First Commonwealth Financial Corp /Pa/ Q3 FY2025 Earnings Call

Thank you for joining us. My name is Danielle, and I will be your conference operator today. I would like to welcome everyone to the First Commonwealth Financial Corporation Conference Call. I will now turn the call over to Ryan Thomas. Please proceed.

Thank you, Danielle, and good afternoon, everyone. Thank you for joining us today to discuss First Commonwealth Financial Corporation's Third 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; Brian Sohocki, Chief Credit Officer; and Mike McCuen, Chief Lending 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 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 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. A reconciliation of these measures can be found in the appendix of today's slide presentation. With that, I will turn the call over to Mike.

Thank you, Ryan. Our performance in the third quarter reflects broad-based momentum across our regions and lines of business. Key highlights include our return on assets improved to 1.34%, and our core pretax, pre-provision ROA grew 10 basis points to 2.05%. Net interest margin expanded 9 basis points to 3.92%, marking another quarter of improvement. Average deposits increased 4%, reflecting balanced growth across all of our geographies. The cost of deposits declined 7 basis points to 1.84%, underscoring effective pricing discipline, balanced with growth. Loans were up $137 million or 5.7% despite some payoff headwinds in commercial real estate. Loan growth saw meaningful contributions from equipment finance, commercial banking, indirect, and home equity lending. Mortgage lending provided a headwind to balance sheet growth, although some of that runoff was by design, and the outlook for the business is improving. Geographically, we had strong loan contributions from all markets in Ohio and Pennsylvania. Fee income remained resilient post-Durbin, representing 18% of total revenue; a healthy quarter-over-quarter improvement in our wealth business was offset by slower gain on sale income. The third quarter efficiency ratio improved to 52.3% from 54.1% in the second quarter, reflecting good expense control. Tangible book value grew 11.6% annualized on a linked-quarter basis and 9.1% year-over-year. On the credit side, core provision expense increased by $2.4 million quarter-over-quarter, reaching $11.3 million. As disclosed last quarter, we had a $31.9 million dealer floor plan customer who was out of trust. In the second quarter, we set aside $4.2 million in reserves for this relationship. In the third quarter, a receiver was appointed to liquidate the collateral. The out of trust amount and related liquidation costs rose as the process evolved. During the third quarter, $5.5 million was charged off, and an additional $3.1 million was added to reserves, resulting in a net provision impact for this relationship of $4.4 million in the third quarter. This recent dealer floor plan fraud is isolated, and we expect it to be largely resolved by year-end. As of September 30, our floor plan exposures totaled $122 million across 21 traditional auto and RV relationships with individual exposures ranging from $2 million to $18 million. Net charge-offs for the quarter were $12.2 million, primarily driven by the aforementioned $5.5 million dealer floor plan charge-off, and $2.8 million associated with the sale of 5 recently acquired Center Bank loans. This was an opportunistic sale utilizing the allocated loan mark from the acquisition with only $100,000 in provision expense. These two items accounted for 34 basis points of the quarter's 51 basis points of net charge-offs. With the dealer floor plan relationship now at $16 million, nonperforming loans declined to 0.91% compared to 1.04% in the prior quarter. Our loan portfolio maintains negligible exposure to private credit funds, equipment finance firms, NDFIs, or subprime lenders. Our recent Center Bank acquisition in Cincinnati is exceeding our customer retention expectations. We're grateful for the opportunity that acquisition has given us to accelerate the build-out of that region. On the digital front, we see good growth in services and high digital satisfaction in survey results. We continue to add customer-facing features to our platform and to improve productivity through the use of RPA and AI. We are excited about the outlook for First Commonwealth and the confluence of profitable growth, a regional focus leading to better low-cost deposit gathering, and higher fee income, coupled with lower credit costs in the future. With that, I'll turn it over to Jim Reske, our CFO.

Thanks, Mike. This quarter's core results demonstrate the impact of some NIM expansion and loan growth. Pretax pre-provision net revenue increased by $4.3 million compared to last quarter, and nearly all financial metrics showed improvement. The rise in spread income offset a slight decrease in fee income and a minimal increase in expenses, which led to gains in core EPS, NIM, core ROA, core ROTCE, and efficiency. Additionally, despite an increase in provisions and charge-offs, key asset quality indicators for nonperforming loans and classified loans improved from the previous quarter. Looking at the details, spread income rose by $4.9 million from last quarter due to balanced loan and deposit growth. The net interest margin expanded by 9 basis points, moving from 3.83% last quarter to 3.92% this quarter, mainly driven by a 7 basis point reduction in the cost of deposits to 1.84%. Loan yields remained relatively stable this quarter, as a minor decline in purchase accounting marks was largely offset by a $25 million macro swap that matured on August 25, along with the ongoing upward repricing of fixed-rate loans. The fourth quarter NIM will experience the full impact of the Fed's September rate cut and possibly today, as well as any additional cuts throughout the quarter, countered by the continued upward repricing of fixed-rate loans and the expiration of $75 million in macro swaps in the fourth quarter. There’s typically a seasonal decline in deposits during this time of year, which we would need to replace with more expensive borrowings if historical trends hold. These elements could create some short-term downward pressure on the NIM in the fourth quarter. However, we anticipate the NIM will recover in 2026 to around the level of the recently concluded quarter, approximately 3.9%, give or take 5 basis points as usual. In 2026, the end of $175 million in macro swaps and the expected ongoing upward repricing of fixed-rate loans should mitigate the impact of declining short-term rates on loan yields. This projection assumes we will experience two more rate cuts this quarter and four next year, leading to a steepening yield curve. It also anticipates continued mid-single-digit growth in loans and deposits, along with improvements in the deposit mix that we expect will lower the cost of deposits in alignment with the projected drop in loan yields. Core fee income, excluding gains from securities, decreased slightly from last quarter by $261,000. As Mike noted, this was influenced by lower gain on sale income due to some REO gains realized in the second quarter and a $400,000 decline in SBA gain on sale income. However, these declines were partially offset by improved results in our wealth division, with trust income up by $0.5 million and brokerage income increasing by $0.4 million compared to last quarter. We expect gradual increases in fee income in 2026. Core noninterest expenses, excluding merger expenses, rose slightly from last quarter by $350,000, primarily driven by higher salary expenses due to increased incentive accruals linked to recent performance and loan growth. Looking ahead, we project expenses will rise by about 3% next year. During the third quarter, we repurchased approximately 625,000 shares at an average price of $16.81. We had $20.7 million of share repurchase authorization remaining at the end of the quarter, most of which we plan to utilize in the remainder of '25, assuming our share price stays near current levels. Now, we’ll take any questions you may have.

Maybe we just start on the credit side. It seems like everything was mostly focused around the credits you mentioned, the floor plan and the credits from Center. Let me just make sure I have this right. So the floor plan relationship at quarter end is $16 million. You provided some information on the floor plan in total, which is $122 million, but the floor plan relationship with the fraud is now $16 million. Do you have that right? Sorry about that.

That's correct. It went from $31.9 million to $16 million this past quarter. And $122 million overall floor plan exposure.

Okay. And the, I guess, remaining stress in that particular relationship you expect to be resolved in the fourth quarter? Or did I not hear that?

Yes, largely, we're just unwinding it.

Okay, and what are reserves on that loan now, did you say?

4.4.

4.4, okay. And then the relationship from the Center acquisition that is driving these, what are the numbers on that? I don't know if I have those.

Yes, there were 5 recently acquired Center Bank loans, and we had an opportunity to sell those loans with a minimal hit. So I don't know if you want to expand upon that.

Yes, sure, Mike. This is Brian. There were 5 loans. They were all marked at our original time of acquisition. And as Mike mentioned, the charge-off of $2.8 million resulted in only provision of just over $100,000 for the quarter. They were PCD loans, and the mark did not reduce the carrying value. So you see the charge-off, but you don't see the impact on provision.

Okay. And so those have been sold now and they're gone. Okay. All right. Great. And as it relates to the rest of the portfolio then, back in the kind of historical range for charge-offs? Or do you have any thoughts on where net charge-offs kind of or provision, whatever is easier discussed moves here?

Yes. No change from prior comments from a charge-off perspective; expectation is to operate in the mid- to high 20 basis point range. Last quarter, we said 25 to 30 basis points. Similarly, from a provision basis, that will grow with our loan growth, respectively.

Okay, terrific. Finally, regarding credit, the non-performing loans are at 92 basis points of loans. Does that seem like a comfortable level for you? Is it likely to remain stable, or do you expect that number to decrease further?

We expect it to come down. And we have a nice slide in our deck, our supplementary deck that really shows historically where credit quality has been. Really, if you look on Page 10, bottom left quadrant there, we've just been really quite elevated from third quarter of last year, fourth quarter and first quarter of 2025, where we were between $61 million and $76 million of nonperforming assets.

I'll just add to Mike's comment that we'll have the tailwind of the majority of the dealer floor plan wind down in the fourth quarter and then kind of normalization of cleanup of the portfolio from there.

Just a quick one on the floor plan credit. I think you implied this, but as you see it today, no incremental provision from this in 4Q?

That's correct.

Okay. And then, Jim, I guess, on the margin, I was a little surprised to not see loan yields tick up a little bit higher. So I was hoping you could help us with what the fixed asset repricing was and then kind of what the accretion headwind was? And then just kind of how you see loan yields trending?

The fixed asset repricing was still 87 basis points in the third quarter, which is slightly down from the second quarter, reflecting the rate cut. However, it remains positive. This resulted in positive replacement yields for the portfolio of about 25 basis points overall. Currently, fixed rate production comprises about one-third of the total production. The 87 basis points of positivity on the fixed rate indicates that the entire portfolio is repriced up by approximately 25 basis points. We hope the fixed-rate repricing will continue even after a few more rate cuts.

Okay. Since you mentioned it, I'll inquire about the 2026 NIM expectations. Previously, we discussed your models projecting it towards 4% or higher for the margin. Is that still accurate? Is this due to a cautious approach, anticipated competition, or something else? Help us understand what leads you to the 3.90% figure.

I appreciate the question and I'm happy to share our thoughts on it. We have included more rate cuts in our projections than before, with two cuts this year and four by the end of next year. The rate cuts we anticipate are not evenly distributed, as the projections we use from a third-party source predict cuts of 28, 18, 9, and 40 quarters next year, meaning they are somewhat backloaded. This scenario would result in an overall decline in loan yields by 15 basis points, and since rates are falling, we can also reduce deposit costs by a similar amount, leading to a stable net interest margin (NIM). The numbers we are targeting for a 4% rate likely reflect a slightly more optimistic rate forecast than what we have this quarter. It's important to note that the yield curve is steepening rather than shifting in parallel, which is beneficial for banks. This situation aids us with the short-term end, allowing us to lower deposit costs. Additionally, if the mid- to long-term part of the curve remains stable or increases, it will support the repricing of fixed assets. All these factors combined present a stable outlook moving forward.

This is Charlie on for Kelly. With a lot of the NIM expansion driven by the deposit repricing this quarter and then expecting basic cuts to increase here. Can you kind of flesh out some of the deposit repricing dynamics going forward? Maybe just dive into the drivers behind like the near-term compression and then a little bit of the neutrality from there?

Yes. I'll provide some details on the deposits. We're pleased to see the growth in our deposit balances. It has been advantageous for us this year to increase deposit balances while also lowering the cost of deposits. We have expanded our time deposit portfolio and maintained it, noting that the pipelines were relatively short, which is common among banks. In the second quarter, we had just over $400 million in CD maturities, and in the third quarter, that number increased to over $800 million. We are managing those maturities effectively, repricing them downward while keeping the retention rate at a satisfactory level. Our retention rates for time deposits have been steady at around 80%, which aligns with the industry average. For other types of deposits like money markets and transaction accounts, our retention rates exceed 90%, which we view as stronger than the industry standard. Additionally, regarding money market accounts, we've effectively managed to reprice those as well. In the second quarter, 83% of money market account balances had yields above 3%, but that percentage has now decreased to 49%. We have managed to keep our deposit balances growing even with these pricing adjustments. I hope this information provides clarity and is helpful.

Yes, that's great color. I appreciate that.

This is Mike. I would just add that for the people in the room, Mike McCuen, Jim Reske, Jane Grebenc, and Norm Montgomery, they monitor this every other week. And they're looking at the loan and deposit volumes that come on, they're looking at the net impact on liquidity and also the impact on margin. This is something that we feel between our fingers every other week, and we make game-day decisions of where we're at and where we're going and how we're going to get there. And I just love the process, and it also just keeps us informed of what's happening in the bank.

By the way, all of us are supported by great teams of people who provide us with data and help us stay informed about that policy.

I appreciate the insight into the woodworks there. Regarding organic growth, it's come in pretty steady. Can you just speak to the expectations moving forward if payoffs are starting to pick up, maybe sizing up that headwind? And on the talent you got from Center Bank or anything in particular you're focusing on or excited about in terms of growth?

Yes. Some of the payoffs we've observed are strong commercial real estate projects refinancing into permanent markets, nonrecourse in the 5s. So that's not something we're going to pursue. That's some of the headwind we expect to continue into the fourth quarter. However, we have plenty of opportunity across consumer, mortgage, equipment finance, and indirect auto; our loan growth will likely be more limited by liquidity than by our ability to execute. That's the main constraint we are facing. Mike McCuen, would you like to add anything?

I completely agree. I believe the production volumes are looking good, despite some setbacks, and I feel optimistic about our production results as we head into next year.

Yes. And our guidance remains mid-single digit. Just a surprising bright spot this past quarter is growing home equity loans, like $15 million or $16 million. So we just have a lot of ways to get there.

Jim, you had mentioned that with the Fed cuts, you expect a little bit of near-term NIM pressure. To what extent might we see NIM pressure in the fourth quarter?

Yes, it's always difficult to predict. Even with the standard guidance I provided, I typically mention a variation of about 5 basis points because no model is perfect. However, it’s likely within that range. I don’t believe we would see a shift of 5 to 10 basis points, as that would be a bit extreme for just one quarter before bouncing back. So, it’s probably around 5 basis points.

Okay. Is it possible, let's just say we get a few cuts this quarter. We're down to 5 bps. Is it possible to get down another couple of basis points in the first quarter from bleed over and maybe an additional cut in the first quarter as well before we start to see some stabilization?

Yes, it is certainly possible. We are attempting to project based on a rate forecast, which includes many implied rates. However, in our bank, we have observed that there is a lag in how quickly these changes impact us. If there is a rate cut, it affects the prime portfolio and the SOFR portfolio immediately, but there is a delay in adjusting our deposit pricing. It is never perfectly aligned; some effects are felt right away while the liability side catches up gradually. Additionally, I want to mention the seasonal changes in deposits to prevent any surprises, as we encounter this every year. We see variations across different categories, some of which are due to consumer holiday spending, and some shifts from the fourth quarter into the first quarter with commercial accounts. This phenomenon occurs annually, and we will be borrowing at the marginal rate, which tends to be a bit more expensive, but this will recover early next year.

And then you had also mentioned that you expect some improvement in deposit mix next year. What's behind that assumption? And maybe help us out with where you think we'll see some of the largest kind of mix shifts?

Just have a real push towards transaction accounts, and I gave some time deposit numbers a few minutes ago. We've loan time deposits because we had to do some of that just to raise the deposit balances, but we have a deep, deep push towards transaction accounts across the bank, both in consumer and commercial. Jane, I don't know if you wanted to add anything because that kind of your.

I can just reiterate it. It's been grinding. Transaction accounts are grinding, and it means we've been grinding the amount for a couple of years now. We're starting to throughput that labor and we'll just keep grinding.

Got it. Okay. Maybe just a couple more. Securities were down this quarter. We're now below 13% of total assets. It feels on the low side for you. Could we see some growth there in the coming quarters?

Probably not. I think we're going to maintain the current level. Our plan right now is to gradually replace the runoff, but we don't intend to grow that portfolio significantly. Part of this strategy is to utilize that liquidity for loan growth instead of leveraging the bank by borrowing to purchase securities. Therefore, the current level is where we plan to stay, likely through 2026.

Great. And then just on equipment. Equipment finance continues to be a real driver of underlying C&I, is plus 10% a quarter sustainable? Or where do we start to see that revert to the mean?

We're likely about a year away. This is Mike Price, and we are very pleased with both the yields and the credit performance. We have a team that has been working in this field for about 25 years, so we feel confident about it. Mike, do you have anything else to add?

I think there's some incentives this year when it comes to depreciation, and we expected that to impact and benefit equipment finance. At least for the next few quarters, we feel pretty good about that growth.

If could you provide some color on the competitive factors on the lending side right now? I've heard a lot of give on structure and pricing in various markets, wondering if you're seeing the same thing within your footprint?

I think it depends on the market, Dan, and I'll let Mike take this. There’s a big difference between Columbus, Ohio, and rural Pennsylvania. Mike, what would you add?

I would say yields have likely decreased by 25 basis points over the year. We haven't significantly altered our structural approach, but this has affected the yields. The metro markets are much more competitive compared to the rural markets, as Mike mentioned. In terms of structure, the competition has become more aggressive. We talked about the permanent markets and agency lending, which are currently very competitive. This isn't something we typically engage in, but it does have an impact on our balance sheet. Does that answer your question, Dan?

Yes, sir. I appreciate that. And then maybe color on the M&A front. I mean, we've seen activity pick up a little bit here recently. Wondering what you're seeing come across your desk if chatter has picked up, or it's slowed down from last quarter?

I believe there are more discussions taking place. Our goal has been to enhance our depository and liquidity. We've had numerous conversations about being prudent, perhaps overly cautious at times, as I mentioned last quarter. However, we are optimistic about growing through acquisitions. We've been around $12.5 billion, and when crossing the $10 billion mark, it can diminish your profitability. Despite this, we’ve managed to maintain our position with the aim of reaching 140, though we fell slightly short this quarter due to credit issues affecting our return on assets. This isn't an excuse; we need to achieve excellent net interest margins and return on assets regardless of our size. That said, having the right acquisition or two could significantly enhance our position. We generally prefer smaller acquisitions due to lower risk and to ensure we choose a solid depository that would support our liquidity and financing for the bank. I'm not sure if that answers your question, Dan.

That concludes our Q&A session. I will now turn the conference back over to Mike Price for closing remarks.

Yes. Thank you. I appreciate your interest in our company. I would just add that we've really shifted to deliver the bank regionally, and we really expect the payoff of that to be not just to better deliver the mission, but also better grow households and low-cost deposits in the depository and then also better grow our fee income. We do feel like we can grow the loans, and the other thing that's kind of interesting and exciting, I think, is as we look at as an executive team, 30 operating plans for our lines of business for our business units for our geographies as part of our strategic planning process, we really feel there's probably one, two, or three ways that we can continue to get more efficient. Using technology like robotic process automation or AI or just better straight-through processes. So we just have bright people that can look at their operation and make it better. And so there's just a lot of things that we're excited about the company, to move the company forward and make it better. And we just also have a pretty talented team up and down throughout the organization. So thank you again. Look forward to being with a number of you over the course of the ensuing weeks, and just appreciate you.

This concludes our conference call. You may now disconnect.