First Commonwealth Financial Corp /Pa/ Q4 FY2020 Earnings Call

Good day and welcome to the Fourth Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I'd now like to turn the conference over to Ryan Thomas, Vice President of Finance and Investor Relations. Please go ahead.

Thanks, Operator, 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; Brian Karrip, Chief Credit Officer; and Jane Grebenc, our Bank President and Chief Revenue Officer.

Hey, thank you, Ryan. And I will begin with the fourth quarter and then reflect on the year and the outlook for 2021. In the fourth quarter, net income of $25.7 million drove earnings per share of $0.27, beating the consensus estimate of $0.23 per share. Core ROA and the core efficiency ratio were 1.14% and 56%, respectively. Our core pre-tax pre-provision ROA was 1.76% due to an increase in the core net interest margin, at 3.29%, and continued strength in non-interest income, driven by mortgage interchange income, wealth management, and SBA. Fourth quarter loan volumes and commercial C&I lending were soft due to lower utilization of lines of credit and some payoffs. This math reflects the strength we saw in the consumer businesses, which resulted in a contraction in the overall loan portfolio ex-PPP. Expenses for the quarter were up due to higher salaries and benefits, particularly hospitalization expense. Provision expense at $7.7 million included a pass-through item of $3.2 million in unfunded commitment expense. It's important to note that we adopted the CECL methodology for the allowance for credit losses in the fourth quarter. Shifting gears, as we think about the future, we consider our customers' changing behavior. This is why we continue to make significant investments in next-generation technology in 2020, with a new online mobile platform, a new Treasury management system, 100% issuance of contactless debit and credit cards, and new P2P solutions like Zelle and real-time payments. We also refreshed our digital account opening customer experience with a new mobile responsive design.

Thanks, Mike. Let me highlight a few things from our fourth quarter financial results before offering some guidance for 2021. First, fee income was strong in the fourth quarter. We anticipated but did not see a seasonal slowdown in mortgage originations in the fourth quarter. Fee income was actually suppressed by $1.2 million due to the mark-to-market single derivative. Despite this, fee income still came in at near record levels. We talk a lot about mortgage, but we're very pleased to see our wealth businesses coming along nicely compared to where they were a year ago as well.

Thank you, Jim. Good afternoon. I'll walk you through some prepared credit comments and then we'll go to Q&A. Our strong fourth quarter results underscore the effectiveness of our portfolio management practices, risk management strategies, and disciplined credit culture. Over the past few years, we tapped the brakes on certain higher-risk sectors. We selectively reduced certain segments, such as energy. We've adjusted our corporate and consumer loan guidelines to achieve a more moderate risk profile.

Hey, thanks, Brian. And questions. Operator.

We will now begin the questions-and-answer session. The first question comes from Frank Schiraldi with Piper Sandler. Please go ahead.

Good afternoon. Just a couple of questions on guidance, Jim. You mentioned - you sound pretty confident in loan growth being fairly robust, I think you said at the high end of mid-single digit, so 6%, I guess that's sort of what you're guiding to. And then I just kind of wondered if you could, given line utilizations were low in the quarter, what gives you the confidence in this sort of more robust growth? And if you could break that out between sort of residential and commercial expectations?

Yes, this is Mike. We really see some strength in the consumer lending side in our branches, certainly with mortgage lending, and we portfolio a portion of that and then also with our indirect business. We really haven't had those engines before. We have broader engines in non-interest income and now a broader base in consumer and commercial banking to grow. And we do expect a rebound here, perhaps as early as the second quarter in the commercial side of the business. We even see some early pipeline growth in certain markets on the commercial side. We think as demand comes back, the lines of credit are down, and because accounts receivable and inventory that working capital cycle that businesses need is down as well. We think that could rebound and really create some momentum. We've constructed our budget meticulously year in and year out, and we just feel like we have more engines than we've had before and better teams and producers. Jim or Jane, do you want to add to that? Jane?

Thanks, Mike. No, I don't have much to add. I'm glad that we've got five different regions identified for the bank, because we see different tailwinds region by region. We're running the company much more geographically, and we see much more accountability by geography.

And I'll build on that just a little, Frank. I mean, five, six years ago, we were domiciled and we really operated 80% to 90% of the franchise out of Western PA. As we've done acquisitions, they probably accounted for about 20% of our deposits and loans and they now account for 34% and they're growing very rapidly in the three metro markets in Northern Ohio, Columbus, and Cincinnati. The other thing is, as I think we've gotten larger and we've performed better, Jane and the team, we've got better and better producers. So I think it's pretty simple, but there's definitely more momentum there.

Okay. Thanks for all the color. And then just quickly on the fee income guide. Jim, I think you said that fee income will continue to be strong through the first half of 2021. So does that imply that we’ll see similar levels to what we see in the back half of 2020 in terms of total non-interest income?

Yes, that's about right. Look, I'll be very clear to you, Frank. I think generally, the overall consensus estimate for us for fee income is a little on the light side. It looks like it's annualized from the mortgage experience that we had in the first half of 2020. The second half of both quarters were really strong on fee income. There was a time in the middle of the fourth quarter that we thought, well, this mortgage refi boom will come to an end, and there'll be seasonality and it just hasn't slowed down. So I think some of that will keep rolling in during the first half of this year. Some of that will play its course and then it might come down in the second half. But I do think it's going to be a pretty strong year for fee income.

Okay, great. And then if I can sneak in one last quick one on credit. The increase in criticized assets in the quarter, does that reflect more just sort of a loan review that is now completed? Or if it does reflect a loan review, is that still in process?

Hey, Brian?

Yes. Great question, Frank. So a number of things happened in the fourth quarter. First off, we began getting many financial statements that had been on extension. As those financial statements were analyzed, we looked and identified whether there were some financial covenants tripped; we used it as an opportunity to have a real negotiation and discussion with our borrowers. Secondly, we completed the second full loan review; that semiannual loan review covered 972 names, $2.75 billion. As part of that, we also adjusted risk ratings. Finally, I would just draw your attention to our fervent belief that there might have been an exploration of the CARES Act. We wanted to act with a sense of urgency on any forbearances, so we could provide certain short-term modifications consistent with the CARES Act. Our relationship managers spent a fair amount of time with their borrowers saying, if you think you're going to need a forbearance and would like to negotiate for one, then now would be a good time. The confluence of those various events led to higher forbearances or deferrals in the fourth quarter, as well as some migration and an increase in the criticized assets.

Okay. It sounds like you feel like that migration is complete now, though, since you completed that loan review process in the fourth quarter.

Yes, I feel very comfortable. We've marked the book properly. Mike will say over and over again, we call balls and strikes honestly at First Commonwealth, and I feel very comfortable that we've appropriately marked our credits and that we will continue to watch them over 2021.

Okay. Thanks for all the color.

Next question, Operator?

The next question comes from Steve Moss with B. Riley Securities. Please go ahead.

Good afternoon, guys. Can you just perhaps start by following up on credit here? I'm just kind of curious about how you're thinking about credit costs and what the potential is for the formation of charge-offs in 2021?

I think our feeling is that it might be similar to 2020. But I'll let Brian expand upon that.

Yes. Here's what I'm seeing. I'm beginning to see some light at the end of the tunnel. We may see a little bit of an uptick in the first two quarters of this year. Our viewpoint, our outlook is that the back half of the year will begin to improve. We think 2021 numbers will be generally in line with where we were in 2020, which is right in line with our internal targets.

Okay, that's helpful. And then on the margin front, can you give a number or details around funding at the ramp CDs repricing and following the bigger pricing as well? Where are your repricing CDs these days? It was a pretty good quarter for funding costs coming down. How much further do you think we could go here?

Yes, most of those time deposits will reprice at the rack rate. Our rack rate is actually very similar to others in the market depending on the term that there are 10 to 20 basis points, which is very low. Even if those rates fell, we will still see half to two-thirds which is rollover. The rest will at some time just roll into savings accounts; that will earn between zero and five basis points. So, there's quite a bit of - and that's why we're happy about it, because there's quite a bit of healthy repricing opportunity on that front.

Right. Okay. That's helpful. And then just in terms of business activity here, it sounds like, maybe - correct me if I'm wrong, but Ohio continues to be stronger relative to Pennsylvania. Just kind of curious about the dynamics you're seeing between markets and any color there?

Sorry, I muted you Steve, forgive me. Yes, we've had good growth and it's been broad-based, on both the consumer and the commercial sides, and more on the C&I side as well. C&I and commercial real estate. I think in Pennsylvania, Brian gave you a pretty good list about 10 minutes ago, four or five ways that we derisked the bank. Trust me when he says that we have derisked the bank. We've gone from 70-plus names over $15 million in credit. And Brian, don't get it wrong, but the number is probably closer to 25 now. That created some headwind for us, it has for our core franchise for a number of years. The other thing is the demographics, quite frankly, in the metro markets in Ohio, are a little better. I think as we've moved palpably to a regional business model here in the last several years, each market is improving and performing better each year, which gives me great confidence that we will have a year where our consumer and commercial will run on all cylinders in each region. I'm just more optimistic about growth for our company than I have been at any time since I've been here.

Okay. And maybe one last follow-up from me. Just in terms of potential acquisitions, what level of activity is there and any reason for interest?

Yes, I don't want to sound like a broken record. We've done things that have been executed very well. They've been smaller. We've done things that have been in adjacent markets and they haven't been a stretch for us. I hope we can continue to use that playbook. We're very mindful of the cost of deals, I think we've probably looked at 40 plus opportunities, five or six, maybe five, right. If the numbers don't work and it's not strategic, we don't do it. That's pretty conservative. I'd like to do something a little larger, but we also invite a different kind of risk, and you have to feel very comfortable that you can execute that risk and that there is nothing that's going to bite you. Jane, I, and a number of others in the team have done big and small banks, dozens and dozens of deals. We just want to grow it responsibly and thoughtfully. I think we have a better organic engine, but we really would like to do deals. Don't get me wrong, it just has to work for us. But I'd love to do something in an adjacent market here or fill in, small or a little larger.

The next question comes from Russell Gunther with D.A. Davidson. Please go ahead.

Hey, good afternoon, guys. I wanted to follow-up on the margin discussion. So, first to make sure I heard the guidance right, the 320 plus or minus 5 basis points on either end, that's core and that's why you guys consider exclusive of PPP fees, so that's question one. I want to make sure I have that right. Two, what dynamics need to materialize to hit the high end of that range?

Jim?

Yes. Well, there are a couple of things really on that. First, for sake of clarity, yes that's core. We published a reconciliation of core in our earnings deck supplement. We're excluding PPP loans and all the P2P forgiveness income. We are also excluding the effect of the excess cash from the balance sheet; that's our definition of core and reconcile back to GAAP NIM for everyone's benefit. We think that could be quite a bit of PPP forgiveness in the first half of this year for the PPP loans that remain on our books. The $588 million that we did in total last year, about $100 million was forgiven before the year ended, so there's quite a bit left to go. If it renews by now the amortization will accelerate and that could really boost the stated NIM quite high in the first half of this year, depending on the pace of that forgiveness. We'll continue to publish that core NIM. Some of the upside of that number chance for the second part of your question will depend on the slope of the yield curve, and how that might shift over the course of the year. Like I mentioned, we purchase rate forecasts from Moody's. Some of that culture seems steepening, so to the extent that happens, that could really bring some upside to our NIM, somewhat in this year but even more so next year. Hope that helps?

Thank you, Jim. Yes, it does quite a bit. I guess one follow-up to that would be, what that includes in terms of your assumptions with the investment portfolio going forward, from an overall size to the percentage of earnings assets and the reinvestment opportunity.

Yes, great question. A lot of that will depend on the pace of deposit withdrawals and for lots of those PPP loans have been forgiven. As the PPP loans are forgiven, all that does is turn the PPP loan asset into a cash asset for us. Then it depends on the pace with which customers pull that money out and use it and deploy it. As that cash sticks around, it's very expensive to let it sit around because while it sticks around, it's generating very little income. Yes, we intend to invest some of that excess cash over the year. You asked about our assumptions, so we assume that investment yields on securities are not aggressive at all. We're seeing our yields on plain vanilla MBS securities that range between 1% to 1.1%. We really don't look at that book as a place to stretch for yield and take on any risk. So we don't consider anything esoteric in that portfolio; it's very plain vanilla. That's the assumption. Specifically, with regard to your question regarding what percentage of the book it will represent, our general assumptions won't change a whole lot. But it's really going to depend on how much cash we have in and how much more of that cash we have to invest.

Got it. Okay, great. Thank you, Jim. Then switching gears a little bit, I appreciate the color on the expense outlook. I just tried to tie together a lot of the conversation we've had. It seems to me like the answer would be yes, but are you able to commit to generating positive operating leverage for 2021?

We’re going to - like a lot of banks, I think we're going to have to scramble to get there. That's the goal. We scrambled last year with some cost takeout and other actions. If the revenue line moves, it could get a lot tougher. But that is the goal, is to have positive operating leverage.

Let me answer that also with a brief anecdote. I think it was around the end of March when Mike looked at me and asked me that question. We track it internally; obviously, we're very focused on operating leverage as part of our core DNA as a company. At the end of March with COVID hitting us in the pandemic, I thought it was over. There's no way we could get positive operating leverage in calendar 2020, and we did. It was quite positive. Our core revenue grew $9.3 million and core NIE only grew $2.8 million, so we're very pleased with that. We'd love to continue, but time will tell.

Understood. And then maybe a similar type of question. Profitability ratios have been really strong, and I think as you called it in your deck from a PPNR perspective, in the 175-ish range. Do you have a target that you are striving for, either a PPNR ROI perspective or something else that you set out for 2021?

Yes. Longer term, I would qualify that in our plan on the first page is 180, pre-tax pre-provision ROA and sub 55% efficiency ratio. That doesn't set up really well for this year. I won’t look to that, but we need to be moving palpably and we need to find dollars to continue to invest in our digital platform. I started there because we made a lot of investment that really enabled us through the pandemic to achieve the kind of year we had, and to allow those fee businesses to grow with talent at the same time, we shifted expenses. We just have to be nimble and thoughtful and when we're in front of you, Russell quarterly, we're very accountable for our status and our future aspirations.

I appreciate it, guys. Thanks for taking my questions. That's it for me.

Next question comes from Steven Duong with RBC Capital Markets. Please go ahead.

Hi, good afternoon, guys. Just first, on the margin. It looks like you have a little over $550 million in CDs. How much of that do you expect to roll off by the end of the year?

Yes, thanks for the question. With $471 million maturing next year, we will probably retain half to two-thirds of that; that's been the pace recently. Even without offering any deposit specials or reaching for yield, about half to two-thirds will roll over.

Okay. So basically by the fourth quarter of this year, that could get down to like a $300 million number?

Yes, absolutely.

And that $300 million, you're saying the cost is around 10 to 20 basis points?

That's right. Now, the rest of the money, just to be clear, may not roll into CDs; it might just be that someone does not renew their CD. They might say, well, the rates are so low, I might as well just put it in my savings account. A lot of that money stays with the bank; it just doesn't go into a time deposit.

Right. And so then, like right now, it looks like your total deposit costs are less than 20 basis points. Do you see the potential for breaking through the 10 basis point line by the end of the year?

Steve, it's a great question. I have not calculated it that way. I would say we have a good chance of doing that by bringing these costs down. I provided some numbers in my prepared remarks: $290 million at 1.21% and another $130 million of money market to 1.22%. Those will come down by 100 to 110 basis points. So that really could reduce the total cost of deposits in half.

Steve, this is Mike. Just to be clear, I mean, longer-term, the engine that Jane Grebenc is on the phone has developed, along with Greg Sipos, our head of corporate banking and head of retail—to go out and get business deposits is key. Non-interest-bearing deposits and checking accounts drive your fee income. I don't want to be dismissive of deposits in general. Long-term, we will cherish every checking account and every transaction account we have. But our focus is and our DNA has to be to get non-interest-bearing business accounts. Thankfully, we've shifted in the last five years, which really enables flexibility with the time deposits.

That's good to hear. And I saw in your presentation you had $1.7 million in the PPP fees. Was that just the accelerated portion or was that the total PPP fees for the quarter?

That was just the accelerated amortization. That does not include the regular recognition of the fee income for the rest of the PPP portfolio.

Okay. And what is the total recognition and how much do you have remaining?

Well, like I say, we have about $100 million on the books by the end of the fourth quarter, so there's about $480 million or $490 million remaining in that portfolio. I don't have a dollar figure handy for the total amount of amortization on the portfolio in the fourth quarter, but I could probably get that for you.

Okay. And then just one last one for me. On the loan growth side, on the commercial side, you seem pretty positive on it. Just curious, do you think your clients are sitting on a lot of liquidity right now? How does that factor into your expectations?

They are. I have Jane on the phone. Jane, why don't you take that one on liquidity?

Thanks, Mike, and thanks for the question. We've seen our line utilization drop in 2020 from about 50% down into the high 30s. So, an indication that our clients are also sitting on lots of cash. The bank is flushed with cash. We anticipate that as the economy begins to open up, our clients will start to use that cash and they'll begin to borrow again, drawn down on some lines.

Great. Thank you. That's it for me.

The next question comes from Joe Plevelich with Boenning & Scattergood. Please go ahead.

Good afternoon. Two quick questions. One, on the next round of PPP, any sense of what kind of applications you've received? How much volume might you get from that? And the second question is on the allowance for loan side, it’s at 1.5%. Where do you see that longer-term? Could we see reserve releases here as soon as this quarter?

All right, let's start with the credit question, and Jane, if we could find the PPP numbers, I think you might have those. But Brian, on the loan loss reserve.

Yes, thank you. Here's how we're thinking about the loan loss reserve. As we completed this year-end and the transition to CECL, we want to continue being disciplined and credit prudent in how we address our reserves. We'll look at both our qualitative and quantitative components and our high-risk portfolios throughout the year, with an expectation that we may be in a position to reduce these reserves as the economic outlook improves.

Jane on the PPP?

Yes. And back to the question on PPP volume. Right now we've received about $174 million in applications, and that's about 1,300 apps. The pace is much, much different than it was last year. That’s another reason for optimism around the loan growth. I'm really proud of the work that we did around PPP in 2020, but it was an all hands on deck kind of initiative. We used virtually every resource. This year, it's been much more quarantined. The process is much more automated. We knew what we were getting into. We're prioritizing our own customers and really like the cadence compared to last year. So we're pleased with where we are.

So Joe, that's about 22%, or about a fifth of the volume we saw in the first two waves in 2020.

Do you think that could get to a third or 50% or what's your gut feeling?

My gut says that it's going to stay around here. Those are absolute dollar amounts, but we received about $600 million last year. I don't think we'll do more than $200 million, maybe a little bit more.

Thanks, Joe.

This concludes our question-and-answer session. I would like to turn the conference back over to Mike Price, CEO for any closing remarks.

Yes. Thank you. Jim, did you have something?

I do. Thank you, Mike. Before we close the call, while we're still on the line, I have a couple of answers to questions that were asked earlier. One of the questions was about the total deposit cost. Could that come down in half from '20 to a split to 10 basis points by the end of the year? It's not going to come to quite that 10 basis point level, and I want to be clear about that. In our planning, it looks like it'll be more like 12 to 15 basis points by the end of the year. The other question was about the total amount of PPP spread income that was recognized in the quarter. The total amount was $5.5 million, but that includes the $1.7 million of accelerated amortization. So the rest of it, the remaining PPP interest income recognized for the remaining PPP loans in the fourth quarter was $3.8 million. Just wanted to clarify while we're still on the call.

Thanks, Jim. I want to thank all of you for your interest in our company. We look forward to reporting positive momentum in the first quarter and the rest of the year as the economy recovers and people get vaccinated. Thank you very much for your interest in First Commonwealth; sincerely, take care. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.