeners that this 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 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.

Speaker 1

With that, I will turn the call over to Mike.

Speaker 2

Thank you, Ryan, and welcome everyone. Our 3rd quarter 2024

Speaker 3

core earnings per share

Speaker 2

were $0.31 Loans were essentially flat, deposits grew and the net interest margin fell 1 basis point up to 3.56 percent as rates declined in anticipation of the Fed rate cut in September. Growth in other fee income offset a $3,000,000 decrease in interchange income as we incurred the long anticipated impact of Durbin. Expenses were elevated primarily due to several one time items. All of this led to pre tax pre provision ROA of 1.73 percent and efficiency ratio of 56.66 percent and core pre tax pre provision net revenue of $50,900,000 which was within $1,000,000 of analyst consensus. Turning to credit, The provision expense at $10,600,000 was up $2,800,000 over the 2nd quarter.

Speaker 2

Our credit story in the 3rd quarter was largely the tale of 4 credits. Embedded within the elevated provision expense are specific reserves for 2 legacy loans and 2 charge offs related to the Centric acquisition now in our capital region. Most, but not all of the 2 Centric charge offs had been previously provided for, but they together accounted for approximately $1,500,000 of provision expense this quarter on top of the $5,500,000 for the 2 legacy loans. Over the last 7 quarters, a disproportionate share of our credit costs have stemmed from our acquisition of Centric that closed in the Q1 of 2023. As we've shared previously, we understood their credit profile going in, so we marked the credit and priced the deal accordingly.

Speaker 2

However, the acquired portfolio continues to impact our credit performance. For a bank that was 10% of our size, the former Centric loans have accounted for 76% of commercial charge offs and 51% of total charge offs in 2023. In 2024 year to date, former Centric loans have accounted for 86% of commercial charge offs and 42% of total charge offs. At September 30, criticized loans were 2.68% of total loans. Excluding Centric loans, that ratio would be 1.69%, which is actually an improvement from the 1.72 figure on the day that Centric closed.

Speaker 2

However, we continue to make substantive progress with Centric credits in the capital region each quarter. Also important, stronger third quarter gain on sale income in SBA alongside increases in service charge and wealth management income and $926,000 in BOLI income all worked together to blunt the $3,000,000 impact of having our debit card interchange income cut in half due to the Durbin Amendment. In fact, non interest income drifted down only $683,000 Looking ahead, we expect non interest income to be in the $22,000,000 to 20 $4,000,000 range in the Q4. Turning now to expenses, we had elevated expenses this quarter of $70,100,000 up $4,300,000 over the prior quarter. 3rd quarter expenses reflect approximately $1,800,000 of one time items, including a $1,100,000 operational loss in credit card and a $750,000 in severance expense.

Speaker 2

We expect non interest expense to be $67,000,000 to $68,000,000 in the $67,000,000 to $68,000,000 range in the Q4. Beyond the financials, there are a few other items worth mentioning. First, Commonwealth earned recognition as the number 2 SBA lender by dollars in Western Pennsylvania for the 2024 fiscal year ending in September. As of October 15, our overall customer satisfaction score and net promoter scores have hit 5 year peaks at 90.4 and 70.3 respectively. We've seen a steady trend of increases in these figures since 2020 with both exceeding industry benchmarks.

Speaker 2

These are important metrics for us, especially as we cross $10,000,000,000 in assets. Although we are disappointed by our 3rd quarter earnings per share miss, I'm encouraged by the momentum in our businesses and prospects for stronger growth ahead. Despite a relatively healthy level of loan originations this year, our overall loan growth has in some ways been purposefully muted by: 1, our rebuilding of the Centric portfolio 2, our strategic decision to reduce exposure to certain sectors like sponsor finance and 3, the shift to selling nearly all of our mortgage originations. More importantly, our regional presidents have a growth mindset, have attracted new commercial banking talent that will drive the bank forward for years to come. Our new capital regions credit performance will converge with the strong credit metrics at First Commonwealth overall and become a key source of future growth in attractive Central and Eastern PA markets.

Speaker 2

And with that, I'll

Speaker 3

turn it over to Jim Huretsky. Jim? Thanks, Mike. Mike's already talked about the major financial metrics. So I'll take a closer look at the net interest margin and then wrap up with about 30 seconds on capital.

Speaker 3

Last quarter, our NIM guidance was for stability or even slight improvement from current levels for the remainder of 24, give or take 5 basis points as usual. While we didn't get the slight improvement part, we did get the stability part. Our NIM guidance didn't contemplate a 50 basis point rate cut in September. So in that sense, we are pleased to see our NIM exhibit relative stability by only going down by 1 basis point from last quarter. The NIM is facing various headwinds and tailwinds that largely offset each other in the Q3, but they do give us some insight into where the NIM is going.

Speaker 3

One headwind is excess cash. We've been holding excess cash all year because we locked in low cost borrowings through the Fed's BPFP program early in the year and we were reluctant to pay that off. Plus loan growth was slightly negative in the Q3 while deposits continue to grow resulting in a steady build above excess cash. On top of that, we received a large commercial deposit right at the end of the 3rd quarter. All of this cash had a suppressive effect on the NIM, even though it's additive to earnings because it pumps up both sides of the balance sheet with a very thin margin asset.

Speaker 3

That cash had a suppressive effect of 6 basis points on

Speaker 4

the NIM in the 2nd quarter, but

Speaker 3

in the Q3 that's depressive effect of 9 basis points. Neutralizing the effect of excess cash in both quarters would therefore have changed our one basis points of new impression to 2 basis points of expansion, but realistically that's all still within the range of what we would call stability. Looking forward, the headwind of excess cash has been largely removed because on October 3, we used it to pay down $436,000,000 of the $516,000,000 of BTFP borrowings that we had and we will likely pay down the remaining $80,000,000 when the Fed raises rates here in November. Another headwind to the NIM was the 8 basis point increase in our cost of deposits. That 8 basis point increase however was down from 10 basis points in the 2nd quarter and a 25 basis point increase in the Q1.

Speaker 3

We expect that downward trend to continue. The pace of what we call deposit rotation, that is the migration of deposit dollars from lower cost of the categories to higher cost ones, continued to slow down in each month of Q3. Another indicator of the slowdown is the cost of interest bearing non time deposits or savings in NOW accounts, which had been moving up by 3 to 4 basis points per month in the second quarter, but didn't go up at all in the 3rd quarter. Perhaps more importantly, the incremental cost of deposit growth in the Q1 was about 4.21 percent, in the 2nd quarter it fell to 3.61 percent and in the 3rd quarter it fell again to 3.22%. In terms of competition, we see deposit pricing pressures abating rapidly in our markets, allowing for lower deposit repricing upon maturity without jeopardizing our deposit growth trajectory.

Speaker 3

And that trajectory has been remarkable, 8% deposit growth on an annualized basis so far this year. That deposit growth helped bring our loan to deposit ratio down by 3 60 basis points in the 3rd quarter to 92.5% at September 30. As for loans, replacement yields have been a tailwind to the NIM all through this rising rate cycle. Loan yields went up by 3 basis points in the 3rd quarter largely because new loans still came on the books at about 50 basis points higher than the ones that ran off. About a third of our total loan production in the Q3 was fixed rate loans and those fixed rate loans actually came on the books at 172 basis points higher than the fixed rate loans that ran off.

Speaker 3

We believe that this upper repricing should continue for a while even in the face of falling rates. This environment is one in which we're glad to have built a diversified bank with a broad mix of fixed and variable loans and loan types, both in our portfolio and in our origination mix. In addition to all of that, there are a few other tailwinds to the NIM that are incorporated into our forecast as well. Purchase accounting contributed about 7 basis points in the Q3, down by about 1 basis point from the prior quarter. We do, however, expect that benefit to fall to only 4 to 5 basis points next quarter.

Speaker 3

And we are looking forward to the expiration of received fixed macro swaps in the near future. Dollars 50,000,000 of received fixed macro swaps would mature in the Q4 of 2024, dollars 250,000,000 mature in 2025, $175,000,000 mature in 2026. These explorations should provide a lift to our NIM in 2025 and in 2026. That, however, brings us to the biggest headwind to our NIM, rate cuts. About 50% of our loan portfolio is priced off of 1 month SOFR, so rate cuts are felt immediately.

Speaker 3

Our latest forecast calls for Fed funds to end 2024 at 4.29% and to end 2025 at 2.95%. That's about 40 basis points to 50 basis points lower than our rate forecast than the rate forecast that we used last quarter. So taking all of these headwinds and tailwinds into account, our guidance for the Q4 sounds a lot like what we said last quarter, stability, at least for the near term. In our latest forecast, our NIM stays in the mid-350s range through the Q1 of 2025 as always, give or take 5 basis points for normal variability, then gradually falls over the course of the year to end the year 2025 in the mid-340s about 10 basis points lower than where we are today. That assumes by the way a return to normalized mid single digit loan growth in 2025.

Speaker 3

You might sum it up this way, all of the NIM tailwinds we have, removal of excess cash, falling deposit rates, positive loan replacement yields, macro swap expirations, all of them work together to blunt the effect of falling rates, but aren't quite enough to overcome them if rates fall fast enough. To bracket this for you and give you some idea of the impact of rates on our balance sheet, if the Fed funds rate falls to the projected year end twenty twenty level year end 2024 level of 4.29 percent and then just hold at that level through year end 2025, the tailwinds would win out. In that scenario, we would expect that our NIM would actually increase steadily over the course of 2025 into the mid-360s. I would note that the futures market is currently projecting a year end 2025 Fed funds rate at 3.40 percent, which is about 45 basis points higher than our latest rate forecast. So reality will likely play out somewhere in the middle.

Speaker 3

In terms of capital management, tangible book value per share increased $0.47 from the previous quarter to $10.03 due in part to a $28,700,000 reduction in AOCI. We raised the threshold for share repurchases this quarter, buying on prices below $17 a share. And so this quarter, we repurchased 146,850 shares at an average price of $16.83 And with that, we'll take any questions you may have.

Operator

Thank you. We'll now begin the question and answer session. Your first question comes from the line of Daniel Tamayo from Raymond James. Your line is open.

Speaker 5

Sorry about that. Good afternoon, guys. Hopefully, you can hear me okay. Maybe first to start, just on as we think about overall asset growth, just curious where you stand on where you want the size of the securities portfolio going forward? And you touched a little bit on the loan to deposit ratio kind of similar.

Speaker 5

Just curious if you still want that coming down from these levels or you're comfortable in the 92% level? Thanks.

Speaker 3

Yes. No, just to be we expect the securities portfolio to expand a little bit over the next year, maybe by about $100,000,000 over the course of 2025 from where it is today. Not huge expansion, but we want to grow it a little bit. Is that what you're asking, Danny?

Speaker 5

It is. Yes, yes. Thank you. And then, just to follow-up, switching gears to credit, just maybe if you could provide a little detail on the loans, I apologize if I did miss this earlier, but the loans that you took specific reserves on the quarter? Thanks.

Speaker 2

I'll turn it over to Brian Fakih.

Speaker 6

Hi, Daniel. Yes, on the reserve side, there was 2 credits that drove the specific reserve for the period in the provision. First was a $2,700,000 specific reserve taken on a $10,000,000 fully funded construction loan as for a mixed use office property located here in Pittsburgh. This is a participation in a global $58,000,000 loan. The property came to a maturity in the Q3 and while an amendment is being negotiated, the current level of vacancy combined with the uncertain outlook resulted in the move of the entire $10,000,000 balance to non performing.

Speaker 6

The second driver in that provision was a $2,800,000 specific reserve taken on a $4,800,000 term loan. That loan was in our sponsor finance portfolio. The credit specifically was in the distribution space. And while payments do remain current, the long term outlook is challenged. That accounted for 5,500,000 dollars of the provision in the primary increase in the specific.

Speaker 4

The 2 combined. The 2 combined. Thank you.

Operator

Your next question comes from the line of Karl Sheppard from RBC Capital Markets. Your line is open.

Speaker 3

Hey, good afternoon guys.

Speaker 2

Good afternoon.

Speaker 4

Just to pick up on credit for a second. Can you anything you can say about expected block content from 2 of those 2 legacy credits?

Speaker 3

Loss content on legacy credits?

Speaker 6

Sure. The driver of the short term outlook for our charge offs will be through the specifics that we've made. We've had appraisals for the real estate property and we expect to come to resolution over the next short term period next quarter to 2.

Speaker 4

Okay. So maybe not much in the way of incremental provisioning for those 2? Yes,

Speaker 6

that would be an excellent question.

Speaker 4

Okay. And then just to follow-up on the Centric credit piece. You mentioned convergence with the broader portfolio. Kind of over what timeline and would you expect any more originations or charge offs or kind of anything to emerge before we get to kind of a steady state back with the larger book?

Speaker 3

I'll just start out at

Speaker 2

a little higher level, Carl. Just looking at Centric, the criticized loans decreased from $124,000,000 in the Q2 to $102,000,000 this quarter. The watch loans decreased $271,000,000 to $261,000,000 So we are seeing those come down from highs and watch has been consistently improving from $376,000,000 to start the year. So we have a group of SWOT lenders that are out there in early stage collections and a really working bank and that's we've seen nice results from that. What do you want to add Brian?

Speaker 6

Yes. I think that's helpful, Mike. From a global perspective, we'd anticipate the Setriq headwind to start dissipating in 2025. It will be somewhat offset by normalized net charge off levels in the core portfolio. I would add one point to Mike's as you look at our charge off ratio year to date through the Q3, it was 39 basis points on an annualized basis.

Speaker 6

I apologize, just in the quarter it was 39 basis points annualized, 27 of that came from the Centric portfolio. So the core franchise charge off level is in the low teens and we're excited about that performance.

Speaker 4

Okay. That's helpful, Brian. To follow-up, then I wanted to ask about Lonco. You guys have been pretty deliberate and measured kind of managing to a pace. What gives you confidence that it's going to reaccelerate here?

Speaker 1

And in this, what kind

Speaker 4

of near term visibility do you have for the quarter into 2025?

Speaker 2

On the commercial side, in particular, the production has been really good. The headwinds have been, probably for the year about $49,000,000 in payoffs in sponsor and probably another $97,000,000 in Centric. And the other thing is we've just added a lot of talent to our regional teams in corporate banking and they're really starting to hit the ground running. So we just feel that we can mid single digit and is very achievable next year and perhaps a little higher. We shall see hopefully get some tailwinds with economic growth and but that's the reason.

Speaker 2

And we've also been able to fund it and that is we're proud of that and at the same time we've had we'll have ample liquidity to grow loans. We've paid down borrowings, retired sub debt with increasing capital ratios and kind of supported the margin. So I think the team can do it.

Speaker 4

Okay, great. I'll let someone else pepper Jim on the margin, but thanks for the help.

Speaker 3

Thank you. Thanks, Karl.

Operator

Your next question comes from the line of Kelly Motta from KBW. Your line is open.

Speaker 7

Hey, good afternoon. Thanks for the question. I was hoping to kind of dig into the deposit growth you saw this quarter. It looks like NIBs were up meaningfully, although not so on an average basis. I'm wondering as we're thinking about that line, was there any sort of end of quarter volatility that we should be managing here?

Speaker 7

And also any kind of broader comments as to whether or not we've seen a perhaps a trough in the pressure on non interest bearing accounts?

Speaker 2

Yes. We had a nice big win at the end of the quarter with a business person in one of our regional markets who sold the company and we had a pretty significant inflow of about 170,000,000 dollars in deposits in the last week of the month and some of that was parked in non interest bearing. Jim, what do you want to add?

Speaker 3

Yes. So that really helped the quarter end number. So if that's what you're looking at, Kelly, that's what you'll see. But the other thing I would just want to point out, this is kind of behind the scenes in my deposit rotation comments. If I just look at the trend in NIB month to month in the Q3, in July, there was $20,000,000 of outflows.

Speaker 3

In August, there were $2,600,000 of inflows. In September, dollars 35,000,000 of inflows. So those are averages, not end of period. So, the rotation seems to have really slowed down overall. We're really happy that we get a large deposit like that anytime.

Speaker 3

But for the rest of the bank, it seems like it's all moving in the right direction.

Speaker 7

Okay. That's yes, absolutely. That's super helpful. And then I appreciate all the color and commentary you've given around sort of your outlook for margin. Just wondering, if you could expand a bit on how we should be thinking about deposit betas during rate cuts.

Speaker 7

It looks like on during the tightening part of the cycle, your interest bearing deposit beta was about 50%. Wondering if you could just provide some color on how you're thinking about that on the way down at least initially?

Speaker 3

Yes. No, happy to address that. Our deposit beta assumption is generally about 25%. That's just backed up by long term look back studies that kind of look at what the historical average has been. The number you're thinking about, there's always slight variation in the way people calculate cumulative through the cycle betas because it depends on when you start the cycle and when you end it.

Speaker 3

When we were just looking at that the other day and it looked like for what I calculation I was doing internally or my team was doing internally showed that we had a cumulative through the cycle beta on the deposit side of about 46%. Just starting from right before when the Fed started this rate hike cycle to that last the first rate cut in September, about 46% and accumulative. And the odd thing about that was we try to look at the loan data over the same period and it was also about 46%. Just in both what you see is like at any bank, the timing is different. So in the early stages, we're able to reprice the loans upward very quickly and then, the deposit pricing caught up, but it evens out over time.

Speaker 3

So in this downward cycle, we'd expect the loan deposit I'm sorry, the loan beta to hit us pretty quickly with the falling rates at a variable rate portfolio. And then, the deposit beta at about 25% able to kind of reprice those downward to kind of make up for it.

Speaker 7

Got it. That's very helpful. And then you talked about cash being elevated during 3Q because and you used some of that to pay down BTFP. I apologize if you already answered this, but what are you guys doing as a more normalized level of cash as we look to just manage the size of the balance sheet?

Speaker 3

Yes, the normal level of cash will be just in the below $50,000,000 It just depends on any given day how much we need to fund the bank. So I think I'm not sure off the top of my head what it is right now today, but in any given day it might be $10,000,000 $20,000,000 of excess cash you have to make sure you can balance the bank at the end of the day, but it's not going to be $400,000,000 lying around like it was on September 30. If you look at the balance sheet in the press release financials that we issued, that number sticks out like a sore thumb, this huge increase in cash and it's not going to stay at that level long term. It's just going to be a minimal amount of balance of bank.

Speaker 7

Understood. And then finally, I was hoping you could provide any update or color on the M and A environment and the pace of conversations as it pertains to deal activity?

Speaker 2

There's been a conversation or 2. Nothing has materialized and we're very interested in M and A. I think we will do smaller as well as larger And if the 6 deals that we've done and had the privilege to do have ranged from $55,000,000 to $1,100,000,000 So, they've been deals that we feel like we could appropriately control the risk. And I've also shared with you that we have a team that could scale and do a larger transaction. It just it would have to be just right.

Speaker 2

And Jim always likes to share, we looked at well over 60 deals to do 6. So we're pretty disciplined. But there are there have been 1 or 2 things out there and I think we've passed on 1 or 2, passed on both actually into the process. So, hopefully there will be some nice opportunities to grow our bank and contiguous markets and do strategic things and rural depositories and all the kinds of things you've heard us say before.

Speaker 3

Hey, Kelly, just to go back to just for what it's worth, cash this morning was stood at $45,000,000 It's kind of a normal level for us.

Speaker 7

Awesome. Thank you so much for the color. I will step back.

Speaker 3

Thank you.

Operator

Your next question comes from the line of Matthew Breese from Stephens. Your line is open.

Speaker 8

Good afternoon, everybody.

Speaker 9

Jim, I was

Speaker 8

hoping to start, you had mentioned that 50% of your loan portfolio reprices, I think you set off a 1 month. So, in the past, it might have even been last quarter, you whittled that down, that number to like 30% and even a piece of that was affected by the swaps, so the true floating rate portion of the book, I think was closer to 27% of total loans. Could you just clarify for us and I'm sorry if it's going to put you on repeat a little bit, the true floating rate portion of the book, if it's 50% or 27% just because it matters a lot as we head into a down rate cycle?

Speaker 3

Yes. I'm so glad you asked that and you gave me a chance to clarify. So, I wanted to make sure I didn't speak before. About half the portfolio is variable, half fixed. That's just kind of a general rule of thumb.

Speaker 3

It does vary a little bit from time to time. At the end of the Q3, it was 50.67% was variable, okay, so very, very close to 50%. But, the part that is linked to 1 month silver is only 30 3% of the total portfolio, not 50%. So the other section, the other 17%, that's tied to all kinds of things along the yield curve. So the variable over time might be like a mortgage rate with a 5.1 ARM or 7.1 ARM that's going to be price the charge.

Speaker 3

So it's a variable, but it's not going directly to Sulfur. That's only 33%. And even those, most are all it's Sulfur, it's prime. There's still 1 or 2 BSB loans left that we're phasing out because that's going away. But it's 32% is all the short stuff.

Speaker 3

Thank you for letting me clarify that.

Speaker 8

And I would assume as well as these swaps expire, it won't be 27%, it will actually be truly more like 30%, it sounds like the low 30% range that's accurate as well?

Speaker 3

Well, the numbers I was giving you was irrespective of swaps. I didn't adjust the number I was giving you to say that some of that portion was swapped into fixed rates. So those are just the raw underlying portfolio numbers I was giving you.

Speaker 5

Okay.

Speaker 3

They don't have the same thing that you're talking about. It will take away these low rate pre C fixed swaps that we've got on the books and let this stuff float again and it will start floating upward and the cash flow actually will be the higher floating rate.

Speaker 8

Okay. Setting the true floating rate stuff aside, could you help us a little bit understand what the maturity profile is like for the fixed rate portion of the book? What either duration or how much you expect it to kind of come up to maturity in the next year?

Speaker 3

Yes. I don't have it broken down by like type of loan. The overall loan portfolio duration is only 2.76 years. But that reflects the that portion of loan portfolio, that 32% linked to the short end of the curve, the other part that's variable and then a fixed rate stuff as well. It must be conceptually if this helps you, we think about the concept of what we call yield curve diversity, not really needless return, but something we talk about.

Speaker 3

So we have things that are priced at the long end of the curve, things like fixed rate mortgages not been on the books, but you also have things there at the very short end of the curve. What you have in the middle of the curve are things like indirect auto. So we're at a $1,000,000,000 portfolio over $1,000,000,000 that reprices up a 2.5 year part of the curve. And then the equipment finance portfolio we're building, those are almost all 5 year loans that don't really prepay at all. We call sometimes leasing, but 85% of those are loans.

Speaker 3

And when there's a loan or leases, they have almost a perfect 5 year duration that doesn't prepay. So that kind of builds that duration overall in case it's kind of it's those repricing characteristics that smooth out the repricing of the portfolio over time. But the total duration on loans, 2.76 years on securities, 4.35 years. Total assets, that would be, it's 2.79 years on total assets.

Speaker 5

Hope that's easier.

Speaker 4

Okay. And

Speaker 8

then very helpful. And just one more on this topic, and apologies if it's belaboring the point. But you'd also mentioned that there's still a positive repricing gap on the fixed rate book by I think 170 ish basis points. Do you mind providing for us what those what the before and after those numbers are? What is the repricing to and from?

Speaker 3

Yes. It might take a second to find it, but I have it here.

Speaker 8

Maybe while you're looking for that.

Speaker 5

Oh, sure. Go ahead.

Speaker 3

It'll take me a second. Go ahead and ask you another question.

Speaker 8

Yes. While you're looking through your papers, Mike, just one for you. We've seen

Speaker 2

a little bit of a

Speaker 8

pickup here in NPAs. It sounds like some of it is your own, some of it is from Centric. Where would you be surprised to see NPAs climb to? I mean, are we near the top in

Speaker 5

year over year or are you expecting a

Speaker 3

little bit more than mobilization?

Speaker 8

And maybe some color on how you expect charge offs to behave as well?

Speaker 2

Yes, I do. I think we're near the peak. It could tick up a little bit, but I think it would come down in the ensuing quarters. We have about a third of that NPL and NPA stack is centric. We feel like we have good line of sight on those credits.

Speaker 2

We're not being surprised as much anymore and they're well marked as Brian outlined. So I think hopefully that's a peak. In terms of charge offs, I think Brian shared as well our charge off figure this past quarter versus what it would be normalized at would be in the low teens. And that feels right to us longer term. And I hope that's helpful.

Speaker 3

It's helpful to me because it gave me some time to find the answer to the previous. So going back to what you're asking, I think what you're asking is the replacement yields on fixed rate loans. When I talk about 172 basis points, what are the underlying numbers? And here they are for better or worse. In the Q3, we originated $290,000,000 of fixed rate loans at 7.24 percent, but $265,000,000 ran off at 5.52%.

Speaker 3

So the nice thing about that is rates fall under the 25 basis points. Hopefully, your replacement yields on those are 150 basis points. And another 25 basis point cut, replacement yields still 125 basis points and you still get a lift even in a falling rate environment. That's how we think about it.

Speaker 8

Appreciate that. Wouldn't that have a bit of a dampening effect on the loan beta? It just feels like that's a steep gap and it's more than half the book. So I'm just curious, would that wouldn't that dampen the 45% expected loan beta over time? And that's my last question.

Speaker 8

Thank you.

Speaker 3

Yes, I think it's baked in there. I just think about whether it dampens it or and to what extent. When we think about our loan beta for next year, it's not that far off our deposit beta. I mean, just thinking about it depends a little bit on when you start the falling cycle. You start in September, just to get the math, the loan beta for next year, loan beta actually is a little less than that.

Speaker 3

It's like 10% to 15%, like 10% to 15% next year, but deposit beta is like 25%. So, that appointment by the way was just over time you go through the whole cycle. So whenever this cycle ends 3 years from now, they tend to even out over time.

Operator

Your next question comes sorry, go ahead.

Speaker 3

No, thank you.

Operator

Your next question comes from the line of Frank Schiraldi from Piper Sandler. Your line is open.

Speaker 10

Hey, guys. Good afternoon.

Speaker 2

Good afternoon.

Speaker 10

Just a question on the large deposit that came in at the end or near the end

Speaker 2

of the quarter, last week of the quarter.

Speaker 3

Should that or would that tend

Speaker 10

to create some volatility in the Q4? Just curious if you expect some of that to flow back out or perhaps even seen some of that already given we're at the end of October here?

Speaker 2

I think, our best line of sight right now is that we'll have a good portion of that that, might flow out in the Q1 of next year.

Speaker 3

Got you. We'll do everything we can

Speaker 2

to hold on to it and we'll take it while we can get it. Sure.

Speaker 3

And then just a follow-up on

Speaker 10

the trends in deposit costs. Jim, I thought you had mentioned that you thought we'd see and maybe I'm wrong, but thought we'd see another quarter of increased deposit costs perhaps at a lower level.

Speaker 3

But

Speaker 10

first of all, is that what you said? And then secondly, is it possible just given 50 basis points we've seen here already in September in terms of cuts that maybe this is an inflection point for deposits in the Q3 here?

Speaker 3

Well, on the last point, it felt like it. It felt like the 50 basis point cut in September felt like it was reflected in the markets. We could just see the market competition dissipate and the deposit movements kind of change and it feels like everyone's got the message that rates are falling. So it's much easier to pass along falling deposit rates and still grow deposits at the same time. So, that did seem to be it felt like a shift in September to the last part of your question.

Speaker 3

On the first part of your question, I'm not sure I said what you said. I hope I didn't. If I do, let me clarify a little bit. I do think that that rate of the rate of increase in the cost of deposits was moving downward over the course of the year. That's the point I was trying to make in the prepared remarks.

Speaker 3

So, it was up in the Q1, but it was up less than the second quarter, it was up less than the Q3, by only 8 basis points. We actually think it should come down a little bit in the Q4. It's just a projection. So, I didn't mean to say that I think it will increase. I've been talking about the trend of increases coming down.

Speaker 3

We think we might turn the quarter in the Q4. I will couch that with a huge pain of salt. Predicting deposit costs and deposit rate movements has been the hardest thing for this whole cycle. So, I wouldn't put too much stock in that, but we don't we do not predict or any internal forecast that the cost of deposits will continue to increase next quarter. It should plateau.

Speaker 10

Okay. So said another way, is it maybe the thinking that the trough is in the Q4 here?

Speaker 3

Yes. Okay. Yes. That's right.

Speaker 10

And then just lastly, I mean, I think you're just given the numbers you gave around margin by the end of next year based on a couple of scenarios. Seems like that still kind of translates to about 5 basis points in margin compression for a given 25 basis point cut. And I think you've maybe even said that in the past. So just wanted to double check if that's kind of still a reasonable guidepost for a given 25 basis points?

Speaker 3

Yes. That's kind of our rule of thumb. And the way I thought about that in particular, over the last couple of days was during our last forecast, we're thinking carrying on at the stable of these rates. And now we have a new forecast that's 30 basis points, 40 basis points to 50 basis points lower. And so it's 10 basis points lower than it was with the last forecast.

Speaker 3

So for another 50 basis points of cuts, you get down 10 basis points and that's your 25 basis point per cut. Of course, the way it all plays itself out with those headwinds and tailwinds I was talking about is that you don't just have a pure 5 basis point per 25 basis point cut because if you go from 5.50 to 3% and you're down 2 50 basis points in rates, that's a lot of cuts and I wouldn't take that number by 5 and things like that into the NIM. The tailwinds offset a lot of that. That's why I was trying to give the model the forecast numbers from our model.

Speaker 10

No, that's appreciated.

Speaker 3

Okay, great. Thanks for the color. You bet.

Operator

Your next question comes from the line of Emmanuel Nabis from D. A. Davidson. Your line is open.

Speaker 9

Hey, starting on the fees for Q4, that range is it's a little wider $24,000,000 to $22,000,000 if I got it right. Can you just talk about, what gets you to the higher end? Is it like SBA sales? And then can you talk about fees going forward into next year? If rates come down, mortgage should pick up?

Speaker 9

Just kind of thoughts on that benefit as well on the fee side?

Speaker 2

Yes. I'll give you some broad strokes and then Jim can fill in. But we

Speaker 3

do think

Speaker 2

rates come down that will help all across the board with revenue and volume on the commercial lending side and the consumer side as well as our fee businesses, we've really built a pretty formidable SBA offering and continue we'll continue to invest there. Our mortgage banking could snap back pretty nicely with good share, good deposits in our core markets that could turn into refis and other things. So we do feel that could be a tailwind. Jim, other guidance you would provide? Yes.

Speaker 3

We have the fee engines baked into the bank that kind of hung along and some of them done really nicely. 1 we don't talk about a lot of insurance, but that keeps coming along adding some fee. We have our wealth division, which has done really well this year. If you think about growth for next year, I think you're hitting on it in a changing rate environment. You hope that you're able to do more mortgage refi and then more SBA and keep that just grow that business as well.

Speaker 3

The mortgage refi a little bit is independent on just the short term rates though. We got really hopeful that we do some refi business in that middle part of the curve went up again a little bit. And so we just want to I don't want to get too excited just because the Fed funds rate comes down, doesn't mean mortgage rates come down, you get a lot of refi business. So we got to take that into account.

Speaker 2

Yes. The wealth management piece provided $500,000 quarter over quarter of offset to the $3,000,000 headwind with Durbin. That business continues to mature. We also have treasury management. We've just built a really nice offering on the back of the corporate bank.

Speaker 2

We're continuing to get service charge income from there and just do a nice job for our commercial clients. We're just trying to move the bank into the future and make sure as we get to $15,000,000,000 and higher, we're more commercially oriented. We've built mature businesses. We're doing a better job of cross selling through the regional model. So there's real emphasis on relationship banking, C and I, small business base, getting the deposits, which we've already always been pretty good at, but also cross selling the relationship capabilities of our company.

Speaker 2

And Manuel, just for your modeling purposes, that wide range kind of brackets the number that

Speaker 3

we are thinking of $5,000,000 on either side. That's why it is the way it is.

Speaker 9

That's helpful. Just on the swap benefit, is the baseline scenario you're getting fed funds to 300 basis points by year end 2025?

Speaker 3

Yes. I think the swap benefit you'll see in the earnings deck. Right, of 8 basis points. That I think is based on the previous rate forecast, which had Fed funds at 3.29 at the end of 20

Speaker 5

25.

Speaker 3

So it might be so maybe it's 7 basis points if rates go to 2.95 like our revised forecast. Hard to say. If by the end of next year, the yield curve is a little steeper,

Speaker 9

how would that impact kind of your NIM thoughts if that is a very positive scenario?

Speaker 3

What would what could be that upside for second half

Speaker 9

of next year into 2026?

Speaker 3

We talk about that all the time. I'm sorry to mute you off. Go ahead.

Speaker 9

No, no, go ahead. Want to put caveats to it. I know it's

Speaker 3

a very positive scenario, but like what could be the

Speaker 9

upside of that type of scenario for you?

Speaker 3

Yes. In the near term, we think about changes in the cost of funds as we try to grow the deposit book and the yields when new loans come on and replace these, all that stuff. And long term, we think as bankers, it's positive slope to the yield curve. It's an environment we can make some money.

Speaker 2

Jim, I'm just smiling at Jim because he just gave me 4 budget passes scenarios for 2025. Jim, I think it's about $0.09 or $0.10

Speaker 3

Long term a positive slope is great for banks. So that's our story and we're sticking to it. Okay. And then my last question is deposit growth has been really strong. You talked about that large deposit.

Speaker 3

What's kind of the appetite from here with that marginal cost of $320,000,000 for new deposits? Is it

Speaker 9

a loan to deposit ratio target? Is it prefunding loan growth next year? What's kind of the appetite on deposit growth side?

Speaker 3

The appetite deposit growth side is for I'll tell you exactly how we're thinking about this internally. We think about a smooth, steady glide path and the phrase glide path keeps coming up again and again. A smooth, steady glide path in deposit growth. So for example, this last quarter, if we say, hey, loans were not growing that fast, we could have taken our foot off the gas in terms of deposit growth. We don't want to do that.

Speaker 3

We want to keep it growing at 3% per quarter, which is a 3.2% average on average average in the 3rd quarter. We want to keep that going in the 4th quarter. The point is we want to bring that loan to deposit ratio down and get ourselves liquidity for loan growth going forward. And so in terms of the real dynamic that you're getting at, it's really driven by the desire to grow the bank on the asset side and just make sure that you fund it on the liability side. In any given period, those may not match, but long term, that's what we want to do.

Speaker 3

We want the deposit ratio down to 92.5%. We've got a long way to go before it gets over 100%. So we feel like we've got some really got liquidity to grow. Mike?

Speaker 2

As our Bank President, Jay Gebens, likes to say, we are relentless around deposits nonstop. Jay, anything you want to add? You're the impetus behind our great core depository.

Speaker 3

Only that there's really 2 kinds of deposits. There's the transaction accounts that represent new households, whether commercial or consumer. And then there's the time and the money market stuff that has the volatility of exception pricing and goes up and down with rates. And we're always in the business to grow the transaction accounts and transaction households as rapidly and as aggressively as we can.

Speaker 2

There's your answer.

Speaker 9

That helps. Thank you. I'll step back into the queue.

Speaker 3

Thanks.

Operator

Your next question comes from the line of Daniel Cardenas from Janney Montgomery Scott. Your line is open.

Speaker 3

Hey, guys. Good afternoon.

Speaker 4

Good afternoon. Just a quick question on the size of your participation portfolio. How big is that? And are there any other loans within that portfolio that you're watching given the migration of 1 larger credit into NPL status? Yes,

Speaker 6

I'll take that. We've actually really shrunk the portfolio over time as we focused on the credit risk appetite. That shared Nashville credit book is just over $115,000,000 today and only 10 relationships. So it's really not a factor as we look at it. The one commercial real estate credit that moved to non performing was obviously in that Shared National portfolio, but very much not a focus and it's manageable at 10 relationships.

Speaker 4

Okay. Now was the reason for the nonperforming move in that specific loan? Was it related to just bad management of the facility or lack of tenants filling up the space? Can you give us a little color on that?

Speaker 6

Sure. More so the latter. The construction was a rehabilitation that started right before COVID. They experienced COVID delays as well as some significant construction cost increases over the period of time that pushed them to the higher end of their budget. Since then, the rehabilitation has been completed, but the tenancy has not met expectation.

Speaker 6

It is a mixed use. It's not your typical office. There's a grocery space. There's a call center, a 911 call center and some other storage and office. They have some prospective tenants, but we're still working through a longer term road to stability.

Speaker 4

All right. And was that located in the central business district?

Speaker 6

Just outside, still in Allegheny County, but not in the downtown district.

Speaker 4

Okay. Appreciate that. All right. All my other questions have been asked and answered. Thanks, guys.

Speaker 2

Thanks, Ken.

Operator

And that concludes our question and answer session. I will now turn the call back over to Mike Price for some final closing remarks.

Speaker 2

Just appreciate the questions and your engagement with us. We're excited about the future of our company. We feel like we're building good momentum and acquiring talent in our 6 regions and our regional presidents are moving the bank forward positively. Thank you for your time today.

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Earnings Conference Call
First Commonwealth Financial Q3 2024
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