First Commonwealth Financial Corporation (NYSE:FCF) Q4 2022 Earnings Call Transcript

First Commonwealth Financial Corporation (NYSE:FCF) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Good morning. My name is Devin, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Commonwealth Financial Corporation Q4 2022 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. Thank you for your patience. Mr. Ryan Thomas, Vice President of Finance and Investor Relations, you may begin the conference.

Ryan Thomas: Thank you, Devin, and good afternoon, everyone. Thank you for joining us today to discuss First Commonwealth Financial Corporation’s fourth quarter financial results. Participating on today’s call will be Mike Price, President and CEO; Jim Reske, Chief Financial Officer; Jane Grebenc, Bank President and Chief Revenue Officer; and Brian Karrip, our Chief Credit 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 financial information that will be referenced during today’s call. 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 three 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 accessed in the appendix of today’s slide presentation. With that, I will turn the call over to Mike.

Mike Price: Hey. Thank you, Ryan. We had another very productive year and a good quarter. Our fourth quarter core net income increased $2.4 million over the third quarter to $36.8 million. In fourth quarter, core EPS of $0.39 was up $0.02 per share over the third quarter as well. For the fourth quarter, a $5.7 million increase in net interest income combined with a $1.6 million decrease in non-interest expense to more than offset a $1.6 million decline in non-interest income and a $3.2 million increase in provision expense, despite higher provisioning due mostly to loan growth, credit trends improved on virtually all fronts for the year and the quarter. In the fourth quarter of 2022, ROA was 1.47%, core ROA was 1.51%, core return on tangible common equity was 20.32%, also core pre-tax pre-provision ROA was 2.28% and core efficiency was exactly 50%, both records for the company.

Core pre-tax pre-provision net revenue of $55.3 million was up by $6.4 million from last quarter, an increase of 13% and is now approximately 50% higher than it was in the last quarter before the pandemic. Now these results really speak to the culmination to thoughtfully grow our business over the last few years. In a couple of strategies there, we have developed a regional business model, we have added an enhanced customer offerings, things like equipment finance, indirect auto, just to name a few. We have added key talent and leadership, and we have grown our commercial lending teams, we have really increased our digital relevance. So a lot of success there. As we reflect on record profitability, it’s clear that our earnings benefited from an expanding margin and strong loan growth.

The margin expanded by 23 basis points to 3.99% as our asset-sensitive balance sheet responded to Fed rate hikes and new higher rate loans replace the run-off of lower rate loans. About half of our loan portfolio is variable, so we will still see some benefits of the Fed’s December rate and January rate hikes in any ensuing quarters. We expect our net interest margin to expand another 15 basis points in the first quarter, give or take, 5 basis points. Our strong loan growth contributed to an increase in spread income to $88.3 million in the fourth quarter, up by $5.7 million or 7% as compared to the third quarter. The loan growth was fairly evenly split between commercial and consumer categories with commercial loans growing by 14.6% annualized and consumer loans growing by 17.2% annualized.

Equipment finance balances ended the year at approximately $80 million, with equipment finance getting up to speed, we expect loan growth to be around 10% in 2023, which together with our expanding net interest margin should produce strong growth in net income that will lead to positive operating leverage. After announcing the acquisition of Centric Bank on August 30, 2022, we received regulatory approval for the transaction in November and we are pleased to announce that Centric received shareholder approval this morning. As a result, the legal close is scheduled to take place on January 31st. Centric is a commercially oriented franchise in good markets. We expect to push more consumer product through their branch like chassis, and increase their commercial lending and deposit gathering activity.

We believe that we will achieve the requisite cost saves and meet or exceed the targeted 2023 earnings accretion of $0.08 per share. With 2022 in the history books, we can look back on another year of strong performance for First Commonwealth. As I mentioned, we found a terrific partner in Centric with which we can enter the Central Pennsylvania market and leap over the $10 billion threshold. We grew spread income by $33.6 million over 2021, but that includes a reduction of $20.5 million in PPP income, which means that ex-PPP, our spread income grew by $54.1 million. Asset quality measures improved, fee income was down as expected with the slowdown in mortgage and SBA gains, but increased swap activity helped offset that somewhat and our SBA and Equipment Finance originations continue to build momentum.

Expenses were up mostly due to inflationary wage pressures that we achieved positive operating leverage and our efficiency ratio fell. Lastly, I would just add that while the majority of our recent loan growth has occurred in Ohio, our Pennsylvania market is growing as well now and has long been the source of stable low cost funding. And with that, I will turn it over to Jim Reske, our CFO.

Jim Reske: Thanks, Mike. Since Mike has already provided a high level overview of the quarter’s financial results, I will dive a little deeper into our deposit trends, fees, expenses and then touch on credit. Deposit costs remained low in the fourth quarter. The total cost of deposits did rise in the fourth quarter as expected, but only to 20 basis points, up from 5 basis points last quarter. We calculate our cumulative through the cycle beta through the fourth quarter at only 5.6%. We have previously disclosed expectations of a 20% beta which was informed by our near zero betas through the end of the third quarter of last year, and in fact, our fourth quarter incremental beta was 18%, in line with those expectations. We are, however, revising our cumulative through the cycle beta estimate to 25% by the end of 2023, just to be more consistent with our long-term historical beta.

The positive picture for us in the fourth quarter was clouded a bit by our conscious strategy to stay below $10 billion in total assets through year-end. While assets are easy to manage, our concern was that a sudden influx of deposits might inadvertently push us over the $10 billion mark on December 31st and we were able to successfully manage that. So our Durbin impact will be mid-2024 as planned. Midway through the quarter just ended, we did introduce several deposit strategies that have started to have a real tangible impact as the quarter progressed and continue to pull in deposit balances. Fee income was down by $1.6 million last quarter, due almost entirely to a $1.6 million drop in swap income. We feel good about our fee businesses, but fee income will remain under pressure — remain under some pressure in 2023 due to macroeconomic variables like the housing market, asset values and SBA premiums.

Nevertheless, we still expect fee income to be up by about 6% in 2023 over 2022, inclusive of Centric. Non-interest expense improved by $1.6 million from last quarter, in part due to about $800,000 of third quarter expenses that we had identified and previously disclosed that weren’t present in the fourth quarter. While the first quarter of 2023 will be noisy due to one-time items associated with the Centric acquisition, we still expect to hit the previously announced 35% cost save figure. Now in the past, we have not parsed out in our comments the difference between operating expense and total non-interest expense, because intangible amortization wasn’t that material. But we will likely break these figures out more carefully post acquisition.

For the full year 2022, our standalone operating expense without Centric, of course, was $224.7 million, up by 7% from 2021 and we expect that in 2023, it will probably be up by another 7% to 8%. In 2023, however, total operating expense will include Centric and then to get to total non-interest expense, we will have to add intangible amortization. That last figure will include the new intangible amortization from the acquisition, which we will calculate at close and disclose with our first quarter results. Provision expense was up in the fourth quarter, but not because of any credit deterioration, in fact credit metrics improved, roughly half the provision or $4.6 million was due to loan growth. The remaining provision expense reflected about $2 million in net charge-offs, which is lower than last quarter, plus about $3.7 million for changes in our economic forecast.

All asset quality measures remain strong. At 11 basis points, net charge-offs are lower than last quarter and charge-offs also came in lower for the full year. Compared to the end of last year, Non-performing loans are down from 80 basis points to 46 points to total loans, non-performing assets are down from 59 basis points to 37 basis points of total loans and the dollar balances of non-accrual, non-performing, criticized and classified loans are all down 30% to 40%. If a credit recession is looming, we have yet to feel it and if it does come, we are starting from a very good position. On a different note, our tangible book value per share grew by $0.32 to $7.92 and our tangible common equity ratio improved by 13 basis points to 7.79% due mostly to our strong earnings capacity, but also reflecting a $4.6 million reduction in accumulated other comprehensive income.

Finally, our effective tax rate was 19.98%. And with that, we will take any questions you may have.

Operator: Our next question comes from Daniel Tamayo with Raymond James.

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Q&A Session

Daniel Tamayo: Good afternoon, guys. Thanks for taking my questions. Maybe first, just on the margin. I appreciate the guidance for the first quarter and the further expansion. Just a clarification, does that include purchase accounting accretion that’s coming with the deal?

Mike Price: A great question, it does, and thanks for asking so we can clarify it. It does include that that based on our assumptions again at the time the deal was announced. So those — all those — it was a different rate environment. So that will change. So I will tell you just a broad your question a bit. The thing that could produce some downward pressure on that NIM estimate is deposit costs. Deposit costs rise as we thought that will — that’s why we give some guidance within plus or minus 5 basis points. That will be downward pressure. But we are going to read you all the marks at closing in a different rate environment and we don’t have that answer for you yet or where we would give it to you, but it’s likely that that we might provide some upside to the number we disclosed a minute ago.

Daniel Tamayo: Okay. Do you have a sense or just a guide for what the core margin would be in the first quarter excluding those marks?

Mike Price: Well, we are 3.99 now and the guide we are giving is 15 basis points up, so it will be about 4.14, 4.15, plus or minus 5 on either side. That’s the best guidance we can give you now and we will just have to revise it once we close the deal and have the final market calculated and provide further guidance as we go.

Daniel Tamayo: No. That’s great. I appreciate that. And then as we think about kind of the rest of the year with you revised your deposit beta assumption cumulative back up to 25%. As we think about that, playing out over the course of the year assuming no other rate hikes maybe after the first quarter, how do you envision the margin moving throughout the rest of the year?

Mike Price: Go ahead, Jim.

Jim Reske: Yeah. So we see — we — and we have disclosed this before, but we do see a peak in margin at deposit rates eventually catch up. What we had disclosed before is still the way we see it, which is margin probably peaking in the second quarter of this year and then coming down from there. Now some of that is based on our rate forecast, which is based on a weighted average of Moody’s baseline forecast and an upside and the downside. And our rate forecast, the peak rates are only 4.7%, not much far higher than we are now and the EBIT rate start to kind of come down in the second half. So that informs the key estimate that I am giving you. If the rates go higher and stay higher that the peak might be delayed. But inevitably, with everyone else in the industry deposit costs are going to keep growing catch-up that eventually cause in the peak.

Mike Price: Yeah. Let me just add to Jim’s comment, Dan, if I can. Jim mentioned that we could not afford to trip over $10 billion in the fourth quarter. That was really a play and we really feel like we can gin the commercial deposit gathering machine like we did in the prior years where we — you have seen some of our pie charts before that we are 60% plus of our non-interest-bearing deposits was business. And so that’s really going to be our focus. It will be a point of strategic focus and goals and incentives. We are running specials and tests that we monitor week-to-week. We just have a good feeling about 2023 what we can accomplish and getting to a point where we can fund our loan growth at 10% and if that’s a little off because of a bump or a mild recession, those — the funding pressure might not be the same.

Jim Reske: Right.

Daniel Tamayo: Okay. That’s great. And just, finally, to stay on the margin here.

Mike Price: Yeah.