Earnings Call Transcript - FCF Q3 2024

Operator, Operator

Thank you for joining us for the First Commonwealth Financial Corporation Third Quarter 2024 Earnings Release Conference Call. We have muted all lines to minimize background noise. Following the presentations, we will have a question-and-answer session. Now, I would like to hand the call over to Ryan Thomas, Vice President of Finance and Investor Relations. Please proceed.

Ryan Thomas, Vice President of Finance and Investor Relations

Thanks, Rob, and good afternoon, everyone. Thanks for joining us today to discuss First Commonwealth Financial Corporation's third quarter financial results. Participating on today's call will be Thomas Michael Price, President and CEO; James Reske, Chief Financial Officer; Jane Grebenc, Bank President and Chief Revenue Officer; Brian Sohocki, Chief Credit Officer; and Mike McCuen, our 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've 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.

Thomas Michael Price, President and CEO

Thank you, Ryan, and welcome, everyone. Third quarter 2024 Core Earnings Per Share were $0.31. Loans were essentially flat, deposits grew, and the net interest margin fell 1 basis point to 3.56% as rates declined in anticipation of the Fed rate cut in September. Growth in other fee income offset a $3 million decrease in interchange income as we incurred the long anticipated impact of Durbin. Expenses were elevated primarily due to several one-time items. All of this led to pretax pre-provision ROA of 1.73%, an efficiency ratio of 56.66%, and core pretax pre-provision net revenue of $50.9 million which was within $1 million of analyst consensus. Turning to credit, the provision expense at $10.6 million was up $2.8 million over the second quarter. Our credit story in the third quarter was largely the tale of four credits. Embedded within the elevated provision expense are specific reserves for two legacy loans and two charge-offs related to the Centric acquisition now in our capital region. Most, but not all of the two Centric charge-offs had been previously provided for, but they together accounted for approximately $1.5 million of provision expense this quarter on top of the $5.5 million for the two legacy loans. Over the last seven quarters, a disproportionate share of our credit costs has stemmed from our acquisition of Centric that closed in the first quarter of 2023. As we've shared previously, we understood their credit profile going in, so we marked the credit and priced the deal accordingly. However, the acquired portfolio continues to impact our credit performance. For a bank that was 10% of our size, the former Centric loans have accounted for 76% of commercial charge-offs and 51% of total charge-offs in 2023. In 2024 year-to-date, former Centric loans have accounted for 86% of commercial charge-offs and 42% of total charge-offs. At September 30, criticized loans were 2.68% of total loans. Excluding Centric loans, that ratio would be 1.69%, which is actually an improvement from the 1.72% figure on the day that Centric closed. However, we continue to make substantive progress with Centric credits in the Capital Region each quarter. Also important, stronger third quarter gain on sale income in SBA alongside increases in service charge and wealth management income and $926,000 in BOLI income all work together to blunt the $3 million impact of having our debit card interchange income cut in half due to the Durbin amendment. In fact, non-interest income drifted down only $683,000. Looking ahead, we expect non-interest income to be in the $22 million to $24 million range in the fourth quarter. Turning now to expenses, we had elevated expenses this quarter of $70.1 million, up $4.3 million over the prior quarter. Third quarter expenses reflect approximately $1.8 million of one-time items, including a $1.1 million operational loss in credit cards and $750,000 in severance expense. We expect non-interest expense to be in the $67 million to $68 million range in the fourth quarter. Beyond the financials, there are a few other items worth mentioning. First Commonwealth earned recognition as the number two SBA lender by dollars in Western Pennsylvania for the 2024 fiscal year ending in September. As of October 15, our overall customer satisfaction score and net promoter scores have hit 5-year peaks at 90.4 and 70.3, respectively. We've seen a steady trend of increases in these figures since 2020 with both exceeding industry benchmarks. These are important metrics for us, especially as we cross $10 billion in assets. Although we are disappointed by our third quarter earnings per share miss, I'm encouraged by the momentum in our businesses and prospects for stronger growth ahead. Despite a relatively healthy level of loan originations this year, our overall loan growth has in some ways been purposefully muted by: One, our rebuilding of the Centric portfolio; Two, our strategic decision to reduce exposure to certain sectors like sponsor finance; and three, the shift to selling nearly all of our mortgage originations. More importantly, our regional presidents have a growth mindset and have attracted new commercial banking talent that will drive the bank forward for years to come. Our new capital region’s credit performance will converge with the strong credit metrics at First Commonwealth overall and become a key source of future growth in attractive Central and Eastern PA markets. And with that, I'll turn it over to Jim Reske. Jim?

James Reske, Chief Financial Officer

Thanks, Mike. Mike has already talked about the major financial metrics, so I'll take a closer look at the net interest margin and then wrap up with about 30 seconds on capital. Last quarter, our NIM guidance was for 'stability or even slight improvement from current levels for the remainder of 2024 give or take 5 basis points as usual.' While we didn't get the slight improvement part, we did get the stability part. Our NIM guidance didn't contemplate a 50 basis points rate cut in September, so in that sense, we were pleased to see our NIM exhibit relative stability by only going down by 1 basis point from last quarter. The NIM is facing various headwinds and tailwinds that largely offset each other in the third quarter, but they do give us some insight into where the NIM is going. One headwind is excess cash. We've been holding excess cash all year because we locked in low-cost borrowings through the Fed's BPFP program early in the year and we were reluctant to pay that off. Plus loan growth was slightly negative in the third quarter while deposits continue to grow, resulting in a steady build above excess cash. On top of that, we received a large commercial deposit right at the end of the third quarter. All of this cash had a suppressive effect on the NIM even though it's additive to earnings because it pumps up both sides of the balance sheet with a very thin margin asset. That cash had a suppressive effect of 6 basis points on the NIM in the second quarter, but in the third quarter that's depressive effect of 9 basis points. Neutralizing the effect of excess cash in both quarters will therefore have changed our 1 basis point of the impression to 2 basis points of expansion, but realistically that's all still within the range of what we would call stability. Looking forward, the headwind of excess cash has been largely removed because on October 3rd, we used it to pay down $436 million of the $516 million of BPFP borrowings that we had, and we will likely pay down the remaining $80 million when the Fed raises rates here in November. Another headwind to the NIM was the 8 basis points increase in our cost of deposits. That 8 basis points increase however was down from 10 basis points in the second quarter and a 25 basis points increase in the first quarter. We expect that downward trend to continue. The pace of what we call deposit rotation, that is the migration of deposit dollars from lower cost categories to higher cost ones, continues to slow down in each month of the third quarter. Another indicator of the slowdown is the cost of interest-bearing non-time deposits or savings in Now accounts, which had been moving up by 3 to 4 basis points per month in the second quarter, but didn't go up at all in the third quarter. Perhaps more importantly, the incremental cost of deposit growth in the first quarter was about 4.21%, in the second quarter it fell to 3.61%, and in the third quarter it fell again to 3.22%. In terms of competition, we see deposit pricing pressures abating rapidly in our markets allowing for lower deposit repricing upon maturity without jeopardizing our deposit growth trajectory, and that trajectory has been remarkable, 8% deposit growth on an annualized basis so far this year. That deposit growth helped bring our loan to deposit ratio down by 360 basis points in the first quarter to 92.5% at September 30th. As for loans, replacement yields have been a tailwind to the NIM all through this rising rate cycle. Loan yields went up by 3 basis points in the third quarter largely because new loans still came on the books at about 50 basis points higher than the ones that ran off. About a third of our total loan production in the third quarter was fixed-rate loans and those fixed-rate loans actually came on the books at 172 basis points higher than the fixed-rate loans that ran off. We believe that this upper repricing should continue for a while even in the face of falling rates. This environment is one in which we're glad to have built a diversified bank with a broad mix of fixed and variable loans and loan types both in our portfolio and in our origination mix. In addition to all of that, there are a few other tailwinds to the NIM that are incorporated into our forecast as well. Purchase accounting contributed about 7 basis points in the third quarter, down by about 1 basis point from the prior quarter. We do, however, expect that benefit to fall to only 4 to 5 basis points next quarter and we are looking forward to the expiration of received fixed macro swaps in the near future; $50 million of received fixed macro swaps would mature in the fourth quarter of 2024, $250 million mature in 2025, and $175 million mature in 2026. These expirations should provide a lift to our NIM in 2025 and in 2026. That, however, brings us to the biggest headwind to our NIM, rate cuts. About 50% of our loan portfolio is priced off of one-month SOFR, so rate cuts are felt immediately. Our latest forecast calls for Fed funds to end 2024 at 4.29% and to end 2025 at 2.95%. That's about 40 to 50 basis points lower than the rate forecast that we used last quarter. So taking all of these headwinds and tailwinds into account, our guidance for the fourth quarter sounds a lot like what we said last quarter: stability, at least for the near term. In our latest forecast, our NIM stays in the mid-350s range through the first quarter of 2025 as always give or take 5 basis points for normal variability, then gradually falls over the course of the year to end the year 2025 in the mid-340s, about 10 basis points lower than where we are today. That assumes, by the way, a return to normalized mid-single-digit loan growth in 2025. You might sum it up this way: all of the NIM tailwinds we have, removal of excess cash, falling deposit rates, positive loan replacement yields, macro swap expirations, all of them work together to blunt the effect of falling rates, but aren't quite enough to overcome them if rates fall fast enough. To bracket this for you and give you some idea of the impact of rates on our balance sheet, if the fed funds rate falls to the projected year-end 2024 level of 4.29% and then just holds at that level through year-end 2025, the tailwinds would win out. In that scenario, we would expect that our NIM would actually increase steadily over the course of 2025 into the mid-360s. I would note that the futures market is currently projecting a year-end 2025 Fed funds rate at 3.40%, which is about 45 basis points higher than our latest rate forecast. So, reality will likely play out somewhere in the middle. In terms of capital management, tangible book value per share increased $0.47 from the previous quarter to $10.03 due in part to a $28 million reduction in AOCI. We raised the threshold for share repurchases this quarter, buying on prices below $17 a share, and so this quarter we repurchased 146,850 shares at an average price of $16.83. And with that, we'll take any questions you may have.

Operator, Operator

Thank you. Your first question comes from Daniel Tamayo from Raymond James. Your line is open.

Daniel Tamayo, Analyst

Sorry about that. Good afternoon, guys. Hopefully you can hear me okay. Maybe first to start, just on as we think about overall asset growth, just curious where you stand on where you want the size of the securities portfolio going forward. You touched a little bit on the loan to deposit ratio kind of similar. Just curious if you still want that coming down from these levels or you're comfortable in the 92% level? Thanks.

James Reske, Chief Financial Officer

Yeah. No, just to be clear, we expect the securities portfolio to expand a little bit over the next year, maybe by about $100 million over the course of 2025 from where it is today. Not huge expansion, but we want to grow it a little bit. Is that what you're asking, Danny?

Daniel Tamayo, Analyst

It is. Yes. Thank you. And then, just to follow-up, switching gears to credit, just maybe if you could provide a little detail on the loans, I apologize if I did miss this earlier, but the loans that you took specific reserves on in the quarter? Thanks.

James Reske, Chief Financial Officer

I'll turn it over to Brian Sohocki.

Brian Sohocki, Chief Credit Officer

Hi, Daniel. Yes, on the reserve side, there were two credits that drove the specific reserve for the period in the provision. First was a $2.7 million specific reserve taken on a $10 million fully funded construction loan for a mixed-use office property located here in Pittsburgh. The property, part of a global $58 million loan, came to maturity in the third quarter and while an amendment is being negotiated, the current level of vacancy combined with the uncertain outlook resulted in moving the entire $10 million balance to nonperforming. The second driver and that provision was a $2.8 million specific reserve taken on a $4.8 million term loan. That loan was in our sponsor finance portfolio. The credit specifically was in the distribution space. And while payments do remain current, the longer long-term outlook is challenged. That accounted for $5.5 million of the provision, the primary increase in the specific.

Daniel Tamayo, Analyst

The two combined?

Brian Sohocki, Chief Credit Officer

The two combined. Thank you.

Operator, Operator

Your next question comes from the line of Karl Shepard from RBC Capital Markets. Your line is open.

Karl Shepard, Analyst

Hey, good afternoon, guys. Just to pick up on credit for a second. Can you anything you can say about expected block content from those two legacy credits?

James Reske, Chief Financial Officer

Lost content on legacy credits.

Brian Sohocki, Chief Credit Officer

Sure. The driver of the short-term outlook for our charge-offs will be through the specifics that we've made. We've had appraisals for the real estate property and we expect to come to resolution over the next short term period, next quarter or two.

Karl Shepard, Analyst

Okay. So maybe not much in the way of incremental provisioning for those two.

Brian Sohocki, Chief Credit Officer

That would be the next big thing.

Karl Shepard, Analyst

Okay. And then just to follow-up on the Centric credit piece. You mentioned convergence with the broader portfolio. Kind of over what timeline and would you expect any more originations or charge-offs or kind of anything to emerge before we get to kind of a steady state back with the larger book?

Thomas Michael Price, President and CEO

I'll just start out at a little higher level, Karl. Just looking at Centric, the criticized loans decreased from $124 million in the second quarter to $102 million this quarter. The watch loans decreased from $271 million to $261 million. So we are seeing those come down from highs and watch has been consistently improving from $376 million to start the year. So, we have a group of SWOT lenders that are out there in early-stage collections and a really working bank and that's we've seen nice results from that. What do you want to add, Brian?

Brian Sohocki, Chief Credit Officer

Yeah. I think that's helpful, Mike. From a global perspective, we'd anticipate the Centric headwind to start dissipating in 2025. It'll be somewhat offset by normalized net charge-off levels in the core portfolio. I would add, one point to Mike's as if you look at our charge-off ratio, year to date through the third quarter, it was 39 basis points on an annualized basis. I apologize, just in the quarter it was 39 basis points annualized, 27 of that came from the Centric portfolio. So the core franchise charge-off level is in the low teens, and we're excited about that performance.

Karl Shepard, Analyst

Okay. That's helpful, Brian. To follow-up, then I wanted to ask about long term. You guys have been pretty deliberate and measured kind of managing to a pace. What gives you confidence that it's going to reaccelerate here? And just what kind of near-term visibility do you have for the quarter into 2025?

Thomas Michael Price, President and CEO

On the commercial side, in particular, the production has been really good. The headwinds have been, probably for the year about $49 million in payoffs in sponsor and probably another $97 million in Centric, and the other thing is we've just added a lot of talent to our regional teams in corporate banking and they're really starting to hit the ground running. So we just feel that mid-single digit growth is very achievable next year and perhaps a little higher. We shall see, hopefully get some tailwinds with economic growth, but that's the reason, and we've also been able to fund it, and that is we're proud of that and at the same time, we'll have ample liquidity to grow loans. We've paid down borrowings, retired subordinated debt with increasing capital ratios and supported the margin. So I think the team can do it.

Karl Shepard, Analyst

Okay, great. I'll let someone else pepper Jim on the margin, but thanks for the help.

Operator, Operator

Your next question comes from the line of Kelly Motta from KBW. Your line is open.

Kelly Motta, Analyst

Hey. Good afternoon. Thanks for the question. I was hoping to dig into the deposit growth you saw this quarter. It looks like NIBs were up meaningfully, although not so on an average basis. I'm wondering as we're thinking about that line, was there any sort of end-of-quarter volatility that we should be managing here? And also, any kind of broader comments as to whether or not we've seen an asset trough in the pressure on non-interest-bearing accounts?

Thomas Michael Price, President and CEO

Yes. We had a nice big win at the end of the quarter with a business person in one of our regional markets who sold the company, and we had a pretty significant inflow of about $170 million in deposits in the last week of the month, and some of that was parked in non-interest bearing. Jim, what do you want to add?

James Reske, Chief Financial Officer

Yeah. So, yeah. So that really helped the quarter end number. So if that's what you're looking at, I will that's what you'll see, but the other thing I would just want to point out, this is kind of behind the scenes in my deposit rotation comments. If I just look at the trend in NIB month to month in the third quarter. In July, there were $20 million of outflows. In August, there were $2.6 million of inflows. In September, $35 million of inflows, and those are averages, not end of period. So, the rotation seems to really slow down overall. We're really happy that we get a large deposit like that anytime. But for the rest of the bank, it seems like it's all moving in the right direction.

Kelly Motta, Analyst

Absolutely. That's super helpful. And then I appreciate all the color and commentary you've given around sort of your outlook for margin. Just wondering, if you could expand a bit on how we should be thinking about deposit betas during rate cuts. It looks like during the tightening part of the cycle your interest-bearing deposit beta was about 50%. Wondering if you could just provide some color on how you're thinking about that on the way down, at least initially.

James Reske, Chief Financial Officer

Yeah. No. Happy to address that. Our deposit beta assumption is generally about 25%. That's just backed up by long term look back studies that kind of look at what the historical average has been. The number you're thinking about, there's always slight variation in the way people calculate cumulative through the cycle betas because it depends on when you start the, you know, 'cycle' and when you end it. When we were just looking at that the other day, and it looked like for what I calculation I was doing internally or my team was doing internally, showed that we had a cumulative through the cycle beta on the deposit side of about 46%. Just starting from right before when the Fed started, there were this rate hike cycle to that last, the first rate cut in September, about 46%, and accumulative, and the odd thing about that was we tried to look at the loan beta over the same period, and it was also about 46%. Just above what you see is like in any bank, the timing is different. So in the early stages, we're able to reprice the loans upward very quickly, and then the deposit pricing caught up, but it evens out over time. So in this downward cycle, we'd expect the loan, deposit, I'm sorry, the loan beta to hit us pretty quickly with the fallen rates at a variable rate portfolio. And then, you know, deposit beta at about 25% able to kind of reprice those downward to kind of make up for it.

Kelly Motta, Analyst

Got it. That's very helpful. And then you talked about, you know, cash being elevated during 3Q because, and you use some of that to pay down BTFP. I apologize if you already answered this, but what are you guys doing as a more normalized level of cash as we look to just manage the size of the balance sheet?

James Reske, Chief Financial Officer

Yeah. The normal level of cash will be just in the below $50 million. It just depends on any given day, how much we need to fund the bank. So, I think I'm not sure off the top of my head what it is right now today, but in any given day, it might be $10 million, $20 million of excess cash you have to make sure you can balance the bank at the end of the day, but it's not going to be $400 million lying around like it was on September 30th. If you look at the balance sheet in the press release financials that we issued, that number sticks out like a sore thumb. There's huge increase in cash and it's not going to stay at that level long term. It's just going to be a minimal amount to bounce the bank.

Kelly Motta, Analyst

Understood. And then, finally, I was hoping you could provide any update or color on the M&A environment and the pace of conversations as it pertains to deal activity.

Thomas Michael Price, President and CEO

There have been a conversation or two. Nothing has materialized, and we're very interested in M&A. I think you know we will do smaller as well as larger, and if the six deals that we've done and had the privilege to do have ranged from $55 million to $1.1 billion. So they've been deals that we feel like we could appropriately control the risk, and I've also shared with you that we have a team that could scale and do a larger transaction. It just would have to be just right. And Jim always likes to share we've looked at well over 60 deals to do six, so we're pretty disciplined, but there have been one or two things out there and I think we've passed on one or two, passed on both actually in the process. So hopefully there'll be some nice opportunities to grow our bank in contiguous markets and do strategic things and rural depositories and all the kinds of things you've heard us say before.

James Reske, Chief Financial Officer

Hey, Kelly, just to go back to the just for what it's worth, cash this morning stood at $45 million. It's kind of a normal level for us.

Operator, Operator

Your next question comes from the line of Matthew Breese from Stephens. Your line is open.

Matthew Breese, Analyst

Good afternoon, everybody. Jim, I was hoping to start, you had mentioned that 50% of your loan portfolio reprices, I think you set off a one-month SOFR. In the past, it might have even been last quarter, you whittled that down, that number to like 30% and even a piece of that was affected by the swaps. So, like the true floating rate portion of the book, I think was closer to 27% of total loans. Could you just clarify for us and I'm sorry if it's going to put you on repeat a little bit, the true floating rate portion of the book, if it's 50% or 27% just because it matters a lot as we head into a downward cycle?

James Reske, Chief Financial Officer

Yes. I'm so glad you asked that and you gave me a chance to clarify. So, I want to make sure I didn't speak before. About half the portfolio is variable, half fixed. That's just kind of a general rule of thumb. It does vary a little bit from time to time. At the end of the third quarter, it was 50.67% was variable. Okay? So very, very close to 50%, but the part that is linked to one-month SOFR is only 33% of the SOFR portfolio, not 50%. So the other section, the other 17%, that's tied to all kinds of things along the yield curve. So if it's variable over time, it might be like a mortgage rate with a five one arm or seven one arm that's going to be priced over time. So it's a variable, but it's not going directly to SOFR. That's only 33%. And even those, most are all it's SOFR, it's prime. There's still one or two BISB loans left that we're phasing out because that's going away, but 32% is all the short stuff. Thank you for letting me clarify that.

Matthew Breese, Analyst

As these swaps expire, it won't be 27%. It will actually be more like 30%, specifically in the low 30% range. That's accurate as well.

James Reske, Chief Financial Officer

Well, the numbers I was giving you was irrespective of swaps. I didn't adjust the number I was just giving you to say that some of that portion was swapped in the fixed rate. So those are just the raw underlying portfolio numbers I was giving you.

Matthew Breese, Analyst

Okay.

Thomas Michael Price, President and CEO

They don't have the same the same that you're talking about. It'll take away these low-rate fixed swaps that we've got on the books and let this stuff float again and it'll start floating upward and what the cash flow actually we see will be the higher floating rate.

Matthew Breese, Analyst

Okay. Setting the true floating rate stuff aside, could you help us a little bit understand what the maturity profile is like for the fixed-rate portion of the book, either duration or how much you expect it to kind of come up for maturity of next year?

James Reske, Chief Financial Officer

Yes. I don't have it broken down by like type of loan. The overall loan portfolio duration is only 2.76 years, but that reflects that portion of loan portfolio that 32% linked to the short end of the curve, the other part that's variable, and then the fixed-rate stuff as well. It must be conceptually if this helps you, we think about the concept of what we call yield curve diversity. It's not really needed to term, but it's something we talk about. So we have things that are priced at the long end of the curve. Things like fixed-rate mortgages might be on the books, but you also have things here at the very short end of the curve. What you have in the middle of the curve are things like indirect auto. So, we're a $1 billion portfolio over a $1 billion that reprices up the two-and-a-half-year part of the curve and then the equipment finance portfolio we're building. Those are almost all five-year loans that don't really pay at all. You know, we, call sometimes leasing, but 85% of those are loans. And when those are loans or leases, they have almost a perfect five-year duration that doesn't prepay. So that kind of builds that duration overall in case it's kind of those repricing characteristics that smooth out the repricing of our portfolio over time, but the total duration on loans is 2.76 years, on securities 4.35 years. Total assets would be, it's 2.79 years on total assets. Hope that helps.

Matthew Breese, Analyst

Very helpful. And just one more on this topic, and apologies if it's belaboring the point, but you'd also mentioned that there's still a positive repricing gap on the fixed-rate book by, I think, 170 basis points. Do you mind providing for us what those what the before and after those numbers are? What is it repricing to and from?

James Reske, Chief Financial Officer

Yeah. It might take a second to find it, but I have it here. It'll take me a second. Go ahead and answer it, if you have another question.

Matthew Breese, Analyst

Yeah. While you're looking through your papers, Mike, just one for you. We've seen a little bit of a pickup here in NPAs. It sounds like some of it is your own, some of it is from Centric. Where would you be surprised to see NPAs climb to? I mean, are we near the top in year over year or are you expecting a little bit more mobilization? And maybe some color on how you expect charge-offs to behave as well?

Thomas Michael Price, President and CEO

Yes, I do. I think we're near the peak. It could tick up a little bit, but I think it would come down in the ensuing quarters. We have about a third of that NPL and NPA stack is Centric. We feel like we have good line of sight on those credits. We're not being surprised as much anymore and they're well marked as Brian outlined. So I think hopefully that's a peak. In terms of charge-offs, I think Brian shared as well our charge-off figure this past quarter versus what it would be normalized at would be, in the low teens. And that feels right to us longer term and I hope that's helpful.

James Reske, Chief Financial Officer

It it's helpful to me because it gave me some time to find the answer to the previous. So, going back to what you're asking, I think what you're asking is the replacement yields on fixed-rate loans. When I talk about 172 basis points, what are the underlying numbers? And, here they are, for better or worse. In the third quarter, we originated $290 million of fixed-rate loans at 7.24%. But $265 million ran off at 5.52%. So the nice thing about that is rates fall under 25 basis points. Hopefully, your replacement yields on those are 150 basis points, and another 25 basis points cut, replacement yield is still 125 basis points, and you still get a lift even in a falling rate environment. That's how we think about it.

Matthew Breese, Analyst

Appreciate that. Wouldn't that have a bit of a dampening effect on the loan beta? It just feels like that's a steep gap and it's more than half the book. So I'm just curious, wouldn't that dampen the 45% expected loan beta over time? And that's my last question. Thank you.

James Reske, Chief Financial Officer

I believe that's already accounted for. I'm considering whether it reduces the loan beta and to what degree. Our loan beta for next year isn't far from our deposit beta. This will vary depending on when the next cycle begins. For example, if it starts in September, the loan beta for next year will likely be slightly less, around 10% to 15%. In comparison, the deposit beta is approximately 25%. My deployment is aimed at a longer-term perspective, as these figures tend to balance out over the course of the cycle. When this cycle concludes, which could be three years from now, they generally even out.

Operator, Operator

Your next question comes from the line of Frank Schiraldi from Piper Sandler. Your line is open.

Frank Schiraldi, Analyst

Hey, guys. Good afternoon. I have a question about the large deposit that came in at the end of the quarter, specifically during the last week. Will that create some volatility in the fourth quarter? I’m curious if you anticipate some of that to flow back out or if you’ve already seen some of it, especially since we're at the end of October.

Thomas Michael Price, President and CEO

I think our best line of sight right now is that we'll have a good portion of that, that might flow out in the first quarter of next year. We'll do everything we can to hold on to it and we'll take it while we can get it.

Frank Schiraldi, Analyst

Sure. I wanted to follow up on the trends in deposit costs. Jim, I thought you mentioned that we might see another quarter of increased deposit costs, possibly at a lower level. Is that what you said? Additionally, considering the 50 basis points we've already seen in September regarding cuts, could this signify an inflection point for deposits in the third quarter?

James Reske, Chief Financial Officer

The last point seemed to indicate that the 50 basis points cut in September was reflected in the markets. We observed a reduction in market competition and changes in deposit movements, suggesting that everyone understands that rates are declining. This has made it easier to lower deposit rates while still attracting deposits. It appeared to be a noticeable shift in September. Regarding your first question, I hope I didn't say what you mentioned. If I did, let me clarify. I believe the rate of increase in deposit costs has been decreasing throughout the year. It was higher in the first quarter, but rose less in the second quarter and only increased by 8 basis points in the third quarter. We actually expect it to decrease slightly in the fourth quarter, but that's just a projection. I did not intend to suggest that I expect it to increase. I've been discussing the trend of decreasing increases. We may see a turning point in the fourth quarter, but I'm being cautious about that prediction. Estimating deposit costs and rate movements has been quite challenging in this entire cycle, so I advise against putting too much emphasis on that. However, our internal forecasts do not indicate that deposit costs will continue to rise next quarter; they should level off.

Frank Schiraldi, Analyst

Okay. So, said it otherwise, is it maybe the thinking that the trough is in the fourth quarter here?

James Reske, Chief Financial Officer

Yes.

Frank Schiraldi, Analyst

Okay. Yes. That's right. And then, just lastly, I mean, I think you're just given the numbers you gave around margin by the end of next year based on a couple of scenarios. Seems like that still kind of translates to about 5 basis points in margin compression for a given 25 basis point cut and I think you've maybe even said that in the past. So just wanted to double check if that's kind of still a reasonable guidepost for a given, 25 basis points?

James Reske, Chief Financial Officer

Yes, that's our general guideline. Recently, I've been considering that in our last forecast, we anticipated maintaining stable rates. Now, with the new forecast, we expect it to be 40 to 50 basis points lower, which is 10 basis points less than the previous rate forecast. So, for every 50 basis points, it results in a reduction of 10 basis points, equating to 25 basis points per cut. However, because of various headwinds and tailwinds I've mentioned, the relationship isn't simply a 5 basis point reduction for every 25 basis point cut. For instance, if rates drop from 5.50% to 3%, a 250 basis points decline involves numerous cuts, and I wouldn't translate that directly into the net interest margin. The tailwinds counterbalance much of that. That's why I aimed to provide insights from our model's forecast numbers.

Operator, Operator

Your next question comes from the line of Manuel Navas from D.A. Davidson. Your line is open.

Manuel Navas, Analyst

Hey, starting on the fees for fourth quarter, that range is a little wider $24 million to $22 million if I got it right. Can you just talk about what gets you to the higher end? Is it like SBA sales? And then can you talk about fees going forward into next year? If rates come down, mortgage should pick up, just kind of thoughts on that benefit as well on the fee side?

Thomas Michael Price, President and CEO

I'll give you some broad strokes and then Jim can fill in. But we do think if rates come down that will help all across the board with revenue and volume on the commercial lending side and the consumer side as well as our fee businesses. We've really built a pretty formidable SBA offering and will continue to invest there. Our mortgage banking could snap back pretty nicely with good share, good deposits in our core markets that could turn into refi and other things. So we do feel that could be a tailwind. Jim, other guidance you would provide?

James Reske, Chief Financial Officer

Yes. We have the fee engines baked into the bank that kind of hung along and some of them done really nicely. While we don't talk about a lot of insurance, that keeps coming along adding some fee. We have our wealth division, which has done really well this year. If you think about growth for next year, I think you're hitting on it in a changing rate environment. You hope that you're able to do more mortgage refi and then, more, SBA. I think that could just grow that business as well. The mortgage refi a little bit is independent on just the short-term rates though. We were really hopeful that we do some refi business in that middle part of the curve went up again a little bit, and so we just don't want to get too excited just because the Fed funds rate comes down doesn't mean mortgage rates come down, you get a lot of refi business. So, we have to take that into account.

Thomas Michael Price, President and CEO

Yes. The wealth management piece provided $500,000 quarter over quarter of offset to the $3 million headwind with Durbin. That business continues to mature. We also have treasury management. We've just built a really nice offering on the back of the corporate bank. We continue to get service charging come from there and just do a nice job for our commercial clients. We're just trying to move the bank into the future and make sure as we get to $15 billion and higher, we're more commercially oriented. We've built mature businesses. We're doing a better job of cross-selling through the regional model. So there's real emphasis on relationship banking, C&I, small business based, getting the deposits, which we've already always been pretty good at, but also cross-selling the relationship capabilities of our company.

James Reske, Chief Financial Officer

And Manuel, just for your modeling purposes, that wide range kind of brackets the number that we were thinking of $5 million on either side. That's why it is what it is.

Manuel Navas, Analyst

That's helpful. Just on the swap benefit, is the baseline scenario, getting fed funds to 300 basis points by year end, 2025?

James Reske, Chief Financial Officer

I believe the swap benefit will be reflected in the earnings deck, showing an 8 basis point gain. This is based on the previous rate forecast, which projected Fed funds at 3.29 by the end of 2025. If rates decrease to 2.95 as per our revised forecast, it could drop to about 7 basis points, but it's difficult to determine for sure.

Manuel Navas, Analyst

If by the end of next year, the yield curve is a little steeper, could how would that impact kind of your NIM thoughts if that is a very positive scenario? What could be that upside, for second half of next year into 2026? We talk about that all the time. I'm sorry to mute you off. Go ahead. No, no, go ahead. I just want to put, caveats to it. I know it's a very positive scenario, but like what could be the upside of that type of scenario for you?

James Reske, Chief Financial Officer

Yeah. In the near term, we think about, you know, changes in, you know, the cost of funds as we try to grow the deposit book and the yields of new loans come on and replace these. All that stuff. And long term, we think as bankers, it's positive. It's a positive slope to the yield curve. It's an environment we can make some money.

Thomas Michael Price, President and CEO

I'm just smiling at Jim because he just gave me four budget scenarios for 2025. Jim, I think it's about $0.09 or $0.10. Yeah. Long term a positive slope is great for banks. So that's our story and we're sticking to it.

Manuel Navas, Analyst

Okay. And then, my last question is deposit growth has been really strong. You talked about that large deposit. What's kind of the appetite from here, with that marginal cost of 3.20 for new deposits? Is it a loan to deposit ratio target? Is it pre-funding loan growth next year? What's kind of the appetite on the deposit growth side?

James Reske, Chief Financial Officer

The appetite on the deposit growth side is for, I'll tell you exactly how we think about this internally. We think about a smooth steady glide path, and the phrase glide path keeps coming up again and again. A smooth steady glide path in deposit growth. So for example, this last quarter, if you say, hey, loans were not growing that fast, we could have taken our foot off the gas in terms of deposit growth. We don't want to do that. We want to keep growing at 3% per quarter, which is a 3.2% average in the third quarter. We want to keep that going in the fourth quarter. The point is we want to bring that loan to deposit ratio down and get ourselves liquidity for loan growth going forward, and so in terms of the real dynamic that you're getting at, it's really driven by desire to grow the bank on the asset side and just make sure that you fund it on the liability side. In any given period, those may not match, but long term that's what we want to do. We want the deposit ratio down to 92.5%. We've got a long way to go before it gets over a 100%. So we feel like we've got the liquidity to grow. Mike?

Thomas Michael Price, President and CEO

As our bank president, Jane Grebenc, likes to say, we are relentless around the closet, nonstop. Jane, anything you want to add? You're the impetus behind our great core depository.

Jane Grebenc, Bank President and Chief Revenue Officer

Only that, you know, there's really two kinds of deposits. There's the transaction accounts that represent new households, whether commercial or consumer and then there's the time and the money market stuff that has the volatility of exception pricing and goes up and down with rates and we're always in the business to grow the transaction accounts and transaction households as rapidly and as aggressively as we can.

Thomas Michael Price, President and CEO

There's your answer.

Manuel Navas, Analyst

That helps. Thank you. I'll step back into the queue.

Operator, Operator

Your next question comes from the line of Daniel Cardenas from Janney Montgomery Scott. Your line is open.

Daniel Cardenas, Analyst

Hey guys, good afternoon. Just a quick question on the size of your participation portfolio. How big is that? And are there any other loans within that portfolio that you're watching given the migration of one larger credit into NPL status?

Brian Sohocki, Chief Credit Officer

Yes, I'll take that. We've actually really shrunk the portfolio over time, as we focused on the credit risk appetite. That Shared National Credit Book is just over $115 million today and only 10 relationships. So it's really not a factor as we look at it. The one commercial real estate credit that moved to non-performing was obviously in that Shared National portfolio, but very much not a focus and it's manageable at 10 relationships.

Daniel Cardenas, Analyst

Okay. Now was the reason for the nonperforming move in that specific loan? Was it related to just bad management of the facility or lack of tenants filling up the space? Can you give us a little color on that?

Brian Sohocki, Chief Credit Officer

More so the latter. The construction was a rehabilitation that started right before COVID. They experienced COVID delays as well as some significant construction cost increases over the period of time. That pushed them to the higher end of their budget. Since then, the rehabilitation has been completed, but the tenancy has not met expectations. It is a mixed-use. It's not your typical office. There's a grocery space. There's a 911 call center, and some other storage and office. They have some prospective tenants, but we're still working through a longer-term road to stability.

Daniel Cardenas, Analyst

Alright. And was that located in the central business district?

Brian Sohocki, Chief Credit Officer

Just outside, still in Allegheny County, but not in the downtown district.

Daniel Cardenas, Analyst

Okay. Appreciate that. All right. All my other questions have been asked and answered. Thanks, guys.

Operator, Operator

That concludes our question-and-answer session. I will now turn the call back over to Mike Price for some final closing remarks.

Thomas Michael Price, President and CEO

Just appreciate the questions and your engagement with us. We're excited about the future of our company. We feel like we're building good momentum and acquiring talent in our six regions and our regional presidents are moving the bank forward positively. Thank you for your time today.

Operator, Operator

This concludes today's conference call.