First Commonwealth Financial Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 24, 2024

There are 12 speakers on the call.

Operator

Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Commonwealth Financial Corporation Second Quarter 2024 Earnings Release 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.

Operator

I would now like to turn the conference over to Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Speaker 1

Thanks, Regina, and good afternoon, everyone. Thank you for joining us today to discuss First Commonwealth Financial Corporation's 2nd quarter financial results. Participating on today's call will be Mike Price, President and CEO Jim Mareski, Chief Financial Officer Jim Grebenc, Bank President and Chief Revenue Officer Brian Karap, 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've 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. A 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

Hey, thank you, Ryan, and welcome everyone. Core earnings per share of $0.36 beat consensus estimates by $0.01 for the Q2 of 2024. Pretax pre provision net revenue was up by $3,600,000 over last quarter. Headline numbers for the 2nd quarter include a core return on assets of 1.29 percent, a core pre tax pre provision ROA of 1.88%, a core return on tangible common equity of 15.93% and a core efficiency ratio of 53.34%. Importantly, the net interest margin expanded by 5 basis points to 3.57% as the increase in loan yields outpaced the increase in funding costs for the first time since the Q4 of 20 22.

Speaker 2

Other trends follow. Loan outstandings were flat even as average deposit balances grew 8.7% in the 2nd quarter. Looking at loans a little closer, total loans grew just under 1% with growth centered on equipment financed and to a lesser extent SBA. Over the last year, we pinched consumer loans, mortgages, home equity loans and indirect auto and have not chased volume at the expense of spread. We have moved prices up and now the prospect of rate cuts these consumer categories could become more attractive to us in the next few quarters.

Speaker 2

Similarly, we have been cautious over the last year with investment real estate and coupled with tepid demand originations have dropped. We are starting to see more good looks in both C and I and commercial real estate and pipelines are building. As we've shared in the past, our loan growth in Ohio continues to outpace our Pennsylvania loan growth. Looking ahead, we are confident in our loan origination capabilities and we believe we can get to well structured and well priced mid single digit loan growth by the Q4 and into 2025. Conversely, deposit gathering has been broad based across most of our footprint.

Speaker 2

Deposit performance in our Community PA market continues to be exceptional. Community PA just happens to be our largest low cost deposit region as well. We've seen an increasing number of competitors lower deposit rates in our market area, taking some pressure off of pricing. We continue to offer competitive rates on time deposits because we want to bring our loan to deposit ratio down to create the liquidity to fund expected loan growth, but we're doing so at shortened terms to allow for repricing as rates fall. One other important dynamic worth noting is that we saw non interest bearing balances increase slightly over last quarter.

Speaker 2

We're hopeful that means we are at or nearing the end of outflow of pandemic surge deposits as Jim likes to call them. Non interest bearing was 24.5 percent of total deposits this quarter, relatively unchanged from 24.9 percent last quarter. Non interest income grew $1,200,000 to $25,200,000 in the 2nd quarter on the strength of higher wealth management fees and interchange income. The increase in wealth management fees was due to strong fixed annuity sales in our wealth division as customers sought out instruments to protect their investments from falling rates. The increase in interchange income was welcome, but we expect a roughly $3,500,000 quarterly downdraft in interchange income due to the Durbin impact starting next quarter, which appears to be already have been baked into our estimates.

Speaker 2

Expenses continue to be well controlled at $65,800,000 as our FTE remained down from year end even as we staff appropriately to support crossing $10,000,000,000 Our core efficiency ratio improved to 53.6%. Charge offs of $4,400,000 were relatively flat quarter over quarter. Provision expense, however, was elevated as we set aside further specific reserves for non performing loans. Non performing loans increased $14,700,000 for the quarter, roughly 75% of the increase in NPLs was attributable to the former Centric loans. Of course, Centric is fully integrated in the First Commonwealth, now is our capital region.

Speaker 2

So we'll soon stop reporting such items separately. But for now, we would note that approximately half of all of our current NPLs are related to loans acquired in that acquisition, which was about 10% of our total assets at the time. We understood we would have credit pressure during due diligence. We set a fairly robust credit mark and priced the transaction accordingly. And given the achievement of announced cost saves, the transaction has been accretive to income despite the obvious credit workout headwinds.

Speaker 2

As Jim Reske will discuss in more detail, we also used a $5,600,000 gain of $5,600,000 from the sale of Visa B shares to absorb a loss on the sale of $75,000,000 of low yielding securities, which were replaced with securities at current market rates. We also redeemed a $50,000,000 tranche of sub debt in early June. Both of these will result in an annual pickup in pre tax income and will be accretive to our net interest margin. In closing, 2nd quarter financials were solid, particularly pre tax pre provision profitability and ongoing efficiency, and we continue to take steps to grow deposit liquidity to support broad based loan growth into the future. With that, I'll turn it over to Jim.

Speaker 3

Thanks, Mike. We had a few unusual transactions in the quarter that I'd like to walk you through before I turn to our core operating results. 1st, as previously disclosed and as Mike just mentioned, on June 1, we redeemed $50,000,000 of a $100,000,000 in subordinated debt that we had outstanding. The sub debt was issued at the bank level in 2018. The $50,000,000 that we redeemed was a 10 year instrument, so the Tier Q capital treatment was already in the phase on period and was about to lose another 20% of its capital treatment.

Speaker 3

The other $50,000,000 that remains outstanding is a 15 year instrument and so remains eligible for 100 percent Tier 2 capital treatment for another 4 years at a fixed rate of 5.5%. The $50,000,000 that we redeemed was floating at a rate of about 7.5%, and we called it using excess cash on hand, So calling it on June 1 gave us 1 month of benefit in our net interest market for the quarter. This was the perfect quarter to redeem the sub debt since capital ratios grew strongly due to capital generation combined with limited balance sheet growth. On its own, the sub debt redemption would have resulted in a 44 basis point reduction in the total risk based capital ratio, but that ratio only went down by 8 basis points this quarter. And in fact, the tangible common equity ratio actually improved from 8.4% to 8.7% in the quarter as did the CET1 ratio from 11.4% to 11.7%.

Speaker 3

The sub debt redemption contributed to the NIM improvement for 1 month in the Q2 and going forward it should contribute about 2 basis points of NIM in part because we used cash to pay it off and shrunk the balance sheet by $50,000,000 The redemption should also add about $1,000,000 of net interest income on an annual basis. 2nd, we had 2 offsetting non core items in the quarter. We along with approximately 98 percent of banks holding Visa shares, expected Visa's offer to sell half our holdings, an action which we previously disclosed as well. As a result, we recognized approximately $5,600,000 of gain on the stock in the 2nd quarter. Offsetting that was a sale at the very end of the quarter of $75,000,000 in underwater securities at a $5,500,000 loss.

Speaker 3

As a result, these 2 non core items offset each other in terms of their effect on 2nd quarter earnings, leaving GAAP and core EPS exactly the same for the quarter at 0.3 percent. But the net effect going forward is selling low yielding securities and in their place repurchasing securities at current market rates should provide a 2 basis point tailwind to NIM along with approximately $2,250,000 in improved net interest income per year. Now on to our core operating results. Notwithstanding provision expense and the non core items mentioned above, our pre tax pre provision net revenue improved by $3,600,000 over last quarter as the NIM expanded and fee income improved. After 4 quarters of NIM compression, the margin finally expanded this quarter by 5 basis points to 3.57%.

Speaker 3

Yields on earning assets improved by 12 basis points, while the cost of funds only went up by 7 basis points. The cost of deposits went up by 10 basis points, but the impact of the total cost of funds was muted by the sub debt redemption. The NIM also benefited by about 2 basis points from the recognition into net interest income of deferred interest on one loan that had previously been placed on non accrual status. Purchase accounting accretion contributed 8 basis points to the NIM this quarter and we still expect that to fade out by about 1 basis point per quarter. The other big story with regard to the NIM this quarter was a fairly dramatic slowdown in the deposit rotation that we've seen in the past year.

Speaker 3

While there's no standard industry definition for that term, we use it to mean declines in balances in the traditionally low cost deposit categories of non interest bearing, NOW and savings accounts and growth in the balances of the higher cost categories of money market and time deposits. In the Q1 of 2024, for example, we experienced a decline of approximately $233,000,000 in the less expensive categories and an increase of $283,000,000 in the more expensive categories that was the Q1 of 2024. That's been the pattern for the last six quarters. Deposit rotation began in earnest in the Q1 of 2023 and has been running at roughly $200,000,000 to $250,000,000 in each of the last three quarters. In the second quarter just ended, however, the less expensive categories rather than decreasing actually increased by $27,000,000 while the more expensive categories only increased by 173,000,000 dollars Perhaps more importantly, the deposit growth that we had in the Q1 came at an incremental cost of about 4.5% and in the Q2, the incremental cost on new deposit funds fell to 3.4%.

Speaker 3

That combined with the rotation slowdown are noteworthy shifts and give us increased confidence in our NIM forecast going forward. As a result of these dynamics, we would expect NIM stability or even slight improvement from current levels, the remainder of 2024, give or take 5 basis points as usual, but with a bias towards the higher end of that range even with 2 to 3 cut rate cuts. Over the long haul, we are asset sensitive, but in the near term, even with rate cuts, our loan portfolio yields will continue to drift upwards for a while before they start to fall. Most importantly, the notion that we've turned the corner to a falling rate environment should further reduce pressure on funding rates over the medium term, which has been the hardest part to predict. When we forecast using anywhere from 0 to 4 rate cuts for the remainder of 2024 2025, we get the same pattern for NIM and net interest income.

Speaker 3

Slow steady increases for the remainder of 2024, flat through the Q1 of 2025 as lower rates start to have their effect, and then a meaningful lift starting in the Q2 of next year as the macro swaps start to mature. In all of these scenarios, the quarter just ended appears to be the low point in terms of both NIM and net interest income at least through 2025. Though to be clear, our forecast has certainly been wrong in the past. Higher for longer is certainly better for us, but even in an aggregate aggressive rate cut scenario where there are 4 cuts this year and the Fed funds rate ends 2025 at about 3%, Our NIM and NII are both still higher than where they are now over the next 6 quarters, even assuming only modest loan growth. In terms of capital management, tangible book value per share increased by $0.30 to 13% annualized from the previous quarter to $9.56 due to about $24,000,000 in retained earnings combined with a $5,700,000 reduction in AOCI, which ended the quarter at $113,400,000 or 11.6 percent of tangible common equity.

Speaker 3

We repurchased just under 23,000 shares this quarter at prices below $12.50 and have $17,100,000 of authorization remaining in our current buyback program. Given the recent run up in our stock price, the earn back on buybacks becomes longer than we'd like. But if we continue to experience modest balance sheet growth combined with consistent capital generation and reductions in AOCI and especially now that the sub debt redemption is behind us, we may repurchase shares anyway simply to avoid becoming under leveraged. And with that, we'll take any questions you may have.

Operator

Our first question will come from the line of Daniel Tamayo with Raymond James. Please go ahead.

Speaker 4

Thank you. Good afternoon, everybody. Jim, I appreciate all the detail on the loans and the securities and the margin in general. I guess first, normally one of the last things we address, but just curious, you mentioned you would buy back stock if even if it's kind of rather expensive to do so relative to current levels. But just curious how M and A fits into the picture if you guys are still interested in that, especially as your multiples have gone up and how dry powder perhaps influences the amount of buybacks you would be willing to do as well?

Speaker 3

I'll answer that from just a technical perspective because our priorities are like a lot of other banks, they really haven't changed and they might want to comment more on M and A appetite. But we prefer always like most banks to use capital generation to support organic growth. And then we have a smooth we have a dividend, but we just want smooth and steady increases in the regular dividend. We have no appetite for special dividends. And then we would love to do accretive M and A, but if that's not presenting itself, then we'll buy back the stock to maintain the leverage that we want.

Speaker 3

I mean, if a tangible common ratio starts creeping up to 9% to 10%, the bank just gets to be under leveraged. And so even if you're buying back stock at 1.75x book, you have to do something to get capital where you want it to be. So that's that order priority hasn't really changed that much. It's pretty I think it's pretty typical. I don't know, Mike, if you want to talk about just M and A appetite in general.

Speaker 2

Just, I mean, we're interested, obviously, as all of you know, in contiguous opportunities that are both strategic and financial. We also have to see a clear path to execute a deal with low risk. That's been another hurdle, if it doesn't look like that's there. And it's been good for our company. Everyone has expanded our geography, brought us into new markets.

Speaker 2

I think with our regional business model over the last 5 or 6 years, we're getting more effective at delivering in geographies that aren't in our backyard and cross selling other products and services and gathering deposits. So we're extremely interested. The other thing is, it has to be at the right price. We've finished 2nd or 3rd and we just won't go to the M3 to do a deal, where it really pushes out and ceases to make good financial sense and work for us in the next year or 2. You've heard that from me before, Daniel, so I apologize.

Speaker 2

But I think we've also now are probably up to 70 deals that we've looked at and we've done 6. So our batting average is lower than most. So I hope that's helpful. I do think we're going to have more opportunities. It seems like there's chatter than there's been for several years and hopefully they're right

Speaker 3

for us.

Speaker 4

No, that is helpful. I appreciate all that color, Mike. Yes, I guess the

Speaker 2

only other thing I would add is we've done smaller deals. I mean, we tend to groove in that smaller category where we think there's less risk and we tend to be able to make it happen seamlessly.

Speaker 4

Yes. No, I understood. And then maybe just a follow-up kind of unrelated on the organic side on loan growth. You talked about building back up to the mid single digit growth by the Q4 and C and I and CRE pipelines improving. Maybe you could just talk about your appetite for continued equipment finance build out as that happens or how you think about that?

Speaker 4

And then just curious how you're balancing the risk reward in equipment finance. And I think you talked about growth in SBA in the quarter as well as we started to see some other banks talk about some credit concerns in those areas?

Speaker 2

I think with equipment finance, we've our volume has been lighter this year than

Speaker 3

we thought it would be.

Speaker 2

I think we've grown just about $45,000,000 I think our so we had budgeted more. We saw that the growth rate has slowed because there's less demand for CapEx for trucking, construction equipment. We've had lower approval rates for submitted applications just because on the margin, we're not stretching our risk appetite, but we don't really apologize for that. I'm looking at the P and L that Jim does on equipment finance and we're profitable. And it's not perhaps where we had hoped to be after 2 years, but it's a nice business for us with good returns And we've been able to keep our annualized charge offs at a budgeted amount, which we kind of signed up for at about 55 to 65 basis points.

Speaker 2

So we're actually pleased with the business. It's well run. It's staying within our risk appetite and there'll be a time where that will grow a little quicker, but probably not right now. And just like with all of our consumer categories that Jane and the team have run so well, we're just not going to compromise volume for risk and price. We just are not we haven't pushed that envelope.

Speaker 2

We didn't do it on the consumer side and we haven't done it on the commercial side. So, I hope that's helpful with equipment finance. And the other businesses, I just like the way we're teed up on the consumer side. I think if rates drop a bit, those businesses could become more attractive to us pretty quickly within a quarter or 2, particularly indirect auto. And we've maintained a lot of pricing discipline even as we've moved our average cost up from the or not cost, but yield from the 5% to almost 7%, over 7%.

Speaker 2

So the team has done a nice job there and we could drop a half a point and get a lot more volume. We just haven't done that. And again, that's our good people under Jane's leadership. And on the commercial side, I just think just after First Republic and everything, we just kind of hit the pause and on commercial real estate and we're seeing good deals come back and opportunities. We have a great stable of developers in the Midwest and Pennsylvania.

Speaker 2

In our C and I under Mike McEwen's leadership, I just feel really good about pipelines and talent. And we're already pretty good there. We're probably about 60%, 65% tile, but I just think that's where we've got to get a lot better in terms of the concentration in our portfolio and all the value that gets bought through family owned business, depository, all that good stuff and cross selling wealth management and pushing that through the regional model. I just think that's how we go from being a pretty good company to maybe a much, much better company over the next 5 or 10 years.

Speaker 4

Terrific. Very helpful, Mike. Thanks for all the color.

Operator

Our next question comes from the line of Karl Sheppard with RBC. Please go ahead.

Speaker 3

Hey, good afternoon, everybody.

Speaker 5

Good afternoon, Carl. Mike,

Speaker 3

I wanted to

Speaker 5

follow-up on loan growth real quick. It sounds like you're confident in getting back to mid single digit by the end of the year. Is that a year over year pace or do you want us to think about that more like an annualized kind of pace for 4Q?

Speaker 2

It's just annualized, set the bar low.

Speaker 5

Okay. And then I wanted to follow-up on loan growth a little bit more too. You mentioned the impact of consumer loan growth accelerating here and alluded to our rate cut. Is that expectation from better consumer demand or is it your ability to price if your funding position improves?

Speaker 2

I think we could maybe almost do without consumer, but I'm counting on it. And then maybe that gets us to the higher end of the range is the way we're thinking about it. We just have really good people leading those consumer businesses in mortgage or underwriting and it's just been kind of on hot idle and I think it won't be hard there to kind of strike the iron and just do a solid job. And so that for better or worse, that's how we're thinking about it. Okay.

Speaker 5

And then switching over to deposits, we talked a lot about deposit costs and I know aligning loan growth and deposit growth has been a priority for you guys. Can you just talk about your confidence in growing deposits?

Speaker 2

Hey, Jane, why don't you pick up on that? Sure.

Speaker 6

Sure. Glad to. So we're always confident that we can grow deposits. It's a little trickier to grow the low cost deposits. And we're starting to turn that corner.

Speaker 6

We are not raising CD rates. We've started to tamp those back a little bit. And one of the reasons that we are as focused as we are on the loan categories that we are is we are really demanding the full relationship on our credit on our in market extensions of credit. So I think we'll do just fine, but low cost deposits are always going to be a nice fight for us and for everybody else. Yes.

Speaker 2

We look I would just add to James' comments. I mean, we look at all of this regionally, just not by product category. And I'm just looking at growth year over year. And I mean, it's pretty good in almost every market. And our lowest market is 2% and our highest is over 10%.

Speaker 2

I mean, it's just an area of emphasis that's come from Jane for years.

Speaker 5

All right. Well, good quarter and thanks

Speaker 3

for all the help. Thank you.

Operator

Our next question comes from the line of Manuel Nieves with D. A. Davidson. Please go ahead.

Speaker 7

Hey, with the lower kind of marginal deposit costs, are we getting it's still above where you're pricing the book right now, but how close do you think we're getting to like peak deposit costs? And how quickly could they shift in rate cuts?

Speaker 3

That's a great question. And I'll turn it over to Jim. Yes, really insightful. I've used for the loans and deposits, many of you use this motorboat analogy. I was hoping it would catch on like wildfire in the industry that doesn't seem to have done so.

Speaker 3

But we've quick you cut the throttle and you keep drifting forward. And we see that alone, all the projections on the loan book are the same thing in the deposit book. So I wouldn't call the peak just yet. I think that I'm just very encouraged to see the rate of increase on the asset side beat the rate of increase on the deposit side. The rate of increase on the deposit side is not going to reverse.

Speaker 3

This is not the high point. I don't think it will still get separate.

Speaker 5

And what are I appreciate that. What are the

Speaker 7

where are new loans coming on at? Just the

Speaker 3

loan yield improvement was nice, but I know

Speaker 7

some of it was an interest rate recovery. Just kind of what are new loans coming at? And how is that expected to proceed going forward?

Speaker 3

Yes. I'll give you the total and a little bit of color. The new loans coming on a little over 8% in the aggregate, 8.11 actually for the quarter was new originations. So just for originations, there's 1 off as well, so they net, but I mean just for originations, over $850,000,000 of new loan originations, about $630,000,000 of that was variable. That came out at 8.25%.

Speaker 3

So customers are choosing that's what 95% of the originations are variable customers are choosing. They're choosing to go variable as much as we would like them to stay fixed and go long in a long rate environment, they make choices too and they want variable rate loans, so 3 quarters of the new production is variable, that's 8.25. But the fixed up was 7.75. So the variable this quarter, the new rate on that, I just gave you in the quarter was about almost exactly the same rate as the rate at which variable was running off. So nice new loans, but same replacement yields as a runoff on variable, but the new fixed coming out of 7.75% was 250 basis points more than what ran off.

Speaker 3

That's because that's part of that story that gives us confidence that even if rates are cut, you've got to go through a number of cuts before the new fixed comes on at lower rates than the fixed that runs off. That's the motor growth. That will cause us about an upward drift even the fixed rate portfolio even with rate cuts.

Speaker 7

That sounds great. I appreciate that commentary. What rate scenario are you using in the swap discussion of 10 basis points? Is that like September or December and a couple in the first half of next year? Like how many cuts roughly?

Speaker 3

I'm glad you mentioned it. So on the PowerPoint supplement that we put on the Investor Relations portion of our website on Page 14, we get 2 scenarios. 1 is flat, rates unchanged, Fed funds at $5.50 just unchanged. That's in the if you go to that page later, it's in the bottom right corner. But that shows 11 basis points of cumulative NIM benefit by the end of 2025 and an unchanged rate scenario.

Speaker 3

Then we put something we call baseline, that's baseline scenario, that's 10 basis points of NIM improvement. And that's our standard forecast, where we have we put a 40% weight on Moody's baseline scenario than a 30% weight on upside scenario and a 30% weight on the downside. We've been doing that consistently for our forecasting and also for our CECL model for ever since we adopted CECL. But that's the scenario that it's still increased by 10 basis points, cumulatively to NIM.

Speaker 7

Okay. I appreciate that commentary. I just wanted to understand if I

Speaker 3

Yes.

Speaker 7

Getting that into my forecast and such. Okay, I appreciate it. I'll step back into the queue.

Speaker 3

Thank you.

Operator

Our next question comes from the line of Kelly Motta with KBW. Please go ahead.

Speaker 8

Hi, thanks so much for the question. Most of mine have been asked and answered at this point, but I was hoping to get a bit more color on the migration related to the Centric portfolio. I know you mentioned that when you did that acquisition, you expected some hiccups there and had put on an appropriate credit mark accordingly. Just wondering if from a high level, if you could provide how that portfolio is performing relative to your expectations at the time you inked that deal? And if there's any other sort of migration down the line that you would expect to come from that?

Speaker 8

Or what we saw this quarter is likely the bulk of that?

Speaker 2

Yes. This is Mike and thanks for the question. I'll turn over to Brian Karup, our Chief Credit Officer in a minute. We put like a $3,200,000 or $3,200,000 mark, which was in the $30,000,000 and I think we're about $8,000,000 short of that at this point. So we still have a little bit of room.

Speaker 2

It was pretty heavy handed. We also adjusted the price and as we think about that right now, it's about half of the NPLs and it's about half of most of our categories that are challenged. And Brian and the team, we do a pretty extensive line sheet review and we just finished it, probably 30 plus hours and 3,000 notes here in the last month. And we so that's intensive. It's every credit over $1,000,000 and that group in the capital region performed very well.

Speaker 2

We just didn't see that many directed downgrades. And with Brian, I'll let you pick it up

Speaker 9

from there. Yes. Thank you for your question, Kelly. So 51% of our special mention and 55% of our substandard credits are related to loans that were originated from Centric Bank. But we believe that we've largely identified our problems at the acquired bank and we're comfortable that we'll return to our historically strong credit metrics over the next several quarters.

Speaker 9

So we're committed to that and we're working towards it.

Speaker 8

Got it. That's really helpful. And then next question for me is on expenses. You had a pretty strong quarter and loan growth is expected to pick up in the latter part of the year. Just wondering as you look ahead with the investments you're making internally into the franchise as well as your outlook for loan to pick up, wondering how we should be thinking about the trajectory of expenses over the latter part of this year?

Speaker 3

Yes. Hey, Toni, it's Jim. When I looked at the consensus estimates, I didn't look at yours in particular, but the consensus estimates for NIE going forward for the 3rd Q4 this year, they looked about right. I didn't really feel a need to give corrective disclosure, but the consensus has us at around $67,000,000 to $68,000,000 per quarter in the second half and that seems about right. We've obviously could go on and on about our expense culture and how much how important that is to us and actually we're doing quite well there.

Speaker 3

But the consensus looks like it's dialed in. So we're okay with that.

Speaker 8

Got it. Thank you. I'll step back.

Speaker 3

Thank you, Steve.

Operator

Our next question comes from the line of Matthew Breese with Stephens. Please go ahead.

Speaker 2

Hey, good afternoon, everybody. Hey, Matthew.

Speaker 10

Jim, I was really hoping to you gave some great detail on the NIM. I wanted to parse it out just a little bit more. Maybe just to set the stage, it sounds like your floating rate book is yielding 8.25% and the fixed rate book, if I have it right, is in kind of the low 5%, 5.25%, is that right?

Speaker 3

Well, that the numbers I was giving a minute ago were just for new originations in the quarter, not the whole book.

Speaker 10

Right. But you said 7.75% is for the new fixed rates up, which is 2 50 bps better than what's running off. So I assume the runoff was around 5.25.

Speaker 3

Yes, the runoff is. So that's and the actual portfolio yield is in between there somewhere.

Speaker 10

Okay. And what is the duration on that book? How much kind of rolls off every quarter on the fixed rate stuff?

Speaker 3

Yes, the fixed rate stuff, the duration, I don't have the actual duration on the fixed rate. I think I have to get that for you. Duration of the entire loan portfolio is 2.85 years, but that includes the fixed and variable. I'll give you a little color that I do have. So you may probably recall our investor deck, we break out in the pie chart the different slices of the portfolio.

Speaker 3

We try to say that half is fixed and half is variable. And we say that from a risk management perspective to get people understanding that we try to build a diversified loan portfolio. But in this variable portion of that, the part that really re prices right away with rate cuts is only about 33% of the total portfolio. And about 5%, 5 points of that 33% have been fixed and would back our slumps. That's really about 27%.

Speaker 3

That portfolio right now has a weighted average rate of 7.92%. So that's the piece that we'll reprice downward. So it's not 32% of portfolio, but really after the macro swaps, it's until the macro swaps paid off, it will roll off, it's 27% of the total portfolio. Then there's another slice, that's to get to your half of the portfolio that's variable, about 18% of the portfolio. And those are variable, but they just don't reprice immediately.

Speaker 3

They reprice over time. These are when a commercial loan is originated as a reprice date that's 5 years hence or a 5.1 ARM and a mortgage order, something like that. That portfolio, that slice has a rate of about 5.65%. The weighted average term on those is about 4 years. The weighted average time to the next repricing date for those is only about 20 months.

Speaker 3

But this goes into our forecasting because that little slice, we say that half the portfolio is never has fixed, it gives the impression that fully half the portfolio will price downward in a rate cut. That's not true. This little slice of 18% is yielding 5.65%. When those loans come to repricing date, they could be loans that originated 3 years ago in a low rate environment and are repricing. Even though rates are lower than they are today, they can still be repricing upward, especially if that overall full year is only 5.6 5%.

Speaker 3

So I don't know if that doesn't answer your question directly or the duration of the back end of that, but hopefully that gives you a little color on the fixed and variable portfolios.

Speaker 10

No, it helps and I think it helps build the point you made at the beginning, which is that it takes a lot of cuts before the margin starts to feel some pain because the back book still has so much room to reprice higher.

Speaker 3

That's right.

Speaker 10

And so I was curious when you made your remark that the baseline NIM improvement is about 10 bps. Is that through the end of this year or is that through the end of 2025?

Speaker 3

It depends on the rate scenario. So if we have a rate scenario that seems kind of moderate rate scenario that is just run using Moody's baseline forecast. And Moody's baseline right now has 3 cuts by the end of this year, even though the whole world thinks there's going to be 2. And the Moody's baseline has 7 cuts in total by the end of 2025. So that gives the in this Moody's baseline gets the Fed funds rate to about 3.75 by the end of 2025.

Speaker 3

And in that rate scenario, the NIM goes up our NIM, again, with a caveat of forecast can't be wrong. Often are, but it goes NIM goes up at the end of this year. And then goes up another I don't know how to say this, but it really goes up strongly next year because you get that cumulative effect of the burn off of the macro swaps. Right. High end of the range I gave you in my prepared remarks by the end of this year.

Speaker 3

And then in this forecast, it's like another 10 basis points next year with the macro swaps coming off in a cumulative effect. So it's every forecast is wrong today as period, right? The future always unravel and rolls out differently than you think, but that's what the Moody's baseline forecast would show.

Speaker 10

Okay. So a NIM ending 2025 and kind of 3.75 to 3.80 range?

Speaker 3

That's right, under that forecast.

Speaker 10

And to what extent does securities help? Like that was my other question is, how much in securities repricing? What is it rolling off at? What are you putting new securities on?

Speaker 3

The ones that are rolling off are the low 2s. The ones that are coming off are in the mid-five. All those securities we purchased are very plain vanilla. We're trying to buy more J. D.

Speaker 3

Mays because they have a 0% risk weight. There was yield for staying now in the mid-five. We actually bought this quarter I think $160,000,000 $170,000,000 including that includes the $75,000,000 that's on the loss rate we did. But they're coming out of the 5.5% rate. We think that security portfolio is light.

Speaker 3

It's kind of low, but our forecast don't have an aggressive build in the security portfolio. We just want to

Speaker 10

I'm sorry if I missed it. What was the duration of securities book?

Speaker 3

Duration total is I think 4 point 7, it went down from 4.8 last quarter by one tick just because the oh, no, I got that backwards. It was 4.7, it went up to 4.8, 4 by 16 because the new securities you just bought that 75,000,000 for slightly longer durations. But everything we buy is usually in the 4 to 5 year duration.

Speaker 5

Okay.

Speaker 10

I'm sorry to be long winded, but I have the same set of questions for your CD book. What's rolling off and what are new CDs rolling on it at? Are you starting to see a lower roll on versus roll off at what point do you see that?

Speaker 3

I'm sorry if I I was answering questions on the securities, but I'm sorry if I missed a word.

Speaker 10

No, no, I had asked about the securities. Now I'm asking about the CDs.

Speaker 3

Okay. The CDs, so we're still offering competitive market rate specials. In fact, we've in the Q1, we were pricing CDs really like the 90th percentile competitively, very competitive with peer banks. We dialed that back a little bit in the second quarter, because we had such a successful Q1 in growth. But we're staying very competitive here right now.

Speaker 3

What we've done is shorten the term a little bit. So instead of 7 months, we're doing 5 months. And so what we're trying to do is give ourselves a chance to reprice those CDs if rates fall. So I think the rate special we have right now is 5.2% for 5 months and it's been quite successful. The other part of this dynamic that you should understand is that a lot of the stuff we've been doing since rates have come up have been 7, 11 month special short term CD specials, but they're maturing now.

Speaker 3

And so we're seeing those mature. We're seeing about an 80% retention rate on the CDs that come due. And some of those will be rates that are lower than the nominal rate and a lot of but a lot of times our customer come in and say, yes, I don't want that rack rate. We're not migrating people down to rack rate of 5 basis points. But I mean, if it's a rack rate that's lower than current rate, most will come in and say, they want the current rate.

Speaker 3

But it's but the retention has been really strong in the CV book. So hope that it's a little bit of color that helps you.

Speaker 10

Very helpful. Just last one on fee income, particularly mortgage banking was a bit stronger this quarter. Maybe just some comments on overall level of fee income and mortgage in particular.

Speaker 2

Yes. Jane, any thoughts on mortgage?

Speaker 3

The team

Speaker 2

has done a good job. We put thoughts out, but we're also making some more money this year.

Speaker 6

And we have the opportunity to talk about it to sell virtually all of the production. So we are preserving the balance sheet a bit and we're probably selling between 80 percent of everything we're booking and that's really everything that we're originating and that's really helping me.

Speaker 2

Jane, we lost you a bit, but we've got most of that. We're selling most of the origination sprucing the fee income side of it, but it's well run.

Speaker 3

Can I add that actually mortgage originations went up quarter over quarter? So despite the rate environment, we think they actually went up. And the amount that we sold originations, as Jane was saying before we lost, there was 92% in the Q1, 92% in the 2nd quarter. So going just like you're going according to plan. Okay.

Speaker 3

And you think I think on fee income because wealth was really strong this quarter. Really good sales of fixed annuities in our wealth position. So customers who really want to lock in long term fixed rates are able to do that in fixed annuity and that's a good source of fee income for us.

Speaker 2

I'll just add one more as SBA is although our fee income is down a bit, we're keeping a little bit more on the balance sheet this year about $38,000,000 more with a little higher yield And we like that business. Our production will be up year over year and gain on sale is weighted average premiums are in the high 8s. So, and we have a good team there as well. So hopefully that can continue to grow and be a tailwind to our fee income.

Speaker 10

Okay. So we have $25,000,000 West Durbin next quarter. Is it safe to say it's a $22,000,000 $23,000,000 run rate from here?

Speaker 3

Yes. I think that's right. Hang on a sec, because again, I looked at the consensus estimates for fee income, it looked like they really had baked in the derivative impact that we're talking about about $3,500,000 a quarter. So that sounds about right. Yes, the consensus is $22,200,000 $22,300,000 for the next two quarters and that's about right.

Speaker 10

I appreciate taking all my questions. I apologize for being long winded again. Thank you. Thank

Speaker 2

you. Other questions?

Operator

And your next question will come from the line of Frank Schiraldi with Piper Sandler. Please go ahead.

Speaker 11

Hey, guys. Just a few I had remaining were the sub debt that you retired or redeemed, it sounds like given capital levels, you'd no need to replace that with additional debt. Just curious if that's the case and what else you might have coming up that may be repricing that would either be retired or refi in this market?

Speaker 3

Yes. No, thanks very much, Frank. And appreciate that because we actually spent a lot of time with bankers looking at replacement options starting over well over a year ago to look at what was available in the market to replace that capital instrument in case we needed the capital. That's why we're so pleased that capital generation, especially from just capital generation from a dollar perspective and a ratio perspective is strong enough that we did not replace it at all. I think that couple of quarters ago, the message was the window for sub debt ratios is really closed.

Speaker 3

And then what we saw was just starting to open, but still would have been possible, but more expensive than what we just got rid of. So we just got rid of the 7.5%. We were probably hearing indicative price talk of 8.5% to 9% for new sub debt issuance. And so we're just so glad that we didn't have to do that. That's the sub debt.

Speaker 3

And there were other options we would have looked at like preferred because of the Tier one treatment. But at the end of the day, we're just really glad we could just let it go and pay it off and not have to do it either replace it. The only other thing we have, I guess, there's the other piece of the subject that I mentioned, we got 4 years to go at 5.5%. So when rates fell to 0, that seemed like a bad deal. Now it seems like a good deal.

Speaker 3

So we've got that. That's 4 years to go with full treatment, so we'll hang on to that. Not callable anyway for 4 years. And then we'll re examine the call at that time. And then we still have a trust referred outstanding, about $70,000,000 of the holding company.

Speaker 3

And that we swapped into fixed rates. It was floating. We swapped into fixed rates. I don't have it off the top of my head. I think it's swapped into the 4s.

Speaker 3

So it's pretty good money and it's still we're grandfathered in, so that's a Tier 1 instrument. The only thing that would make us call that because we're grandfathered in is if we grew over $15,000,000,000 in total assets through acquisition because from a regulatory perspective, that's when you lose the grandfather Tier 1 treatment. So if that day ever comes, that would trigger a desire to refinance that, but not right now. Okay.

Speaker 11

And then just I know acquisition math and provisioning can be a little different. But just what I'm thinking about the Centric deal, which obviously closed, I think, last year and you mentioned the NPAs that came over in the migration in the quarter, I think majority was from the Centric deal. The provisioning that was associated with the migration, So I would have thought that because Centric was marked already, no need for additional provisioning. Is that can you just walk me through that? Was that more so on the other piece that was originated in house?

Speaker 11

And I guess just anything kind of bulky that significant on one significant loan where we could end up seeing outsized charge offs down the road?

Speaker 3

Yes. So Frank, I'll start a little bit with just a little bit from a maybe more technical accounting perspective, what the marks were at origination and then ultimately final marks and then I'll turn it to Brian for the extra color you're asking for. So the marks, like Mike mentioned earlier, were around the 3.2% to 3.3% at the time of the deal is closed. Under the accounting rules, we're able to take some more and once we owned it, up until June 30 of last year, take some of the marks that we saw back to goodwill. And so the total credit mark ended up being 3.76% on that deal.

Speaker 3

As Mike said, that was priced into the deal. So, we thought that was marked appropriately and priced appropriately. But on that credit mark, that ends up being 30 $6,000,000 $37,000,000 credit mark, dollars 27,000,000 was for PCD and about $9,600,000 was non PCD. So that $27,000,000 was in reserve. On top of that, there was a day 1 reserve of about $10,000,000 Now so we earlier in the prepared remarks, we were saying we added about $11,000,000 to $42,000,000 this quarter to specific reserves for Centric.

Speaker 3

Those aren't related to the time of acquisition. We've owned it now for a while. So there's a list for whatever happens to that portfolio since then. So the $11,000,000 of new specific reserves that we put on this quarter related to Centric originated loans or not from acquisition, that's from our under our period of ownership. So that's additional reserves on top of what I just described at the marks.

Speaker 3

And then for additional color on maybe the yes, go ahead, Brian.

Speaker 9

Yes. So Frank, we did put on $5,800,000 increase in specific reserves this quarter. That was largely due to $19,000,000 credit that we needed to add $4,800,000 of specifics for. So you'll see our specific reserves did increase. Correspondingly, our reserves went up to 137 basis points from 100 and 32 basis points and we're well reserved.

Speaker 11

Okay. So that was 1 Centric loan then that caused the bulk of the additional reserves in the quarter?

Speaker 9

That's exactly right.

Speaker 11

Okay. And then just lastly on the NIM, just want to make sure I understand, if I'm looking at Page 14 of the presentation, so, the cumulative NIM impact scenarios you give at the bottom there, the 2 scenarios, that's just the swap terminations, correct? Not your expectation of NIM in total over the next several quarters.

Speaker 3

You have that exactly right. That's the contribution of the swaps not or any projection of the rest of that.

Speaker 11

Right. Okay. And then if you could just remind, sorry if I missed it, but obviously recognizing given your commentary that you think you're at trough on NIM anyway regardless of the near term rate picture and the NIM should move higher. What does a 25 basis point cut to Fed funds, what is the projection? What does that do to the NIM on an annualized basis all else equal?

Speaker 3

All else equal, normally our answer has always been about 5 basis points. Probably it depends on the season, maybe it's 3 to 5 basis points. But it's just not it's not working that way right now. So when I look at, for example, those forecasts that I was talking about earlier, like with the Moody's baseline forecast, the Fed funds are being cut down to 4.75 by the end of this year, our loan yields still goes up. So our NIM keeps drifting up, that's the motorbulk effect.

Speaker 3

So it's not if all else is equal and we've been in this rate environment for a long time and everything is stabilized, It didn't have positive replacement yields still going on. And then you had a cut, maybe you'd see that 5 basis points per quarter. And maybe you could say it's still 5 basis points per cut, but not per quarter, that's over the long haul. It's just not modeling out that way right now. So it's hard to even describe it that way.

Speaker 3

That's been a rule of thumb for a while. We said that for many years ago. But where we're just positioned right now, that drift up, where still the fixed loans are still pre pricing upwards, stuff a little drift up in deposit rate before we're able to bring those down. And then the macro swaps coming off, there's just so many dynamics affecting it. I would say, I hate to use that rule of thumb.

Speaker 3

Got you.

Speaker 6

Okay.

Speaker 3

No, I appreciate it. I mean,

Speaker 11

I assume that all else equal to higher for longer, like you said, is better. So there is some negative impact. Even if the NIM is going to go higher either way, there's still some it will move even higher in a higher for longer environment. So, yes, I just I guess that 3 to 5 maybe longer term could still be sort of a good rule of thumb, just doesn't seem like in the near term you would see that.

Speaker 3

Yes. No, you're exactly right. You're exactly right. And we are we still are we're praying for a flat rate environment, so because we do much better. There are other effects too.

Speaker 3

I think the little bit lower rates do help, this came up early in the call, spur a little consumer demand. They help some of our clients with credit quality. So there are other benefits from a couple cuts and 1st available on deposit rate demand. So there are some benefits too. Right.

Speaker 3

But mathematically, if you're higher for longer, it's definitely better. Got you. Okay.

Speaker 11

I appreciate all the color. Thanks.

Speaker 3

You bet.

Operator

We have no further questions at this time. I'll hand the call back to Mike Price for any closing remarks.

Speaker 2

Just as always appreciate your interest in our company and look forward to being with a number of you over the course of the next quarter.

Speaker 3

Thank you very much.

Operator

That will conclude our call today. Thank you all for joining. You may now disconnect.

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Earnings Conference Call
First Commonwealth Financial Q2 2024
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