First Commonwealth Financial Corp /Pa/ Q4 FY2021 Earnings Call

Good afternoon. My name is David, and I will be your conference operator today. At this time, I'd like to welcome everyone to the First Commonwealth Financial Corporation Fourth Quarter 2021 Earnings Release Conference Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question during this time, please press *1 on your telephone keypad. Thank you. Ryan Thomas, Vice President of Finance and Investor Relations. You may begin your conference.

Thank you, David, 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, President and Chief Revenue Officer. And Brian Karrip, our Chief Credit Officer. As a reminder, a copy of today's earnings release can be accessed by logging on to fcbanking.com and selecting the Investor Relations link at the top of the page. We've also included a slide presentation on our Investor Relations website with supplemental 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 3 of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statement. 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 to our reported results prepared in accordance with GAAP. A reconciliation of these measures can be found in the appendix of today's slide presentation. And now I will turn the call over to Mike.

Thank you, Ryan. This past year was another good year for First Commonwealth. So much of what we did sets us up well for 2022. We continued multi-year investments in our core systems and digital technologies for businesses, fee businesses, new geographies and credit systems, as well as our leadership and line talent. Here are a few of the 2021 highlights. Regarding loans, we had strong growth excluding PPP of 4% in the second quarter, 8.2% in the third quarter, and 11.2% in the fourth quarter of 2021, carrying good momentum into 2022. Regarding PPP, through two rounds, we made 7,400 loans for $845 million, and realized some $23.2 million in forgiveness income in 2021. We also picked up a number of new business prospects in each round of PPP lending. We suffered in this low-rate environment. But our core net interest margin, net of excess cash and PPP, seems to have bottomed out in the third quarter of last year. Importantly, our loan growth prospects and asset sensitivity position us well for net interest margin expansion in 2022. Our non-interest or fee income was up appreciably in 2021, to $106.8 million, even as gains on sales of mortgage income fell from $5.2 million from record 2020 levels. Our card-related income grouped $4 million to $28 million. Our wealth and insurance businesses were up $2.7 million to $19.6 million. As we transition from PPP activities to traditional SBA lending, our SBA gains on sales business improved by $3.1 million to $6.8 million in 2021. We're now the number one SBA lender in Pittsburgh and a top SBA lender in Ohio. Additionally, SBA is poised to make an even more meaningful contribution to fee income in 2022. In mortgage, we've built a strong balanced offering between purchase money, construction, and refinance, and we were well-positioned to take advantage of low rates and higher premiums. In 2020, we did $787 million in production. Given ongoing strength in the purchase money and construction portions of the business, the team had another strong year with $760 million in 2021 production. Our mortgage division touched over 6,000 households over the last two years. Many are now using debit cards, HELOCs, checking accounts, and other services with us. Expenses were well controlled from 2020 to 2021, even as we added talent in commercial and indirect lending and scaled our risk and governance culture. We also kept up a brisk pace of IT project work each quarter. After years of looking to buy into the equipment finance space, we executed a lift-out strategy from a larger bank. We will see our first origination this quarter in equipment finance. Our actions to close 20% of our branches in 2020 enabled these investments. We also wanted to provide you with a sampling of record levels of digital engagements. Just to name a few, mobile remote deposit capture items increased 43% in 2021. We now have over 50,000 mobile wallet users and saw a 63% increase in monthly transactions. Overall, active mobile users on our digital platform increased 13.5% in 2021, and lastly, debit card dollar volume increased 14.4% year-over-year. On capital, the team took advantage of excess capital and low stock prices to retire 2.1 million shares in 2021 at an average price of $14.29. We still pre-book value per share by 8%, from $7.80 per share at the end of 2021 to $8.43 per share at year-end 2021. On credit, metrics remained strong in the fourth quarter with our allowance for credit losses to loans at 1.3%, with low delinquency and low charge-offs given our business mix. Turning to the fourth quarter, net income of $34.8 million improved by $684,000 as compared to the third quarter. Core earnings per share of $0.37 was a penny better as well. Core return on assets was a healthy 1.45%. A $2.7 million negative provision expense stemming from low charge-offs, a recovery on a previously charged-off loan, and reserve release created tailwinds for the quarter-over-quarter comparison. I wanted to provide some context for our fourth quarter loan growth of 11.2% excluding PPP, which sets us up well for continued growth. In commercial and industrial lending, we were up $26 million and 9.6% annualized to $1.1 billion in footings. Our lines of credit on the commercial side, which have a 35% usage of the total facilities, are still well below the pre-pandemic levels of 48%, indicating potential tailwinds for 2022. Commercial construction was up $65 million from a $318 million base in the quarter, equating to significant growth. Our commitments now run over $750 million, and increased construction draws will be a source of loan growth tailwind in 2022. Commercial real estate was up 3.4% or $2.3 billion. Residential mortgage was up $53 million, or 10.6% to $2 billion, driven by both mortgage and a reinvigorated consumer lending approach through our branches. Consumer lending was up $23 million, or 9.4% to $1 billion, including $15 million in growth in indirect auto loans, which had a terrific year. Looking forward, the outlook in each of our geographies and lending sectors is positive. Looking at the quarter, the performance of our Ohio markets resulted in loan growth exceeding 22% or $500 million for the year, stemming from our acquisitions in Northern Ohio, Columbus, and Cincinnati over the past three to six years. Overall, 2021 was a good year for First Commonwealth, and the fourth quarter was another solid quarter. Our team is enthusiastic about what lies ahead for our company. With that, I will turn it over to Jim.

Great. Thanks, Mike. The PPP wave will soon be behind us, but it continues to affect our results in the fourth quarter. So let me say a word about that before moving onto more fundamental results. At the end of the third quarter, we had approximately $152 million in PPP loans on our books with approximately $6.3 million in fee income left to be recognized as of September 30th. We had thought that most of our PPP loans would have been forgiven by year-end. However, as of December 31st, $71 million of PPP loans still remain on the books with approximately $2.5 million in origination fee income remaining, which will be recognized as interest income over the remaining life of these loans or upon forgiveness. As a result, while we recognized approximately $5.7 million of total PPP income in the third quarter from interest and fees, that figure fell to $4.1 million in the fourth quarter. Nevertheless, the GAAP net interest margin or NIM remained unchanged at 3.23%. Strong loan growth could offset the loss of PPP income, leading the GAAP NIM to remain unchanged. Looking ahead to 2022, as PPP runs its course, the GAAP NIM will lose the benefit of PPP in the first half of 2022 as it will for all banks that participated in the PPP program. The GAAP NIM is then expected to rebound in the second half of 2022 with loan growth and the remaining excess cash utilized effectively. In contrast, our core NIM, which we define to exclude both the PPP income and excess cash, is expected to rise steadily from here. The core NIM increased slightly from 3.16% last quarter to 3.17% in the fourth quarter, confirming our previous guidance that the core NIM bottomed out in the third quarter. We expect that core NIM trajectory to continue in 2022. A forward reconciliation of core NIM to GAAP is provided in our earnings supplement, which can be found on the Investor Relations portion of our website. Fourth quarter fee income benefited from stronger swap income, but that wasn't enough to overcome a seasonal slowdown in mortgage gain on sale income. Expenses were up by $0.5 million over last quarter, almost entirely driven by expenses related to the build-out of our new equipment finance group. I'll wrap up with some guidance for 2022, which hopefully you'll find helpful. We expect organic loan growth to be in the mid-to-high single-digits, and when combined with growth from our new equipment finance division, it should approach double-digit growth in earning assets. Because we can fund that growth with cash and securities portfolio runoff, the bank's total assets should only grow by about $200 million, keeping us under $10 billion in total assets by the year-end 2022. Fee income is expected to remain steady in 2022 compared to 2021, as a long-expected fall-off in mortgage gain on sale income will be replaced by growth in SBA, interchange, and wealth income. Expenses are expected to run at $56 to $67 million per quarter in 2022, partly due to the equipment finance build-out. However, we still expect positive operating leverage when comparing our growth and expenses with a year-over-year growth in our revenue, excluding PPP. Finally, I would note that our buyback program was active in the fourth quarter, during which time we repurchased one million shares at a weighted average price of $15.28. If those numbers sound slightly different from what you recall reading in the earnings release, that's because they are. The repurchase numbers are correct, just for the record. In any event, we have approximately $20 million remaining under our current repurchase authorization. And with that, we'll take any questions you may have. Questions, Operator?

Thank you. We'll pause for just a moment to compile the Q&A roster. We'll take our first question from Frank Schiraldi with Piper Sandler.

Hi guys.

Hi Frank.

Just a clarification on the loan growth expectations. I heard you say mid to high single-digits. So was that excluding equipment finance? And with equipment finance is double-digits?

No, we don't have the exact number yet. The mid-to-high single-digit figure I mentioned excludes equipment finance. It refers only to our regular organic loan growth. If we include equipment finance, the total should approach double digits.

Okay. And then, since you mentioned the core NIM moving higher here, wondering if you can give any sort of color on expectations as we see rate hikes. What would a 25 basis point hike do for your NIM here?

Sure. Every 25 basis point hike results in about a five to seven basis point improvement in the NIM, usually in the quarter in which the hike occurs. Then there are effects as loans repricing continue, which can cause a drift upwards after that; so it does increase after that, and that's about the ratio per hike.

Okay. And any color on how you think about — I would imagine — I don't know if you model it with static deposit betas through hikes. So, what sort of deposit betas do you have baked into those expectations?

We changed our approach last quarter. What we're assuming now is 0% deposit betas for the first two hikes, whenever they occur. We're doing that in our regular planning, and we're doing that in our interest rate sensitivity tables that we published. So, 0% deposit betas with our essential needs in the first year is actually driven by the liquidity levels that we have and everybody else has. After that, our beta assumption is 25% per hike.

Okay, so the five to seven then would be for the first few, and then as we get deposit betas going up a little bit, that would be reduced, I guess, is that the way to think about it?

Yes. It would be, and yes.

Thank you.

Next, we'll go to Daniel Tamayo with Raymond James.

Hi, good afternoon, everyone. Maybe first, you touched on the repurchase activity in the quarter, but I just wanted to know how you're thinking about the repurchase at these prices. And I think you mentioned $14 this quarter, and you repurchased on average a little bit higher than that, obviously with the stock price increasing. Just curious about your thoughts on the process for repurchases now.

We think share repurchases are a very appropriate way to return capital to shareholders in a public way to manage capital levels. We will look at, for example, the earn-back calculations, but it's really driven by where we want the capital to be, how much excess capital we are generating, and how much capital we need to retain to fund what we expect to happen in loan growth. Last quarter in the fourth quarter, we were repurchasing up to $16 a share and just had a cap of $16 every repurchase almost below that. When it gets above that, we just stopped repurchasing. And what we plan to do in the fourth quarter is repurchase just the excess capital generation gap. We now have, as I mentioned a moment ago, $20 million of share repurchase authority remaining. But we have really strong loan growth prospects. If the share price stays above $16 and begins to trend higher, the share repurchase activity will probably slow down a bit from here. However, we are happy to have that authorization, so if the share price does drop, we have the capital available to buy back shares.

Understood, yeah. Thanks. Yes, absolutely. Secondly, on the margin, you have clear core NIM margin guidance in terms of expansion from here. But in terms of the discussion, or the comments you made about the decline in reported NIM in the first half of the year and then a rebound in the back half, what are your assumptions regarding the usage of excess liquidity on the balance sheet?

Yes. Sure. Thanks for asking. I will try to be explicit on the NIM guidance to be helpful. We ended the year with about $300 million excess cash. The number fluctuates a little bit, but we think the excess cash will probably be deployed fully given all the loan growth prospects we have in the third quarter. At the same time, we stopped purchasing securities, and the securities portfolio ended the year at about $1.6 billion. We think that will drift down to about $1.3 billion by the end of next year. That will provide another $300 million of funding we can deploy into loan growth. So, the excess cash will be gone by the end of the third quarter of next year. What will happen is that the GAAP NIM will lose the benefit of PPP early in the year, but still suffer the suppressive effect of the excess cash for the first part of the year. However, by the end of the year, the PPP will be in the rearview mirror, the excess cash will be in the rearview mirror, and core NIM and GAAP NIM will converge. To be specific, we think that if rates don't rise at all levels, both GAAP and core NIM will probably end the year somewhere in the mid-320s. If rates rise two times, which is what we had in our forecast, I know some of you are anticipating rates to rise four times, but if rates rise two times, both the GAAP and core NIM will converge in the mid-330s by the end of the year. The patterns may look different; the GAAP NIM will follow a bit first and then recover, while the core NIM should steadily rise because in the core NIM calculation, we exclude both PPP and excess cash. I hope this is very helpful.

Very helpful. Appreciate all the color there. And then lastly, on the equipment finance guidance, you talked about the difference in the growth targets with and without, but I think last quarter you mentioned $200 to $250 million in balances by the end of the year. Is that still the thought process?

Yes, that's correct. We should start making loans in the first quarter.

Alright. Terrific. That's all I had. Thank you for taking my questions.

Thank you.

Next we'll go to Steve Moss with B. Riley.

Good afternoon. David, just going back to loan growth here — Mike, I hear you in terms of the positive outlook, and obviously guidance is there too. Maybe a little color as to the type of construction projects you're lending on? I heard you're seeing positive commitments, curious as to how you drew that up? A little bit more color on other sources of commercial loan growth you're seeing?

Yes. On the construction side, we received some excellent opportunities with our top developers in strong sub-markets in Cleveland, Columbus, Cincinnati, and Pittsburgh. Areas such as education, medical, and tech are leading the way. We're seeing really good projects coming online with multifamily buildings. Additionally, we're also observing on the industrial side, some major developers creating spaces for large tenants like Amazon, Frito-Lay, Pepsi, and others. These are high-quality projects from reputable clients, and they come online quickly. I think our commitments there have probably gone from $350 million up to well north of $700 million over the last 12 plus months, with much still undrawn. In fact, we expect incremental funding to be about $6 to $9 million per month that will come online this year. This is just one facet of our commercial construction lending, which will then transition to commercial real estate. For other aspects of growth, commercial and industrial lending has seen a nice uptick, especially among small businesses and mid-market family-owned businesses. We've also seen an uptick in SBA loans. Meanwhile, on the residential side, we believe our mortgage pricing will align with the last few years, although we're getting paid a little less on gain on sale. That said, the consumer or branch side of the business has significantly improved productivity, leading to growth. We've also had nice momentum in indirect loans. So, one or two of these areas could miss targets, but the balance between commercial and consumer loan growth keeps us resilient, allowing us to weather weaknesses in any one segment during any given quarter. Was that helpful?

That is helpful. And maybe just with the equipment finance business, as you're starting that after the transition, could you remind me of the yields you expect to achieve? What do you see for the trajectory of growth as the year goes on?

Yes. I mean, the trajectory of growth will be back-end or second-half loaded. We really expect the business to take off from there, with breakout years in the next two years once we get beyond the initial setup. We've built the business from scratch and as of this week, we can book loans. Jane, anything you want to add?

Sure. Thank you. As Mike said, we can go live now and will. We expect the yields to be in the high fours, which will assist in improving NIM a bit, but the growth is anticipated to be exponential, particularly towards the end of the year.

Right. Okay. That's helpful. And then on expenses, can you repeat the expenses guidance, was it $56 million per quarter?

I'm sorry. Yes, the guidance I provided was $56 million to $57 million per quarter.

Okay. Great. That's everything from me. Thank you very much. I appreciate the color.

Thank you.

Next, we'll go to Michael Perito with KBW.

Hey, good afternoon. Thanks for taking my questions. Regarding the cost side, could you spend a minute on the run rate? It's clear that you’re at a little higher than what you were forecasting six months ago. Some of that seems to stem from faster growth on the equipment finance side, while some of it seems related to broader challenges in the labor market. As we think about that range for next year, can we assume that it assumes robust growth on the equipment finance side? If it comes in higher, what pressures should we be mindful of given the challenging cost environment?

Yes. We have budgeted loan growth that falls in the mid-to-high single digits, as Jim discussed. We expect consistent growth across the board in our lending segments and in different geographies. We're seeing nice traction in areas like Ohio, and Pennsylvania growth is beginning to move as well. I apologize, I didn’t catch the second part of your question.

Just generally speaking, what do you see as the upward pressures on expenses that could potentially lead you above the guided range?

We see typical inflationary pressures and supply chain issues. This is concerning to me as we all have lots of open positions, and if we can fill those quickly, it would enhance productivity significantly. Jim, anything you would like to add?

Part of your question was referencing first half of 2021 when the run rate was more like $52 million or $53 million. In the latter half of the year, we think we've stabilized in the $56 million to $57 million range. Some of this relates to the equipment finance build-out. I'm pleased to note that this business will be headed to breakeven in 2022. We think that division will generate positive operating leverage this year, leading to more income than expenditures. There’s also the matter that expenses were exceptionally low in the early part of 2020 due to the closed operational environment. Travel and client entertainment costs were lower than anticipated, but have surged recently. With Omicron impacting expenditures again towards the end of the year, we’re looking at 2022 being much more open to carry expenditures across the board. The growth we noted is spent effort to secure loans, and being incentive-based compensation supportive of our loan growth is crucial to our business.

That's helpful. And regarding fees, could you clarify the expectation? You noted up to $106 million reported GAAP non-interest income this year and are potentially looking at a similar number next year?

I think our total year figures ran $107 million this year. We do think that's going to see slight growth, but generally speaking we expect a decline in mortgage gain on sale to be offset by growth in other areas like SBA loans.

What about swap and hedging income? Is that an area where we could see decent growth as rates exploit and with the commercial customers you're seeing? I recall you were running at about $3.5 million pre-pandemic, are you expecting growth here?

Absolutely; there may be upsides there in addition to our increasing loan fees that are somewhat linked. We’ve seen strong growth from our wealth management group alongside profitability, and we’re eager to sustain that momentum.

On the $200 million of projected earning asset growth, how are you positioned regarding M&A? How are you approaching reaching that $10 billion threshold?

We’ve engaged in five deals and evaluated nearly 60 at this stage. The conditions have to be constructive for both parties both strategically and financially once we enter negotiations. We prefer to focus on deals that align closely with our existing footprint to mitigate execution risks. The nature of a merger involves congruence on both sides, ensuring post-deal, both companies emerge stronger. I believe the caution we’ve shown has served us well. The distinctive platform we’ve established in Ohio, yielding about $0.5 billion growth last year, is evidence of that approach.

On the budgeting side, how long do you think you can operate under $10 billion without significantly disturbing your organic growth efforts?

The strategy of using up the cash in 2022 puts us in a slight borrowing position towards the end of the year, keeping things stable. By 2023, with the ability to borrow, we can better manage the balance sheet. By leveraging our assets through selling securities or paying off borrowings, we can position ourselves at a lower level beneath the previously stated threshold.

Going beyond the $10 billion threshold could significantly increase profitability, stressing that it would not consequently devalue the company. With our growth projected in acquisition prospects, combined with launching equipment finance, we are in a solid position moving forward. We've achieved consistent annual improvement in profitability, showcasing a strong operational perspective.

It's essential to note that our indirect SBA offerings, equipment finance, and mortgage also provide avenues for selling assets. We've intentionally kept many of those assets on our balance sheet, but we have the option not to, and we're ready to adjust if necessary.

The measurements put in place reflect the ability to remain below $10 billion through 2023, extending beyond, taking pressure off us during that timeline. This offers even longer before we confront implications from regulatory constraints.

That's right.

Thank you all for your insights. I appreciate it.

Next, we'll go to Russell Gunther with D.A. Davidson.

Hey, good afternoon, guys. Just a couple of follow-ups. First on loan growth, Mike, you mentioned that commercial and consumer lending can complement each other. Both sectors appear to be performing well at the end of the year. Can you provide insights into your 2022 guidance regarding the mix of these segments? Will there be a shift in consumer lending toward single-family contributions?

I would say commercial lending gained momentum in the second half of the year; the mid-market and larger commercial banking sectors are surging. The mortgage side lagged a bit in the third quarter but surprisingly regained traction in the fourth quarter, with a positive outlook for next year. Gain on sale income is fluctuating, but we’re fostering household engagements launching checking accounts, debit cards, and building lasting relationships with these clients.

If all goes well, we do expect growth across the board, with varying levels across each business line. While we may not foresee rapid commercial real estate growth in community or rural markets, consumer growth should remain strong.

Our producers are consistently improving in each business line, and we feel confident in maintaining a competitive edge against larger banks. We intend to continue investing in our team, notably as we have in equipment finance, bringing forth a favorable return on that investment. Our expense management remains disciplined and guided to ensure we realize our ambitions.

Thank you both. I have one other follow-up for Jim — your guidance concerning NIM improvements converging with equipment finance growth; does this guidance account for those anticipated outcomes?

Yes, it incorporates all aspects, thank you for checking. We're optimistic about improved yields derived from the growth, elevating potential yields, even in the absence of hikes either predicted or undetermined.

I appreciate the clarification there. That's it from me, thank you.

There are no further questions at this time. I'll now turn the call back over to Mike Price for any additional or closing remarks.

Thank you as always for your interest in our company. We're enthusiastic about our future, feeling we have built a balanced bank between commercial, consumer with robust offerings. We connect the dots across lines of business and strive to make a difference in the communities we serve for both consumers and businesses. Thank you again, and I look forward to seeing several of you over the next quarter. Take care.

This concludes today's conference call. You may now disconnect.