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.

Daniel Tamayo: Do you have a sense of how much compression that might be, I mean, assuming you are your 25 basis point — 25% cumulative deposit beta, how much do you think the margin could potentially contract from the peak in the first quarter?

Jim Reske: Well, based on what we know now, we see continuing — the peak is in the first one, the peak is in the second quarter, so we will continue to expand active in the second quarter. But then where we see it ending the year is still over 4%, so not giving back on the expansion. So I am a little higher than we are now. And I hasn’t to go that far out, because I think the marks on Centric as we calculate the final marks are going to affect this number, and of course, deposit costs and how we manage that, of course. Probably, over the course of the year, this could change. So we will have to update this as we go ahead. But as we see it right now, we see that number staying above 4% by the end of the year.

Daniel Tamayo: All right. Terrific. That’s very helpful. I appreciate it. I know it’s a tough number to get at especially with the marks. So I appreciate you answering the questions.

Mike Price: Yeah. Thank you, Dan.

Operator: Our next question comes from Frank Schiraldi with Piper Sandler.

Frank Schiraldi: Hey, guys.

Mike Price: Good afternoon.

Frank Schiraldi: Just on the thinking about the efficiency ratio in the quarter right at 50% and the positive operating leverage for 2023 and the cost base in Centric. So given that you imply obviously a sub-50% efficiency ratio, is that a place you think, as you think about more medium-term maybe that you think you can operate the bank from or I understand an offset will be the Durbin impact in mid-2024? Just wondering your thoughts on kind of longer term where you think you can operate the bank from in terms of efficiencies?

Mike Price: I think you used the term midterm, which to me would apply one year or two years. And I think low 50s we are comfortable with because we plan to grow the bank. You have seen us kind of methodically put together a lot of diversified revenue engines and we are going to continue to ramp those up. So we will — we would like to continue to grow the bank that we have — the way we have in the last two years and make investments. And of course, we have new territory in Central Pennsylvania and in the outskirts of the Philadelphia MSA. And so I think I don’t see us doing sub-50 right away and we want to build out the revenue side of the bank and grow the bank.

Frank Schiraldi: Okay. And then you — a lot of talk about the NIM and I am hesitant to ask because, Jim, you said you were hesitant to go out to the end of next year. But as you think about if the Fed, we get a couple of more rate hikes here and then the Fed is the interest rate picture is a little more static for some time. Do you feel like that NIM above 4% is an area where the bank could see — could operate at, maybe it plateaus there? Are you thinking that in 2024, it’s more likely that the NIM continues to drop to a more normalized level? I guess that’s what I am trying to search out if you think in a static rate environment a normalized level could be above that 4% figure.

Jim Reske: Yeah. It’s a tough question. My — to use an old joke, my crystal ball gets cloudy when we start getting out to 2024, but we have actually stressed it for the kind of scenario you are talking about, because we realize that — we using consistently the rate forecast we are using with this. Our approach that as the way, we do our CECL model with it, 40% laid on the baseline, 30% upside downside, using that rate forecast that they might be under overstated. So we try to stress it, and say, well, what happens if it’s wrong, what happens if rates — the Fed raises rates a little more aggressively here and rates stay up for a while longer. And I can tell you the answer generally for us is that it’s better. The NIM is better.

So the margin is better and it stays higher for longer, but the pattern is pretty much the same. You get to a peak and then it comes down. Now in that world, I would tell you that, we end up pretty based what I know now. You have a margin that ends the year well above 4%. What it goes to in 2024, I actually don’t have that, but my guess would be that it would drift downward and continue downward if deposit costs play out, because if deposits — if rates go to 5%, stay there for two years or three years to sell it, eventually deposit rates are going to keep going up and up and up.

Frank Schiraldi: Got it. Okay. And then just lastly, kind of I was surprised that the consumer continues to be as strong as it has been in terms of the as a driver — as a partial driver of loan growth. Sorry if I missed it in your prepared remarks, but are you starting to see a slow down or are you expecting a slowdown on that side of things, just given the macro environment with more of a pickup in commercial going forward into 2023?

Mike Price: We are. I mean, we did — we might do 10% less in mortgage this next year, but not 20% or 30%. I mean if we were at 4.70, we might be at 4.30 in first mortgage. HELOC, HELOAN is probably much softer and under pressure, but also we think in our good people in the branches and we have really got to focus on deposits and calling on business customers, small business customers. The indirect auto business looks good and the team has done a nice job of getting our spreads up in that business. It’s very well managed. And so that’s a business that can probably help us, but we will be doing some HELOC and HELOAN out of branches, and we will be doing some mortgage and not a lot less actually from maybe the high 4s to maybe the mid or low 4s.

And but that’s also a business that, long-term we like the business, because we get a cornerstone checking account that we cross sell. We get households, a customer for life and so I think the consumer business is something that is important to us. Jane, anything you would add?

Jane Grebenc: Not really, Mike. I think you covered it. We think the consumer is healthy.

Frank Schiraldi: Okay. Great. I appreciate the color. Thank you.

Operator: Our next question comes from Karl Shepard with RBC Capital Markets.

Karl Shepard: Hey. Good afternoon and thanks for taking the questions.

Mike Price: You bet.

Karl Shepard: I know we are all trying to get a sense for the margin trajectory, but I guess I am kind of curious to ask how you feel about core momentum in the bank. I think your numbers look pretty good and you have Centric coming in equipment finance ramping. So how do you feel about just kind of the overall positioning of the bank as you go into 2023 and kind of strategic priorities?

Mike Price: Yeah. We just feel really good. I mean we feel like we are positioned in our lending business as well. Even the businesses that are hitting a bit of a speed bump like our fee businesses, we really believe in SBA and mortgage longer term, good, robust consumer lending through our branches. We are really building out our equipment finance platform or SBA. We have got new talent in C&I lending. We feel good about our company. And I think for those of you who have covered us for a number of years, the one thing we do is we get better every year. I mean this has been a march from a 60-basis-point ROA bank and we get 5 basis points, 10 basis points better every year. We are — we operate with the principle of operating leverage in every budget in every part of our bank.

We are just excited about the future of our company, we are excited about the new markets and it’s fun. And we feel like we make a difference with our clients and the value proposition that we deliver. We think we are turning our focus back to funding, but we have always been pretty good at funding and it’s just going to be fun to see how well we can do this year and how much core deposits we can gather. And then we just feel like there’s a couple more plays left in the playbook at least. We think our regional model starting to knit the bank together in six of our discrete markets, Northern, Southern, Central Ohio, Pittsburgh, Community PA and now this capital region. And I don’t know, we are just — we are excited about the future of our company and thanks for asking.

Karl Shepard: Thanks for the color. And as a, excuse me, as a follow-up too I wanted to ask, what kind of economy are you assuming in your loan growth guidance. I think we all have kind of a different view, but what kind of trends do you see today and what do you need to see over the next couple of quarters to get where you want to be?

Mike Price: Yeah. I mean our — for this year, just because of some downdraft in some places, we have been a little higher but probably 9%, 10% and we think commercial is on a good trick. And then, of course, we have a newer business that everything equipment finance adds $80 million in the second half of the year goes right to growth and higher spread growth, I might add. And so, Jim, anything you would add or Jane?

Jim Reske: I would say it’s not — we are not predicating those kind of expectations on a recessionary environment that requires a pullback in lending or the consumers start to it were unemployment is. I can tell you actually officially in our forecast, the weighted average forecast I keep referencing in this call, the unemployment rate goes to just over 5% by the end of the year. But we are not using that and saying that’s going to result in be pullback in loan volumes. In fact, we kind of see those things working together, because if there is some recessionary pressure on loan volumes slow down a little bit from what our expectations are then that will release some funding pressure and we will be fine that goes into the mix.

Mike Price: Jane, anything you would add, this is your world.

Jane Grebenc: The only thing that I would add, Mike, is in a couple of the businesses we are still seeing supply chain issues. The car business is still challenged, the equipment finance business still seeing supply chain issues, equipment is taking longer to be delivered and we are also seeing construction delays in some of our residential mortgage and SBA loans. So the economy still isn’t completely frictionless. We still see some of the COVID friction in the economy, but it’s not recessionary, it’s just friction.

Mike Price: Great point. Is that helpful?

Karl Shepard: Yeah. Thanks for all the color.

Operator: Our next question comes from Michael Perito with KBW.

Michael Perito: Hey. Good afternoon, guys. Thanks for taking my questions.

Mike Price: Hi, Michael.

Michael Perito: A lot of them have been addressed, but just two quick ones. One, Mike, on the Centric is about to close, most of your peers are saying bank M&A is pretty quiet. Just curious what you are hearing and where your thoughts are at for that heading into the start of this year?

Mike Price: We wake up every day and we think about organic growth and how we grow our company and that’s the highest and best use of our capital. So that’s where fundamentally we start and we have to be successful there year-in and year-out. And then when we have great opportunities like with Centric, with Foundation in Cincinnati, they have to be right. And Jim always likes to say, we have looked at 60 things to do six. So we are not seeing a lot of activity. And then even if we were, it would have to be right for us strategically and it would have to be right for us financially. And we are pretty picky and I don’t — so anyway, we are not counting on that if it presents itself in a way that’s really positive for our company and is a win-win and great, but it’s not a key part of our strategic plan.

Michael Perito: Great. Thanks. And then just within the non-interest income, any — obviously, the environment on mortgage and investments and everything are challenging. Just curious if there’s any particular areas that might have more or less upside relative to your forecast, anything you are excited about or more cautious about on the line item basis?

Mike Price: Yeah. I will start there and let Jane follow on Jim. But just on the SBA piece, we are a little frustrated, because we really have good volume and we are number one SBA lender in a couple of our key markets. That’s a part of our brand. We feel like we are doing good for customers and our bank and but the volume has materialized into fee income, but it will, and that business has been around for a long time. So we are still very bullish on it even though it’s kind of tamped down right now. We have grown that business pretty nicely in the volume. I will speak to that one. I spoke a little bit to mortgage. And obviously, indirect auto too or not indirect auto, but our card business is off probably about 12% and that’s just consumers not spending as much money and swiping their cards as often, at least in our part of the vineyard. Jane, what else would you add in terms of outlook for fee businesses?

Jane Grebenc: There are a couple of things I would add, Mike, that the brokerage business looks good. The Investment Management and Trust business is a little bit soft, because of the market volatility, and we are priced — we are paid against asset values and the volatility is not our friend. But none of that feels like it’s prolonged, it all feels like a blip. And to Mike’s point on, we have a couple of loans still in the pipeline, construction loans, which started in early 2020 and they just haven’t completed yet and they will. But I have stopped counting the days and I just know they will close. They are progressing. They are just progressing slowly.

Mike Price: Is that helpful?

Michael Perito: Thank you, Mike. That’s all I have. Appreciate it. Yeah.

Mike Price: Thank you.

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

Manuel Navas: Hey. Good afternoon.

Mike Price: Good afternoon, Manuel.

Manuel Navas: Can you kind of talk about the loan growth target and explain a little bit more about the mix and then I will dive into the equipment finance group in a second.

Mike Price: Yeah. The mix is — we do it in two ways. We do it with geographically and we do it by product line, and more and more we are running our company geographically. And I would say that Ohio has just been on a tear, probably, average loan growth there of about 20% the last several years and then in Pittsburgh. And our community PA markets have really improved quite a bit. I mean we were leaking oil for a number of years in Community Pennsylvania and I think they grew about or 7% or 8% last year. So that’s one dimension that we look really closely at is how we are delivering geographically. And then also by lines of business, we expect our commercial to really kind of be at the forefront again this year and kind of carry the day and then our indirect auto is off to a good start. And Jim, you are looking at the actual numbers

Jim Reske: Yeah. Just like to see — just one of the things that’s kind of shifted our guidance, because for a long time we are talking about mid single-digit, once in a while I will talk about upper single digits and choosing on that. But one of the things that’s just giving us confidence about saying going out there with 10% is the equipment finance business really getting into speed. We built out that business. We talked about that a lot on previous calls. It’s really kind of — really coming to speed. As Jane mentioned, there are still equipment issues that affect that business. But even then, that’s a good chunk of our expected loan growth next year and so that combined with pretty modest or not modest, but moderate growth in the other areas, all together gets to 10%. And technically, we probably should say loans and leases, but even in our equipment finance business, 85% of the business is loans only about 15% interest right now.

Mike Price: Yeah. And I forgot to mention on the commercial side, just the backlog we have in the commercial construction business and that will delayered in this year and those construction calls are already beginning to occur. So that’s another nice driver. Jane, are we missing anything?

Jane Grebenc: No. I don’t think so. If I am looking at expectations, everybody — every geography is expected to grow modestly and every business line is expected to grow moderately. And so the combination means somebody can be a little bit up or down and another business line or geography will pick it up. So I feel good about the expectations for growth. I feel good. I don’t see any real weakness.

Jim Reske: Yeah. If I could just add one more thought or follow point. Our line utilization is still not up to where it was pre-pandemic. It’s gone up a little bit, but there’s still maybe a little more runway there.

Mike Price: Yeah. Too clear.

Manuel Navas: No. That’s really helpful. Now equipment finance alone, what kind of expectations as a percentage of loans by the end of this year kind of where can that portfolio grow to in the next two years and then kind of what are the yields that you are getting currently?

Mike Price: Yeah. Jane, why don’t we let you take that one?

Jane Grebenc: Let’s start with, Jim, where he would start with yields, Mike, and then I will back clean up.

Jim Reske: Yeah. So the yields in that business are really strong, really nice. But right now growing over 7% and that’s really where we like it to be. We didn’t build that business to be double-digit yields. We don’t want to take on that kind of risk. The equipment is mostly things like trucks and nice bread and butter kind of equipment like that and the yields are really very additive to our overall NIM and to the bank as a whole. In terms of like I think your question was like a proportion of our loan growth next year, it’s probably 30% to 40% of the loan growth next year. We are going to all draw a big picture number of what we expect to be booking this year. We couldn’t finance, it’s really additive. So that’s what we can say. The other businesses are growing at historical moderate growth rates are growing and the equipment finance stayed on top, so they can build — put the whole picture together and build the whole picture. Jane, if you want to add to that?

Jane Grebenc: Sure. We are continuing to add salespeople. And as Jim said, it’s a big portion of our loan growth this year. And I thought I asked — I heard you ask ultimately whether we see it bank and it’s probably never going to be more than 10% to 15% of the loan portfolio.

Manuel Navas: That’s perfect. That’s helpful. How many people have you added? How much is the footprint on your employee base in this division?

Jane Grebenc: It’s small. The leader of the group, Rob Boyer, has been very, very careful. We add out a few employees at a time, because we have been very careful about collection and onboarding. And we have been adding primarily salespeople and we, probably, have a couple of dozen people in the group right now.

Manuel Navas: Okay. That’s really helpful. Thank you, guys.

Mike Price: Thank you.

Operator: Our next question comes from Daniel Cardenas with Janney Montgomery Scott.

Daniel Cardenas: Good afternoon, guys. How are you?

Mike Price: Good.

Daniel Cardenas: Just a quick follow-up on the equipment finance, what’s the duration of that portfolio and the average loan size?

Mike Price: Average loan size is about $160,000. It was up a little bit from our earliest projection just because of the way the market was moving, it might come down a little bit from that. Duration was, I think, 60 months to 70 months or Jane you could correct me on that. One — but one of the features of that business is unlike the auto business, it really prepays. So the duration is very kind of similar to the stated life.

Jane Grebenc: Yeah. Just about five years.

Daniel Cardenas: Okay. So then to get to the growth that you are projecting right now, is it safe to assume that you will kind of stay within that average or do you kind of foresee going up in size to help you get there?

Jane Grebenc: We don’t have any immediate plans to increase the size. We like the space because we like the yields a lot and we like the collateral. So we will probably stay about where we are, at least for the foreseeable future.

Daniel Cardenas: Okay. And what kind of loss rate are you building into your model for the equipment finance?

Jane Grebenc: Jim, do you want me to take that?

Jim Reske: Yeah. If you have it at your fingertips, please.

Jane Grebenc: I do. We assumed initially 75 basis points. As you can imagine, it’s next to nothing. So far the actual losses have been zero.

Daniel Cardenas: All right. Congrats on that. And then maybe just jumping over to borrowings, in this quarter we saw a pretty substantial jump. Can you maybe give us some color as to how we should think about borrowings on a go-forward basis?

Mike Price: Well, like we have been saying, our long-term goal is that we want to make sure that we fund our loan growth and deposit growth. But when in any given quarter, we don’t have that, we are able to tap into borrowings, so we have a very large amount of liquidity. So funding our loan book is not a problem. In the fourth quarter, we just had that dynamic there. We didn’t want to have an influx of deposits, because of the inflexibility of deposits, assets are so flexible. So if we had gotten to the end of December of last year and we are trying to avoid the $10 billion mark, you can sell a loan portfolio very quickly and pay down overnight borrowings, the same day very quickly. You can’t do that if it was funded with deposits, because you can’t stuff money in envelopes and then it back to depositors and give them their money back.

So that gave us this balance sheet flexibility we really like going into the end of last year. Now like I said, there’s plenty of money available. The money that we are raising in the market even with CD specials and other kinds of specials is all below our incremental cost of over net borrowings. So that’s all better for us in the borrowings and the money is really flowing in in response to those specials. So that’s kind of how we manage and how we look at it.

Daniel Cardenas: Okay. Good. And then last question for me in terms of — as I look at your deposits, do you guys have any brokered deposits in portfolio right now?

Mike Price: No.

Jim Reske: No.

Mike Price: None.

Daniel Cardenas: Okay. Great. That’s all I have. Thanks, guys.

Mike Price: Thank you, Dan.

Operator: Our next question comes from Matthew Breese with Stephens, Inc.

Matthew Breese: Good afternoon, everybody.

Mike Price: Hi, Matt.

Matthew Breese: So I wanted to go back to the deposit discussion. I — Jim, I think, I heard you say that you would like to equally fund loan growth with deposits implying that the loan-to-deposit ratio can stay sub-100%, is that accurate?

Jim Reske: Yeah. Look over the long-term. Over the long-term that’s definitely our goal.

Matthew Breese: Okay. And that leads to my next question really, which is we are standing today with 33% non-interest-bearing deposits that compares to pre-COVID levels or I think closer to maybe 25%, Fed funds is obviously very different from that point in time. I am just curious what is structurally different about the non-interest-bearing deposit composition that — should we expect it to stay at this elevated level versus where it was pre-COVID?

Mike Price: I think it will certainly stay at an elevated level compared to this year. I think it will certainly stay at an elevated level with the composition between business and consumer. I think clearly we have an opportunity to leverage a broad business customer base and gather more deposits. And we do that unusually through our branch network. A lot of banks the branch manager does not go out and make calls on small business and in our bank they are rewarded to not only do that, but to bring in core deposits and businesses that grow. So I think that’s fundamentally a little different certainly than our bigger bank rather than sisters and it’s you need to get customers and not just customers that borrow from you, Jane. I mean, this has been your forte and your drumbeat for the last four years or five years. Do you want to add to that?

Jane Grebenc: The only thing that I would add is, our loan portfolio, particularly on the commercial side, looks very different than it did four years, five years, six years ago. The loan portfolio today is overwhelmingly direct clients with whom we have direct relationships and with those clients we expect a depository relationship and it’s made all the difference in the world.

Mike Price: Does that help, Matt?

Matthew Breese: Got it. Yeah. Very helpful. Maybe just as a follow-up. As we look at the book today versus pre-COVID just as a reference point. Are you capturing more client wallet share or are you seeing similar granularity, but over more accounts?

Jane Grebenc: We are capturing better wallet

Mike Price: No. I think we are capturing

Jane Grebenc: I am sorry, Mike. Continue, I will follow you.

Mike Price: No, no, no, go ahead.

Jane Grebenc: I would say both. We are capturing much more wallet share. We have spent some money on our treasury management product and infrastructure and we know that we need to be able to deliver. And so that when we ask for the operating relationship we have got a product set that allows us to ask for it.

Mike Price: I would just add through our regional business model, we are much more likely to have President or a senior lender much more closely it to the other business lines, whether it’s mortgage, wealth management, retail and really bring other partners out to talk to that client and help them, particularly on the personal banking side, also on consumer lending opportunities and wealth management opportunities. So we are getting a better share of the wallet than we were probably five years, six years ago.

Matthew Breese: Understood. I appreciate all that detail. Maybe flipping to the other side of the balance sheet, could you provide what the roll-on blended loan yields are versus what’s rolling off at this point?

Mike Price: Yeah.

Jim Reske: Yeah. Give me a second, let me pull that out. Give me a second.

Matthew Breese: Yeah.

Jim Reske: Yeah. So for the quarter as a whole, we were putting on loans in the high 5s, 588 and what was rolling off at 544. So it was a 44 basis point differential.

Matthew Breese: Okay. And you have the pipeline yield all in?

Jim Reske: I don’t have the pipeline yields all in. But I could tell you that like we are looking at — what I am looking in front of me just speaking historically for the quarter just ended, those numbers include consistently over every month in the quarter. So the new loan yield is going up, up, up every quarter end.

Matthew Breese: Understood. Yeah. I was waiting — I was hoping there was a 6% number either at the pipeline or at quarter end, is that…

Jim Reske: Well, there are — yeah, there are. So like, for example, a bit like historically different. So some businesses have longer tails than others. So, for example, in the mortgage construction business will be locked in a rate for a loan for someone who is building a house eight months or nine months ago. That’s a really low rate. And then in particular, it gets to the power is in the books and it’s a low rate. That brings on the current period, down the term period yield. But for commercial variable adjustable loans, for example, one of our biggest categories, where we originated $400 million. Those new money yields in the fourth quarter were in the high 6s, 667. So that really brings the loan portfolio yield up and that’s been going very nicely. So the story depends on what portfolio you are talking about.

Mike Price: And that category was our largest category in the fourth quarter in terms of volume and throughput, almost $400 million.

Jim Reske: Yeah. Half of all the originations in that category and really helping — and that’s a new origination. The existing portfolio also re-priced with the Fed rate increases. So that’s been really helpful for the bank.

Matthew Breese: Got it. Maybe turning to indirect auto, I mean, I heard you at the onset. It sounds like there’s really no notable deterioration in credit delinquencies, criticized classified. I did want to hone in and get a little bit of additional color on indirect auto, which we are getting more questions. Could you just give us a sense for the health of that book, the FICOs of the book and maybe just an update on duration?

Mike Price: Yeah. Just we brushed up on this before the call. Average ticket is about 30, Jane, as you shared with us, six-year duration and contracted duration, it tends to be shorter than that, two and half years or so. The average payment is up a little bit over the last year about $50 to just over $500. And FICO, do we have that?

Jim Reske: Yeah. Over 700, but let me see if I can get more refined on that.

Mike Price: Yeah. Good. Jane, do you want to add anything while Jim’s finding the FICO. I know that’s on the report there.

Jane Grebenc: Yeah. There’s been really no degradation. You keep waiting for it to happen, but there’s been none. And the used car market is staying very, very healthy, because there are still shortages in the used car market. So few customers are leasing anymore that used car values are holding beautifully, and so far, it’s been magical. We underwrote…

Jim Reske: 90…

Jane Grebenc: Go ahead.

Jim Reske: No. Go ahead. I am sorry, Jane. Go ahead and finish.

Jane Grebenc: I was just going to say we are holding to our underwriting standards, we haven’t blinked and we are a paper shop. So our capture rate is a little bit skinnier, a little bit lower than what you might see in other banks. We just don’t — we don’t buy everything by any stretch.

Jim Reske: Yeah. 92% of our production is over 700 FICO.

Matthew Breese: Okay. Last one for me is just around capital management, hopefully, the worst of kind of any sort of major impact to AOCI is behind us. I am curious, just given where the stock is and how you think about buybacks and if there’s any level where you would be more interested in that?

Mike Price: Jim?

Jim Reske: Yeah. So we have $5.9 million remaining under our previously authorized — authorization from our Board. We had to stay in blackout while the Centric acquisition was pending. Actually, we had to stay in out of the market technically through today through their shareholder meeting, but obviously, with the earnings out of the market. Anyway, we could go back into the market in a few days with that authorization. Generally, though, as far in our big picture view of capital is that we are generating capital and using it for organic growth and that’s the primary purpose of generating the capital. So we want to use that capital to fund our organic loan growth. If there’s excess capital we use that for buybacks. I think with the $5.9 million of authorization we have, if we look at price reaction today, for example, that completes a buying opportunity.

We will be in the market. We can’t go to the market equally for at least three days from today anyway, so that that would be a buying opportunity and we will continue to use that remaining authorization for buying on those kinds of dips. But, by and large, they are going to use the rest of the year’s capital generation to fund the organic loan growth.

Matthew Breese: Great. That’s all I had. I appreciate taking all my questions. Thank you.

Mike Price: Thanks, Matt.

Jane Grebenc: Hey, Mike. If it’s okay, I hate to retread, but I do want to break for just a minute. Back to the FICO score, we can be even more precise that 90% or greater than 700, the average FICO score for the auto portfolio is 770. The average for rec is 785.

Mike Price: Thanks, Jane. I am sure Matt heard that.

Matthew Breese: Okay.

Mike Price: Hey, Operator, any other questions?

Operator: Our final question comes from Manuel Navas with D.A. Davidson.

Mike Price: Pretty good. Manuel?

Operator: I see there are no further questions at this time. I will now turn the call back over to President and CEO, Mike Price.

Mike Price: I always say this that we just really appreciate the interest of the covering analysts for questions and the opportunity to share our story and our business with you. We are pretty passionate about it. We care a lot. And I hope it shows the results and look forward to being with a number of you over the course of the next 90 days. Thank you.

Operator: That concludes today’s conference. Thank you for attending today’s presentation. You may now disconnect.