FRBA - NASDAQ

Hello, everyone and welcome to the First Bank Earnings Conference Call Second Quarter 2022. My name is Emily and I will be moderating today's event. [Operator Instructions] I will now turn the call over to our host, Patrick Ryan, President and CEO. Please go ahead, Patrick.

Thank you, Emily. I'd like to welcome everyone today to First Bank's second quarter 2022 earnings call. I'm joined today by Andrew Hibshman, our CFO and Peter Cahill, our Chief Lending Officer. Before we begin, however Andrew will read the safe harbor statement.

The following discussion may contain forward-looking statements concerning the financial condition, results of operations and business of First Bank. We caution that such statements are subject to a number of uncertainties and actual results could differ materially. And therefore, you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described under Item 1A Risk Factors in our annual report on Form 10-K for the year ended December 31, 2021, filed with the FDIC. Pat, back to you.

Thanks Andrew. I'd like to start just by hitting on a few of the highlights for the quarter and the first half of the year and turning it back to Andrew and Peter for a little bit more detail. Overall, I'd say Q2 showed continued strength. We had great margin expansion, up almost 20 basis points quarter-over-quarter. We saw continued tangible book value per share growth which is something not all banks can say given the AOCI situation at a number of institutions. We had strong high-quality loan growth during the quarter and our asset quality trends continue to hold up well. Our core ROA, excluding PPP, continues to move higher and we continue to bring in high-quality new bankers from competitor banks in our markets. We also saw quality growth coming from both our New Jersey and Pennsylvania markets and we saw an increase in our buyback activity during the second quarter. I'd like to highlight a couple of key strong performance metrics. Our return on assets was 1.38% for the second quarter. Return on tangible common equity of just under 14% and we saw our efficiency ratio below 50% for the sixth straight quarter. We also saw our pre-provision net revenue ROA over 1.80%, again, for the last six quarters. And our net interest margin over 3.5% for the past six quarters. Lending, we were up $149 million year-to-date in loan growth, excluding PPP which translates to about 15% annualized growth for the first half of the year. Asset quality is holding up quite well, given some of the challenges and uncertainties in the economy right now. And we saw a nice rebound in SBA activity. We've got 7 closed loans so far in 2022 and we've got 18 deals in process and we continue to be very busy across all of our markets and lending specialties. On the deposit side, we were down a bit in Q2, although that was partly a result of our concerted effort to try to keep our deposit costs low despite the increases in Fed funds during the quarter. At this point, through the first half of the year, most of our excess liquidity has been deployed given the strong loan growth and we will be focusing on commercial deposit growth as we move forward for the second half of the year and we're looking for strong commercial deposit growth to help fund loan growth moving forward. In summary, I think we had a strong first half of 2022 and we believe that leaves us well positioned to achieve or exceed our full year goals. We continue to see strength in lending. We're ahead of plan in loan growth. The pipeline is still very active. And that gives us the ability to be particularly selective as we move forward regarding loans we make in the second half and that's selective both in terms of credit quality and making sure we're earning an appropriate yield on those loans. As I mentioned before, we definitely need to get the deposit gathering engine cranked up again and I'm confident we will do so. And we expect to see some continued margin expansion and good credit quality through the back half of this year which should translate to even better financial performance than what we achieved in the first half. At this time, I'd like to turn it over to Andrew to discuss additional financial details for the second quarter and first half of the year. Andrew?

Thanks, Pat. For the three months ended June 30, 2022, we earned $8.8 million in net income or $0.45 per diluted share which translates to a 1.38% return on average assets. The primary factors contributing to another strong income quarter included an improving net interest margin and effective management of noninterest expenses. Net income increased $665,000 from the linked first quarter but declined slightly by $70,000 compared to the first quarter of 2021. The first quarter of 2021 income benefited from higher PPP fees and a negative loan loss provision during that quarter. After strong loan growth quarters in Q1 2022 and Q4 2021, we are very pleased with our net loan growth in Q2 2022. Excluding PPP loan forgiveness, loans were up $84 million compared to an increase in non-PPP loans of $65.3 million in the first quarter of 2022. During the second quarter of 2022, $15.5 million in PPP loans were forgiven, leaving $10 million in PPP loans outstanding. During the second quarter of 2022, we earned $493,000 in PPP fees. This compares to $860,000 in the first quarter of 2022 and $1.3 million in the second quarter of 2021. As of June 30, 2022, we have $336,000 in deferred PPP loans left to amortize. Deferred fees, I'm sorry. Total deposits were down $12.7 million during Q2 but noninterest-bearing deposits were up $3.1 million. We continue to reduce our reliance on higher cost deposits and noninterest-bearing demand deposits now represent 27.7% compared to 27.4% at the end of the first quarter of 2022. Due to our shifting deposit mix and disciplined deposit pricing, our total cost of deposits increased only 4 basis points in the second quarter of 2022 compared to the linked prior quarter. Our tax equivalent net interest margin increased to 3.76% for the quarter ended Q2 2022 compared to 3.57% in the previous quarter. Excluding PPP fee income, our margin would have been approximately 3.68% in the second quarter of 2022 compared to 3.43% in the first quarter of 2022. Our margin benefited from the rising rate environment and our variable rate loans and investments repriced immediately, while our deposit portfolios were priced more slowly. We are well positioned for a rising rate environment and anticipate that excluding the impact of PPP fees, we have opportunities to improve the margin through rising asset yields as our June 30, 2022 GAAP position continues to be slightly asset sensitive. Based on our strong loan growth and small amount of deposit runoff during the second quarter of 2022, our liquidity levels decreased during the quarter. However, we have already seen some improvement in our excess liquidity position in July. Our historically high loan growth of $283.7 million, that's excluding PPP activity over the last nine months, has reduced our liquidity position but we have already ramped up our deposit gathering efforts. We also have reduced our broker deposits and FHLB balances by approximately $57 million over the last 12 months. We may use some of these ancillary sources if loan growth opportunities present themselves. The strong organic loan growth has also contributed to our investment portfolio being relatively small when compared to peers. We have also been very prudent on credit and interest rate management in our investment decisions. The size and short duration of our investment portfolio has limited our unrealized losses but these unrealized losses are impacting our stated equity capital somewhat. We also had an uptick in buyback activity in the second quarter of 2022. We repurchased 191,837 shares at an average price of $14 or a total of $2.7 million which also reduced our capital levels but only slightly reduced our tangible book value per share because these shares were bought at only a slight premium to our tangible book value per share of $13.08. In spite of these factors, we were able to increase our tangible book value per share by $0.29 during the current quarter because of our strong net income. Based on another quarter of modest charge-offs and a strong asset quality profile, we maintained our allowance for loan loss as a percentage of loans at 1.13%, excluding the impact of PPP loans. Nonperforming loans were stable compared to the prior quarter and COVID-related deferrals are now at 0. In the second quarter of 2022, total noninterest income increased slightly to $1.5 million from $1.3 million in the first quarter of 2022. The increase from the first quarter of 2022 was due to higher loan sale income, offset somewhat by lower loan fees. SBA loan sale income which is our primary source of loan sale gains, has continued to be slower than expected, primarily due to the rising rate environment which has reduced the premiums earned on sales and in some cases, led us to retaining the loans on our balance sheet. While noninterest income levels may continue to fluctuate, we do not expect a significant increase in noninterest income over the next several quarters. Annualized Q2 2022 noninterest expenses were 1.78% of average assets compared to a peer average of a little over 2%. In total, noninterest expenses were $11.4 million in the second quarter of 2022, up $287,000 or 2.6% compared to the first quarter of 2022. The increase was primarily due to higher salaries and employee benefits, combined with some smaller increases in various other expense categories. We continue to be laser-focused on expense control but we anticipate our quarterly expenses will continue to increase slightly from Q2 2022 levels as we continue to add to staff and inflationary pressures affecting certain other expense items. With continued benefits to our margin by the rising rate environment, strong credit quality metrics and effective management of noninterest expense, we are well positioned to continue our strong and improving core profitability trends during the remainder of 2022. At this time, I'll turn it over to Peter Cahill, our Chief Lending Officer, for his remarks. Peter?

Thanks Andrew. The earnings release outlines very well the overall results for the lending area in the second quarter. Pat and Andrew highlighted a lot of the numbers in their remarks. My comments around the performance on lending will be focused on non-PPP-related results. As the release shows, PPP loans declined by $15.5 million to $10 million during the quarter. The second quarter represented really the third quarter in a row of solid loan growth. This year, loans grew $65 million in Q1 and followed that up with loan growth of $84 million in Q2. Six-month growth of $149 million puts us in good position to meet or exceed our growth goal for the year of $200 million or right around 10% organic loan growth. Loan growth was solid in all areas of the banks. Both the New Jersey region and the Pennsylvania region did very well as did our Specialized Lending Group. Specialized Lending Group encompasses our larger investor real estate borrowers, SBA lending and consumer lending. Investor real estate overall led the way with approximately 60% of our newly funded loans coming from that area. Our ongoing target for investor real estate is around 50% of new business, so we're watching that number closely. The portfolio can fluctuate pretty significantly with payoffs and in fact, we had a couple of sizable payoffs in investor real estate loans in early July. A summary of loan growth thus far in 2022 compared to 2021 has been really increased funding of new loans compared to 2022. Compared to 2021, I'm sorry. Increased loans in 2022 and decreased payoffs compared to 2021. For comparison quarter-to-quarter, in the first quarter of 2022, we funded $126 million of new loans. In the second quarter, we funded $143 million of loans. Regarding payoffs, payoff loans increased a bit in the second quarter, rising from $52 million in Q1 to $62 million in Q2 but still below the level that we experienced last year. Obviously, final loan growth numbers are also impacted by normal amortization of loans as well as line of credit activity. When we review the reasons for the payoffs, 47% of them were from cases where the underlying asset was sold. This is up from Q1 where 33% of payoffs were in this category. Loans refinanced elsewhere comprised 40% of payoffs, down from 45% in the first quarter. Additionally, regarding the line of credit utilization, a number we cite most quarters, the utilization rate was down slightly from 42% at the end of the first quarter to 41% this year. In looking at our more specialized lending areas, we hired what we think is an excellent construction loan manager to assist with our construction loan portfolio. He is not a sales-oriented person but an inside kind of process manager. He joined us right at the start of the second quarter from a much larger bank that was in the midst of being acquired. In the first half of the year, we have seen an increase in requests from mainly existing customers for construction loans. My reference to construction loans here refers only to loans where we are monitoring construction. The tables in the earnings release include acquisition and development loans in addition to concentration, or construction, in those numbers. Our construction loan portfolio commitments stood at $174 million at 12/31/21, then $195 million at 3/31/22 and at June 30, construction loan commitments were at $204 million, all manageable levels. Loans get advanced and roll-off construction and outstanding construction loans haven't varied that much. And in fact, were $76 million at the end of Q2, only a couple of million dollars above the level at 12/31/21. Our new manager there is doing a great job with rising costs and the supply chain issues. We're not looking to expand this portfolio much beyond where it is today. As I said, most of our projects are with experienced, well-capitalized and well-vetted borrowers who we know. The portfolio as a whole is in very good shape. I mentioned during the first quarter conference call that the SBA team had built a good pipeline. Pat referenced some numbers there. After closing only two loans in Q1, the team closed five loans in Q2 and activity continues to be strong. We also have a couple more to close in 2021 that have not yet fully funded but will complete funding soon and that's the point at which you can sell the guaranteed portion. We typically sell a guaranteed portion of the loans and an issue we're running into now that I think Andrew referenced, with all the uncertainty around interest rates is that premiums being offered are quite low. For now, we've decided to hold the guaranteed portion for possible future sale and see if premiums normalize over time. Regarding interest rates, bank-wide we, like most banks and our borrowers, are still trying to react to the impact of rising rates. We have found that most aren't interested in interest rate swaps at this point. They're not wanting to lock in now to a rate they think may come back down. We continue to commit to spreads over a base rate, typically treasuries, five year treasuries and are fixing rates on loans two to three days prior to closing. Our weighted average interest rate on new loans continues to move upward. Our weighted average rate on new loans in May and June for example was around 4.62% in both months, an increase from March, the end of Q1, where we were at 4.17%. At this point, I'll talk a little bit about our loan pipeline which continues to look good. As we've discussed before, our pipeline numbers are based upon "probable funding" which means that we project first year usage and multiply that by a probability factor based upon where in the approval process the loan request is. This means for example that loans that have already been approved will have a higher probability of closing than will one that just went into underwriting. At 6/30/22, our loan pipeline stood at $226 million. This is the low point for the past six months and with the uncertainty in the economy, it may be that new business may be slowing somewhat but I don't think it's enough at this point that makes me concerned. Some reasons, while $226 million is our month end low point, the average at month end for the year has been $254 million. In June, we're 12% off that average which realistically is a couple of loans. Interestingly, last year when we had a very good year, our pipeline at this time was $200 million, less than the $226 million we have now. And our month-end average for the year in 2021 was $225 million, again, right where we are now. Factors that impact the month-end pipeline numbers include the number and size of loans that have recently closed. Therefore, they roll off the pipeline. This means if we have a big quarter closing and funding loans, we might expect the pipeline to be down a bit. Changes in probability factors as the loan moves through the process of negotiation, underwriting, documentation, etc., also impacts the numbers. Speaking of the impact of the number and size of loans in the pipeline, the number of loans in the pipeline at the end of the second quarter was 216. Coincidentally, this is equal to the average month-end number of loans in the pipeline over the first half of the year. One big positive we're experiencing in the loan pipeline is that as of 6/30/22, investor real estate loans dipped to just under 50% of total pipeline in terms of dollars, a level we target on an ongoing basis to keep the ratio of investor real estate loans, the C&I loans, where we'd like it to be. We're very happy about that. As loans move through the pipeline, they eventually hit we hope our projected loan funding report. This report looks out 60 days, projects funding and payoffs for Andrew's team in finance. To get on the list of projected fundings, a loan must be approved and moving towards closing. I mentioned before, due to the healthy loan pipeline that we have, the loan funding report at 6/30 positions us very well to get past our loan growth goals in the second half of the year. Despite the economic uncertainty, I think our loan growth prospects are in line with the rest of the industry which had positive loan growth so far this year and remains cautiously optimistic in the near term. We are planning on continued growth in meeting or exceeding goals and objectives. Lastly, regarding asset quality, there's not much more to say beyond Andrew's comments and what's in the earnings release. Things from my perspective continue to look good. Credit metrics are solid. And as a percentage of total loans, loan delinquencies were lower in Q2 than they were in Q1. They're really about as low as they can get. Now that's my report for lending in the second quarter. I'll turn it back over to Pat for some final comments.

Thank you, Peter. Thanks, Andrew. And at this point, I'd like to turn it over to the conference organizer for the Q&A.

[Operator Instructions] Our first question today comes from Nick Cucharale with Piper Sandler.

Longer term presents more of a forecasting challenge but are there any near-term plans to raise deposit costs? You mentioned the focus on commercial deposits in the back half of the year but commentary on how you expect to not get the rate environment on the liability side would be helpful.

Yes, sure. I mean, listen, the short answer is overall deposit flows and competition are going to drive pricing on the deposit side. Our goal is to continue to grow deposits but at pricing levels that are at or below what we're seeing out in the marketplace. We don't want to drive up deposit costs just for the sake of generating short-term dollars at higher rates. I think certainly, deposit costs are going up. I think over the next couple of quarters, asset yield increases will continue to exceed deposit cost increases. Although I think the margin between those two will start to shrink as we move towards the end of the year. And as you pointed out, 2023 is a question mark, right? But what we're going to see on deposit costs heading into next year are going to be somewhat driven by what the rate environment looks like, the shape of the yield curve, the economy. Is it moving into mild recession or is it holding up? I think there's just too many variables at this point to say with any certainty what Q1 or Q2 of next year deposit costs are going to look like. But I think they'll continue to move higher incrementally over the next couple of quarters but I don't expect it will start to erode the margin at least this year.

Okay, that's helpful. And sorry if I missed it but I believe you were projecting around 10% ex-PPP loan growth for the full year at this time last quarter. Just given 7% growth through the first half, is that still your target?

Yes. We don't change our budget in the middle of the year unless there's some kind of sea change event and I'll let Peter weigh in but I think our view is it's nice to be ahead of schedule at midyear. We historically have seen a lot of production in the back half of the year compared to the front half, so it's a little bit of an unusual situation for us to be ahead of plan midyear. But I think, as Peter said and I'll let him expand on that, we feel like we're in a good position to at least meet plan and we may be able to do a little bit better. But Peter, do you want to weigh in?

Yes. The payoffs number is the killer, right? I mean that hurt us early in 2021 if you recall. We were playing catch-up all year and ultimately had a big fourth quarter and big December actually. This year, I was happy to see January start off strong and the first and second quarters have both been real good. If anybody picked up my comments, investor real estate for example, the area we monitor closely, was way up into Q2 but we did have a couple of decent sized payoffs in the first couple of weeks of July. It's hard to say. It swings up and down. The nature of our client base, they're buying and selling properties. But it's good to see the payoffs have slowed and that carries us through the rest of the year. I mean I think we'll be in good shape to exceed plan.

Our next question comes from Manuel Navas with D.A. Davidson.

What are some of your assumptions for deposit betas? Are you not kind of making them explicit?

Yes. The way we're sort of running the bank is hold as long as we can and move as little as we can while still meeting our deposit needs and our liquidity goals. In terms of how that translates, I tend to focus more on impact on deposit costs. And I think what we saw in the last quarter was an increase of about 4 basis points. I think we'll see next quarter and the quarter after that, that number creep up a little bit. But I hope it will stay kind of in the mid to low-single digits in terms of quarter-over-quarter increase on the deposit cost side.

Yes, Manuel, I'd just add, we have very few deposit accounts that are actually indexed to any rates and we do that on purpose. A couple of things. It allows some more negotiations with folks and it also allows for additional conversations with customers. We're not going to -- as the Fed moves, our deposit rates don't automatically move. On the asset side, we're about 25% give or take on the loan side that automatically move right away. Again, I'll reiterate what Pat said, I think we're going to see deposit costs move higher than what they have in the real short term but we don't have a lot of stuff that's like indexed that's going to go up right away. There's going to be conversations and that will help us kind of hold the line on deposit cost increases.

That's helpful. Can you -- is it hard to quantify then near-term NIM expansion just that it should continue to go up but kind of maybe less across the year as deposit costs do start to rise?

Yes, I think that's right. I mean the magnitude of the shift is a little hard to predict. But if you start thinking through what happened in Q2 and you say to yourself, all right, well the full impact of the increases didn't even show up in the second quarter, so you're going to get a full quarter's worth of the benefit in Q3 plus what we all expect to be another sizable increase today which will show up in the next couple of months of this quarter. Even with an increase on the deposit side, you just start to play around some numbers and it looks like the margin could continue to expand a little bit in Q3 and maybe even into Q4. But beyond that, it's hard to say.

What has been kind of just the tenor of market competition on both loan pricing and deposit pricing so far in your markets? Are you seeing banks raise deposit costs yet? Are you seeing banks push -- are you seeing customers push back on loan pricing yet? Or are both kind of that competition remains muted?

Well, I mean, listen, the competition is out there, right? I mean, I think given some of the M&A activity in the market and with some recessions here on the horizon, I think some banks have dialed back some certain categories of lending and other things. I think the competition is still there, maybe not quite as fierce as it might have been a couple of years ago. But listen, there are certainly borrowers who are saying, hey, I think rates are going to come down, so I'm going to hold off and wait to execute my project until I get a better rate of interest. But most businesses and candidly most real estate investors, they're in the game. It's not -- you may not like the rates that are out there but as long as you're buying assets at the right prices and you're generating reasonable returns, we're still seeing activity. I think the environment right now is -- it's a reasonable one from a competitive standpoint. And certainly, banks are moving up deposit costs but I think most folks are doing it in a similar way to us which is try to move as little and as slowly as possible.

It seems like you're in a great position with loan growth so far this year, that it's okay that the pipeline is a little bit lower than it has been. And you're already seeing some payoffs in July. Is that kind of a welcome slowdown with the loan-to-deposit ratio getting to like 3%?

Yes. I mean I think we like the pipeline to stay robust because even if we want to dial back loan growth a little bit, it's better to have more options and be more selective. Even though, as you mentioned, it's down a little bit, it's actually not really down much over historical averages. And quite honestly, with prepayment activity, with prepayment activity reduced from prior levels, a lower pipeline and slower prepayment activity could still translate into higher net loan growth than what we saw in prior year. I wouldn't read too much into that. And I think to your point, the way we think about liquidity and loan growth is we want to grow loans with high-quality core deposits. And if for some reason there's challenges generating those, that could lead to a slowdown in loan growth just because we don't want to book business without being able to fund it from a core basis. I think the fact that we're ahead of plan just gives us the opportunity to be selective and maybe that selectivity leads to a slower back half of the year or maybe with the number of opportunities and the reduction in prepayments, maybe we'll end up exceeding plan anyway.

Our next question comes from David Bishop with Hovde Group.

A quick question. I noticed in the earnings release it looked like you guys were maybe a little bit more aggressive on the hiring front. Just looking at the FTE employee count, that was up pretty nicely this quarter. Was that you all just seeing some opportunities from some of the bigger M&A transactions within your market? And any commonalities or tenor to those hires that sort of stand out or are they deposit gathers, loan generators? Just curious maybe on the hires.

I think, David and I'll ask Andrew to jump in here, that the uptick in the second quarter is more a seasonal factor because we have a pretty active and robust intern program. We tend to bring in a decent group of folks that help us out during the summer and so I think that weighs in on the numbers. Because yes, we have been adding but we've also been replacing and we've had some folks leave. Sort of excluding the interns, I think the overall number is probably relatively flat. But Andrew, you want to jump in here?

Yes. It was the total FTEs was 219 at the end of last quarter; it's up to 233. Eight of those additions are intern related, so there's six additional. And sometimes it's timing-related in terms of when positions are filled or when people leave. But yes, I think there has been a few good hires, as Pat mentioned, from some larger institutions. Some of that is just replacement hires. There hasn't been a huge shift. The biggest shift is some of those seasonal interns which factor into that number. And if you exclude them, we're up six people. And some of it is replacements or filling open positions and one or two of them are kind of new additions from some bigger banks. Not a huge shift in number of employees.

Got it. The growth you were alluding to in terms of expenses is not going to be a huge outlier with sort of big signing bonuses and such. It sounds like just normal ebbs and flows into the second half of the year, correct?

Correct.

Got it. And then, Pat, maybe just the discussion around loan growth and the concentration with investor real estate, trying to keep that at 50%, do you see an opportunity to grow maybe the pure C&I book a little bit more? Maybe just some update on the state of the multifamily market in your core markets. Thanks.

Yes, sure. The answer is yes. I think we do expect to see continued growth on the C&I side. We had a couple payoffs and paydowns on the C&I side in the first half of the year, somewhat unexpected. We had a sale leaseback from a customer that ended up paying off a commercial real estate loan. And then we had another customer who had a great offer and decided to sell the business which was a significant paydown on the C&I side. I think that was more of a timing issue in terms of C&I growth not as strong as we've seen. But the pipeline there is very active. And on the commercial real estate side, I think we had a couple of fundings in the quarter, a couple of payoffs that we expected in the quarter that didn't happen until early July. I think the increase in CRE during the quarter was somewhat of a timing issue between the fundings and the payoffs. But Peter, I'd love to have you jump in and add any color to that.

Yes. No, I mean I think you hit upon it. We invest in real estate, it's a big part of our business and we want to keep doing it. We just like to moderate the mix between the two. Frankly, over the past few years with struggle, we've always had a little higher level of investor real estate deals in our pipeline. It was a good sign for mentioning here to see as many C&I deals in the pipeline as there were investor real estate in terms of dollars.

We currently have no further questions in the queue. [Operator Instructions] We have no further questions registered, so I'll hand back to Patrick Ryan to conclude today's call.

Great. Thank you, Emily and thanks to everybody for taking some time to listen in on the call. We appreciate your interest. Appreciate the questions today and we look forward to catching up with everybody after the third quarter earnings release. Thanks, everyone and have a great day.