Fnb Corp/Pa/ Q3 FY2020 Earnings Call

Hello and welcome to the FNB Corporation Third Quarter 2020 Quarterly Earnings Conference Call. All participants will be in listen-only mode. Please note, today's event is being recorded. I'd now like to turn the conference over to your host today, Matthew Lazzaro. Mr. Lazzaro, please go ahead.

Thank you. Good morning everyone and welcome to our earnings call. This conference call of FNB Corporation and the reports it filed with the Securities and Exchange Commission often contain forward-looking statements and 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. Reconciliations of GAAP to non-GAAP operating measures to the most directly comparable GAAP financial measures are included in our presentation materials and in our earnings release. Please refer to these non-GAAP and forward-looking statement disclosures contained in our earnings release, related presentation materials and in our reports and registration statements filed with the Securities and Exchange Commission and available on our corporate website. A replay of this call will be available until October 27 and the webcast link will be posted to the About Us, Investor Relations and Shareholder Services section of our corporate website. I'll now turn the call over to Vince Delie, Chairman, President and CEO.

Good morning and welcome to our earnings call. Joining me this morning are Vince Calabrese, our Chief Financial Officer; and Gary Guerrieri, our Chief Credit Officer. Today, I will provide third quarter highlights and an update on our strategic initiatives. Gary will discuss asset quality and Vince will cover the financials. Third quarter operating EPS of $0.26 reflects strong fundamental performance as we continue to have success across many business units, despite a challenging operating environment and provision expense totaling $27 million. This quarter's performance reflects growth in average loans and deposits of 2% and 4%, respectively, as well as continued strength in our fee-based businesses. With strong contributions from capital markets activity and record mortgage banking income of $19 million. On a linked quarter basis, tangible book value per share increased $0.18 to $7.81. As we continue our commitment to paying an attractive dividend by declaring our quarterly common dividend of $0.12 last week. In addition, our CET1 and TCE ratios increased meaningfully, and after adjusting for the indirect loan sale, CET1 improves almost 20 basis points to the strongest level in the company's history. Our bolstered capital base should provide us with increased flexibility to deploy capital in the best interests of the shareholders. Return on tangible common equity was again peer-leading at 14% and the efficiency ratio equaled 55%. These results illustrate the resiliency of FNB's business model and are truly remarkable, given the challenges presented and unique circumstances the industry is facing amidst the global pandemic. I’m extremely proud of our team for going above and beyond to support our customers in this challenging macroeconomic environment. Their hard work was critical to providing timely assistance to our impacted customers through the paycheck protection program by offering loan deferral options and consumer relief, as well as other programs to help clients manage their finances during these difficult times. Customer feedback has been overwhelmingly positive, and we are encouraged by the low single-digit level of second loan deferral requests as a percentage of total loans as of October 15, 2020. Lower demand for second deferral requests is indicative of the quality of our customer base, our consistent approach to credit risk management and FNB's dedication to disciplined underwriting standards throughout various business cycles. Our bankers and credit teams will continue to actively evaluate and work with COVID-19 impacted borrowers as they manage through their pandemic-related disruptions. Earlier in the third quarter, our organization was recognized as a 2020 standout commercial bank by Greenwich Associates, FNB being one of only 10 banks in the country recognized for its response to the COVID-19 pandemic. If you look at the credit metrics on FNB's COVID-19 sensitive sectors, we are favorably positioned to peers on a relative basis. Our disciplined approach to underwriting and portfolio management ensures granularity, diversification and appropriate credit structure within our loan portfolio. On the deposit side, organic growth in government programs have resulted in increased liquidity in our customer base. Looking at the recent FDIC data compared to 2019, FNB has successfully gained share in 4 to 5 top market share positions in Pittsburgh, Baltimore, Cleveland, Charlotte, Raleigh, and the Piedmont Triad with our largest market Pittsburgh surpassing the $8 billion mark in total deposits. Additionally, as of June 30, 2020, FNB ranked in the top 10 in retail deposit market share across 7 major MSAs. When looking at our footprint in total, FNB has a top 10 market share in more than 80% of the 53 markets categorized by the FDIC. Compared to June 2019, FNB continued to gain market share as total deposits increased nearly $5 billion or over 20% overall. If you look back over the last 6 months, we've added thousands of new households and more than $4 billion in total deposits. Diving deeper by examining the regional market share trends, FNB has 5 MSAs with greater than $1 billion in deposits and 16 MSAs with greater than $500 million in deposits. These market positions reflect successful execution of our deposit-gathering strategy centered on attracting low-cost deposits through household acquisition and deepening commercial relationships, thereby enabling FNB to eliminate our overnight borrowing position. The surge in core deposits has strengthened our overall funding mix, and the loan-to-deposit ratio further improved to 89.1%. We continue to be absolutely focused on generating non-interest bearing and transaction deposit growth, given the impacts of the expected lower for longer interest rate environment. To complement our deposit-gathering strategy, we are focused on supporting our customers and expanding our relationships as their primary capital provider with value-added products and services while staying true to our credit culture. Looking ahead to the fourth quarter, we are encouraged by the current position of the balance sheet with ample liquidity to support growth opportunities and an expanded capital base. Additionally, with our PPP efforts, we've added more than 5,000 prospects for non-customer PPP lending to pursue as long-term relationships. Given our success and the quality of our bankers, we have firmly established ourselves as a formidable competitor across our seven-state footprint, providing competitive financial products and services supported by technology investment and the best personnel. With that, I'll turn the call over to Gary for more detail on asset quality.

Thank you, Vince and good morning, everyone. During the third quarter, our credit portfolio continues to perform in a satisfactory manner as we continue to work through this challenging economic environment. Our key credit metrics have held up well with some slight increases noted during the quarter related to the COVID environment that is largely tied to borrowers in the hardest-hit industries, which we have built loan loss reserves for accordingly. I will now walk you through our results for the third quarter, followed by an update on our loan deferrals and some of the proactive steps we are taking to manage the book. Let's now discuss some key highlights. During the third quarter, delinquency came in at a good level of 1.07%, an increase of 15 basis points over the prior quarter, that was predominantly COVID-related tied to mortgage forbearances, while the commercial portfolio remained relatively level with the prior quarter. When excluding PPP loan volume, delinquency would have ended the quarter at 1.18%. The level of nonperforming loans (NPLs) and other real estate owned (OREO) totaled 76 basis points, a 4 basis point increase linked quarter, while the non-GAAP level excluding PPP loans stands at 85 basis points. This slight migration is attributable to some COVID-impacted credits that were placed on non-accrual during the quarter, which is in line with our proactive risk management measures that we have in place to help identify potential pockets of softness. Of our total nonperforming loans at September 30, 50% continued to pay on a current basis. Net charge-offs came in at $19.3 million for the quarter or 29 basis points annualized, with the increase largely due to write-downs taken against a few COVID-impacted credits that were already showing weakness entering the pandemic. On a year-to-date basis, our GAAP net charge-offs stood at 18 basis points through the end of the third quarter. Provision expense totaled $27 million, which includes additional build for COVID-related credit migration driven by the hotel and restaurant portfolios, bringing our total ending reserve to 1.45%. When excluding PPP loan volume, the non-GAAP ACL stands at 1.61%, a 7 basis point linked quarter increase. Our NPL coverage remains favorable at 210% at quarter end, which reflects the reserve build for the COVID-driven credit migration during the quarter. When including the acquired on amortized loan discounts, our reserve position excluding PPP loan volume is 1.87%. We continue to conduct a series of scenario analysis and stress test models under our existing allowance and DFAST frameworks as we work through this COVID-impacted environment. Under the final 2020 severely adverse DFAST scenario, the current reserve position inclusive of on amortized loan discounts would cover 77% of stressed losses, which does not include losses already incurred year-to-date. As it relates to our borrowers requesting payment deferral, 3.4% of our total loan portfolio, excluding PPP balances, were under a COVID-related deferment plan at quarter end with remaining first request representing 1.4% of the portfolio and 2% being second deferrals. As of October 16th, total deferrals have further declined by approximately $100 million to stand at 2.9%. We continue to carefully monitor the credit portfolio as the pandemic evolves and borrowers work to overcome the uncertainty and challenging conditions that many currently face. Our exposure to highly sensitive industries remains low at 3.5% of the total portfolio, which includes all borrowers operating in the travel and leisure, food services, and energy space, with deferrals granted to these borrowers totaling 29% driven primarily by the hotel portfolio as we continue to work through these hardest hit sectors. During the quarter, we conducted another thorough deep dive credit review of our commercial borrowers operating in these economically sensitive industries, which was led by our seasoned and experienced credit officer team. Our portfolio review covered over 80% of our existing credit exposure in COVID-sensitive portfolios, including travel and leisure, food services, and retail-related commercial and industrial and investment real estate. As part of our review process, we assess the adequacy of cash flow, strength of the sponsors backing the deals, the collateral position, and direct feedback from borrowers about their expected short and long-term outlooks. This level of review has helped us to quickly identify potential credit deterioration and take appropriate action, as we did during Q3, to better position us for the quarters ahead, should this challenging economic environment continue. In closing, we are pleased with the position of our portfolio entering the final quarter of 2020 relative to where we are in this COVID-impacted economic environment. Our credit metrics have held up well and continue to trend at satisfactory levels as we remain focused on proactively identifying risk in the portfolio and aggressively working through it. The experience and depth of our credit and lending teams have been paramount to our success, and I would like to recognize these groups for their tireless efforts each and every day as we work through these challenging conditions. I will now turn the call over to Vince Calabrese, our Chief Financial Officer for his remarks.

Thanks, Gary. Good morning, everyone. Now we will discuss our financial results and review the recent actions taken that have enhanced our overall balance sheet positioning, reduced interest rate risk, and boosted capital levels. As noted on Slide 4, third quarter operating EPS totaled $0.26 consistent with the prior quarter. The level of PPNR remained solid and we continue to proactively manage our overall reserve position with provision expense totaling $27 million. We feel good about the strength of the balance sheet and our current level of reserves based on what we know today after a comprehensive review of our loan portfolio. Additionally, the quarter's results reflect the continued execution of our strategies focused on prudent risk management supported by our recent actions. For example, during the third quarter, we took proactive measures to strengthen capital and reduce credit risk. We signed an agreement to sell $508 million of lower FICO indirect auto loans that close in Q4 with the proceeds being used to pay down a similar amount of high-cost Federal Home Loan Bank borrowings, of which $415 million with a rate of 2.59% was prepaid this quarter for breakage fee of $13.5 million. We also sold Visa Class B shares at a $13.8 million gain to fully mitigate the capital impact of the FHLB breakage costs. Results in transactions should add roughly 17 basis points to CET1 group credit risk and be neutral to run rate earnings. We continue to strengthen risk-based capital levels with our CET1 ratio increasing to 9.6% at the end of the quarter. As I just noted, the pro forma CET1 ratio would increase by another 17 basis points after considering the impact of the upcoming loan sale. The pro forma CET1 ratio marks the highest level in our history and will be in line with peer median levels from the most recent filings. Our improved capital levels give us additional flexibility that is important at this stage of the economic cycle. Looking at our TCE ratio, we ended September comfortably above 7%, increasing to 7.2%, which translates to 7.7 when excluding PPP loans. On the expense front, we are progressing well towards achieving our 2020 cost savings goal, reducing run rate expenses via optimizing our branch network and reducing operational costs through ongoing vendor contracts negotiations. On the revenue front, we are leveraging our new geographies to drive market share gains and fee-based businesses, notably mortgage banking, capital markets, wealth, and insurance to offset net interest margin pressure in the current low rate environment. Let's now shift to the balance sheet. Spot balances, total loans were relatively flat compared to the prior quarter, excluding the transfer of $508 million of indirect auto loans to held for sale. Looking ahead, it's important to focus on the position of the balance sheet after the loan sale and excluding PPP. We remain focused on driving organic growth, that's a $2.5 billion in PPP loans enter the forgiveness process and those balances wind down in the future. Compared to the second quarter, average deposits increased 4%, primarily due to 6% growth in interest-bearing deposits and 7% growth in non-interest-bearing deposits, which was partially offset by a 6% planned decrease in time deposits. As Vince noted earlier, core deposit growth generated by building on our commercial and consumer relationships remains a focus for us as we eliminated our overnight borrowing position and have ample liquidity to fund future growth objectives. Let's now look at non-interest income and expense. Non-interest income reached a record $80 million, increasing 3% linked quarter, primarily due to significant growth in mortgage banking, as well as strong contributions from wealth, insurance, and capital markets. Mortgage banking income increased $2.3 million as sold production increased 9% from the prior quarter with sizable contributions from the mid-Atlantic and Pittsburgh regions and a meaningful improvement in gain on sale margins. Wealth management and insurance revenues each increased 10%, these segments benefiting from increased organic commercial growth from greater activity in the mid-Atlantic and Carolina regions. Capital markets revenue, while down from a record level last quarter, was again at a very good level of $8.2 million with these products continuing to remain an attractive option for borrowers given the environment. Termination of $415 million of higher rate Federal Home Loan Bank borrowings resulted in a loss on debt extinguishment and related hedge termination costs of $13.3 million reported in other non-interest income. Offsetting these charges was the $13.8 million gain on the sale of the bank's holdings of Visa Class B shares, also reported in other non-interest income. Turning to Slide 9, non-interest expense totaled $180.2 million, an increase of $4.3 million or 2.4%, which included $2.7 million of COVID-19 expenses in the third quarter compared to $2 million in the second quarter. Excluding these COVID-19 related expenses, non-interest expense increased $3.6 million or 1.9%, primarily related to higher salaries and employee benefit expenses, higher production-related commissions, and lower loan origination salary deferrals given the significant PPP loan originations in the prior quarter, as well as having an extra operating day in the third quarter. FDIC insurance decreased $1.3 million due primarily to a lower FDIC assessment rate from improved liquidity metrics. The efficiency ratio equaled 55.3% compared to 53.7%, which is reflective of the higher production-related expenses noted previously. Looking at revenue, net interest income totaled $227 million, stable compared to the second quarter as loan and deposit growth mostly offset lower asset yields on variable rate loans tied to the short end of the curve. Net interest margin decreased 9 basis points to 2.79% as the total yield on earning assets declined 20 basis points to 3.34, reflecting lower yields on fixed-rate loans originated at lower rates, given the interest rate environment and the impact of a 19 basis point decline in 1-month LIBOR. The benefit of our efforts to optimize funding costs was evident in a 17 basis point reduction in the cost of interest-bearing deposits, which helped to reduce our total cost of funds to 56 basis points, down from 67 basis points. We're very pleased with the performance of our fee-based businesses as they have supported revenue growth amidst the current low interest rate environment, demonstrating the importance of having diversification. Turning to our fourth quarter outlook, we expect period-end loans to be generally flat to September 30th, assuming no forgiveness of PPP loans, given the current timing expectations for the SBA to process requests. While we expect deposits to decline from third quarter levels, that's based on an expectation that customers increase their deployment of funds received through the government programs. We do expect to see continued organic growth from transaction deposits. I'll note that our assumptions do not include any further government stimulus programs or actions. We expect fourth quarter net interest income to be down slightly from third quarter, inclusive of the impact of the loan sale. We are not assuming any PPP forgiveness in the fourth quarter. Absent the loan sale, we would have expected net interest income in the fourth quarter to be flattish. We expect continued strong contributions from fee-based businesses with a similar level in capital markets and some reduction from record levels of mortgage banking. We expect service charges to increase, continuing to rebound, given recent transaction volume trends. Looking at fee income overall, we expect total non-interest income to be in the mid to high $70 million range. We expect expenses to be stable to up slightly from the third quarter, excluding COVID-19 expenses of $2.7 million. We expect the effective tax rate to be around 17% for the full year 2020. Lastly, we are currently in the early stages of budgeting for 2021. Similar to 2019 and 2020, we will again seek to have meaningful cost-saving initiatives, building on consecutive years of taking $20 million out of our overall cost structure to support strategic investments and manage the impact of the low interest rate environment. It's taking considerable effort to bring our efficiency ratio down from over 60% in the past to the low to mid-50% levels we’ve been operating at currently. In addition to the scale gains from prior acquisitions, we have consolidated close to 95 branches in the past 5 years, which is about 25% of our current branch network. We have always been disciplined managers of costs, and it will be an important driver to return us to a position of generating positive operating leverage and mitigate growth in expenses in 2021. We will share more details when we provide 2021 detailed guidance in January. Overall, we are pleased with the performance of the quarter in a very challenging environment. Next, Vince will give an update on some of our strategic initiatives in 2020.

Thanks, Vince. Now I'd like to focus on our progress regarding key strategic initiatives since our last call. In our consumer bank, we continue to focus on optimizing our delivery channels. The deployment of our new website has translated into higher digital adoption through increased website traffic, increased mobile deposits, and exponential growth in the number of online appointments. In the current environment, customer activity trends continue to shift towards digital channels with mobile enrollment up 40% compared to 2019 averages. In fact, we have seen both monthly average mobile and online users increase by 50,000 each compared with the 2019 average level. Regarding website traffic, monthly visitors are up nearly 70%. Looking at our physical delivery channel, we continue to execute our established readiness program to optimize our branch network, which included more than 60 consolidations since May of 2018, making FNB one of the more active banks for branch consolidation. We will continue to thoroughly evaluate additional consolidation opportunities as well as select de novo expansion across our footprint as consumer behaviors evolve. We recently announced plans to develop additional de novo locations, which will enhance our retail strategy and support our corporate banking efforts in these attractive new markets. For example, our Charleston branches are performing exceptionally well with nearly $50 million of deposit growth compared to 2019. And these branches are currently ranked among the upper quartile for performance compared to FNB's entire retail network. This consumer growth works in tandem with our successful corporate banking efforts as the Charleston region has grown nicely with our South Carolina commercial loan balances approaching $200 million at the end of September. We recently brought the wholesale bank and respective credit teams back into the offices on a rotational basis as we remain steadfast in supporting our customers while building momentum to carry into the next year. Given the impact from the government stimulus programs, customers have increased liquidity with lower commercial line utilization rates. A more normal environment offers upside moving into 2021. Our model is built on local decision-making and the high-touch relationship-based approach, coupled with consistent investment in technology. This has served us well during the pandemic where our local bankers are in the market and working closely with our customers. As we built out certain high-value fee-based businesses, such as treasury management and capital markets, we've embedded local specialists across all markets to support our commercial bankers' efforts. During this pandemic, where travel, physical mobility and face-to-face interaction is limited, having well-informed decision makers directly located in our market enables FNB to best support our customers. Together with our efforts in the wholesale bank, FNB has also benefited from our long-term consumer strategy clicks-to-bricks by investing heavily in our digital platform. One key element necessary for FNB to continue to deliver attractive returns for our shareholders is our commitment to our employees. I am pleased to share that FNB was included for a 10th consecutive year as a greater Pittsburgh area top workplace by the Pittsburgh Post-Gazette, signifying the strength of our culture with a decade of excellence and consistency. These results benefit our shareholders, and we would like to recognize the hard work and dedication of all of our employees who have made these results possible. With that, I'll turn the call over to the operator.

Yes. Thank you. Please note, the first question comes from Frank Schiraldi with Piper Sandler.

Thanks. Just first on the NIM mechanics. Vince, you talked about a flattish NIM next quarter. Obviously, it sounds like no PPP forgiveness, so I guess PPP will still be there and negatively impacting the margin, I guess. But just trying to think through the moving parts, think about reinvestment rates for securities going lower. Is there more room on the deposit side? And then, does purchase accounting accretion, how does that play into the quarterly progression?

Sure, Frank. I would like to mention a few points. The PPP is actually slightly beneficial to the margin by a few basis points when you account for the fees generated. Looking forward to the fourth quarter, I see the third quarter as a baseline, so it's likely to remain stable from there. LIBOR has been consistent at 15 to 16 basis points, with the beginning and end of the quarters within a basis point of each other. I believe the stability of LIBOR will be an advantage. There is still potential for a reduction in interest-bearing deposit costs. As shown in the slide, we've reduced it by 17 basis points to 55. The spot at the end of the quarter was 51. Therefore, you start with a 4 basis point advantage, and we anticipate an additional 3 basis point monthly improvement in the fourth quarter. So, overall, we expect a reduction of around 9 to 10 basis points in the cost of interest-bearing deposits in the fourth quarter, which will support the margin. Additionally, new loans are being issued at lower rates, given the current interest rate environment. When you consider all these factors, it aligns with our earlier comment about stability.

Got you. Okay. Regarding the balance sheet actions, if you can increase capital without affecting earnings, it appears to be beneficial in terms of providing more flexibility. However, I'm curious if there's more to consider about the rise in capital levels. You've always aimed for a streamlined capital approach. Is there a shift in your perspective, or are there any external pressures in the industry that suggest where ratios should be headed, and could there be further actions to achieve that?

No, there’s no change. We've been saying for at least the last year that we've been more actively looking at the asset side of the balance sheet and considering different options to kind of just optimize it to balance sheet position and the capital position. So they are underlying that other than we've been looking at indirect for a while and securitizing or selling a portion of the portfolio. We're remaining in that business, so we'll continue to generate new assets as we go forward. But then it was just kind of planets aligning. There is a good opportunity to sell that at basically a slight gain, and then to boost the capital ratios, 17 basis points to CET1, about an 11 basis points to the TCE ratio in a non-dilutive manner, which just felt like a good smart thing to do right now. And then as we kind of come through and get more certainty about the economic environment and where everybody is going, there's opportunity for us to restart the share buyback program and this gives us some powder to do that. So it's really just looking at the opportunity that presented itself. And then we also had to gain the Visa Class B shares that we’ve been monitoring for a while became very attractive so we can sell those, pay off some home loan borrowings that were at 2.59 rate kind of helping the run rate earnings going forward. So it just kind of made sense economically to do that. And again, like I said, create some more powder for share buybacks going forward.

Okay, great. And then just really quick, if I could just ask Gary, do you provide, or would you provide where criticized and classified the trend from 2Q into 3Q?

Yes. Let me walk you through that, Frank. I mean, as I mentioned in my remarks, we conducted another really deep dive review of the borrowers operating in the hardest hit COVID-sensitive industries and we really looked at about $3 billion of the total portfolio pulling in a few other credits that maybe slightly impacted. We wanted to be proactive in building reserves where appropriate against these hardest hit borrowers under the current economic environment. And this review was important from the bank's perspective. Really a handful of our senior group reviewed these relationships with our regional credit officers, one-by-one over a 4-day period to really assess these up to date positions on each borrower. And we took aggressive risk rating actions against the COVID-impacted portfolios, primarily the hotel and restaurant portfolio. And we moved about $350 million of that into classified and about $79 million into special mention. We are essentially migrating about 90% of the hotel portfolio and about 25% of the restaurant portfolio to prudently build reserves against these pieces of business that are impacted by the COVID economy. Just finishing up there in total, we also included some retail IRE. We've built during that quarter $22.5 million of the total of $27 million provision against these portfolios. So it was pretty meaningful piece, which we felt was the prudent thing to do. Overall, when we look at these industries and building these reserves and reviewed these credits, we were really pleased with the positions of the majority of the borrowers across the space, and we remain confident they'll weather the storm. Finally on deferrals. The deferrals are heaviest in the hotel space, as you would expect right at about 53%. Restaurants are very low at this point, only 12% and retail IRE only 5.6%. So overall pleased with that review and the reserve positioning that we were able to accomplish during the quarter.

Great. Thanks for all the detail.

Thanks, Frank.

Thanks, Frank.

Thank you. And the next question comes from Casey Haire with Jefferies.

Yes. Thanks. Good morning, guys.

Good morning, Casey.

A couple of questions on the PPNR front. First off, housekeeping, the purchase accounting adjustment in the quarter. How much was that?

The PCD accretion was $11 million in the third quarter. Just for reference, it was $13.2 million in the second quarter.

Okay, excellent. So for the fourth quarter outlook, it appears that you anticipate revenues to decline. Mortgage banking was very strong, and a normalization is expected. I'm curious why expenses wouldn’t also decrease. What factors are keeping expenses stable or slightly higher? Why aren’t we seeing leverage in the fourth quarter?

In the fourth quarter, there are typically specific end-of-year factors to consider. Firstly, the mortgage sector is expected to remain strong, which means commission-related expenses will again be significant and correlated with revenue. Additionally, there are year-end incentives depending on how various business units conclude their performance. Thus, it's normal to anticipate these factors in the fourth quarter. We are actively managing costs and have removed $40 million from our overall cost structure over the past two years, aiming for a total of $60 million in three years. We eliminated $20 million last year and plan to do the same this year. This effort involves branch optimization, renegotiating contracts, process improvements, and daily operational tasks. These initiatives are ongoing and assist in funding our strategic investments, which reflects typical activities alongside the factors mentioned.

Okay. Very good. Can you clarify how much of the charge-offs were driven by the hotel book? Also, what do we expect regarding the loss trajectory moving forward from the current level in the third quarter? Lastly, what is the deferral strategy for the hotel book, considering that half of it is in deferral?

Yes. Regarding the charge-offs, they were just over $3 million in that portfolio. Looking ahead, we will continue to engage with those borrowers. We were satisfied with the review of that segment of our business. Some borrowers will face more challenges than others, and we will address those specific accounts. This is why we established a reserve for that portfolio. It is the most affected industry in this COVID economy that we are experiencing. We will take the necessary actions as we transition into the fourth quarter and manage it appropriately. There was only one new nonaccrual in that business segment during the quarter, and we evaluated every credit over $2 million. This provides an overview of our current situation, and we will remain proactive with that portfolio as we progress.

Okay. Very good. And just one last question, Gary. I believe you mentioned, or perhaps Vince did, that you expect to sell the indirect auto portfolio at a gain. So there isn't a possibility of a loss, and no reserves have been built against that portfolio?

No, it actually came in. We were able to sell it a bit better than we expected through dealer reserves and various factors on the books. We managed to sell it at a slight premium to par, and also had the reserve component. The execution was better than what we anticipated.

Okay. So I'm sorry, so was that portfolio has already been sold or I thought it was due to be closed in November?

Yes. It's in held for sale, Casey. You're right. It's held for sale. It's all executed as of yesterday. It'll close in the fourth quarter, but it's in the held for sale bucket on the balance sheet 9.30.

Understood. Thank you.

Thank you. And the next question comes from Michael Young with Truist Securities.

Hey, thanks for taking the question. I wanted to start on kind of the expenses as a follow-up. You've kind of mentioned the $20 million of additional cost saves that were kind of already targeted for 2021. Obviously, the revenue environment is going to be challenging and some headwinds still on that kind of year-over-year basis. So you'd expect more of those cost saves to drop to the bottom line next year, or is it better to think about it in terms of efficiency ratio next year, and you guys just maintaining that positive operating leverage, so efficiency ratios should be stable to better?

We are continuing to work on strategic initiatives this year, including upgrading our teller platform and branch systems. Our goal for next year is to manage expense increases while aiming to restore positive operating leverage. This is crucial for us, as it directly impacts our bottom line by offsetting other cost increases, leading to an improvement in EPS. We're in the early stages of our budgeting process and will discuss this in detail soon, including a list of items we've focused on in the past. In January, we will update our outlook for next year after completing that process. We aim to reach a three-year target of 60, and we'll share more information at that time. Additionally, I'd like to highlight that we've closed 95 branches over the last five years, representing 25% of our network. We will continue to assess and optimize our network, considering how customer behaviors have shifted during the pandemic. Some changes may be permanent while others remain uncertain, but we will keep exploring opportunities within our branch network.

That's helpful. And maybe this is more a question for Vince, but I guess over the last year or two, you guys have done a good bit of reinvestment in some of the digital initiatives, new branch openings, et cetera. So it seems like maybe a lot of that's behind you. So there would be more of an opportunity for some cost saves to drop to the bottom line. But I guess, just to put that against the new branches in Charleston, et cetera, that have obviously been doing well. And so just kind of generally trying to think about your thoughts there on reinvestment and new initiatives versus maybe just taking a pause or a breather on some of that stuff.

We have developed a longer-term perspective as we are currently in the second cycle of our three-year strategic planning process. We have outlined our capital expenditure investments and technology. This involves discussions about our future objectives, followed by budget creation and integration into our forecasts. This ongoing requirement for investment has been met, which is what you are emphasizing. I believe we are well-positioned to continue executing our strategy. We will expand our digital offerings, allowing us to originate various loans directly through our website. The depository side is nearly complete, and we are now focusing on the loan side, along with integrating fee-based services into our digital platform. This will enable us to market our banking services globally without needing a physical presence, facilitating end-to-end account openings on our platform. If you visit our website, you'll notice a new, unique format that allows users to add multiple products to a shopping cart for simultaneous purchase. Our aim is to streamline this process for consumers so they can fill out one application to open both loans and depository products efficiently. Interactions with customers around the PPP program have significantly increased traffic to our website, resulting in a substantial uptick in clicks. This is beneficial for us, as we have incorporated digital content regarding our products and services on our platform. Users can explore options, utilize comparison tools, purchase various products, or schedule appointments—something we implemented before the pandemic. As everyone turned towards digital solutions during this time, we benefited greatly. This is reflected in our growing deposit balances and market share. We’ve also achieved impressive results with appointment scheduling during the pandemic, garnering several accolades for our response. In the initial phase of the PPP, we outperformed many larger banks with an 83% capture rate, thanks in part to our fully digital process. As we continue to navigate through the pandemic, we believe we can leverage this advantage moving forward. I want to clarify that our decision to enhance capital should not be misinterpreted; we had intentions to improve our CET1 levels even before the pandemic. We’ve made significant progress toward that goal, particularly in relation to our peers. The steps we took with our portfolio were strategic and have strengthened our capital without impairing our earnings potential for next year. This provides us with the flexibility to buy back shares and pursue various options according to our objectives, with no immediate pressure to alter our operational strategy. Additionally, I see opportunities ahead; as observed in FDIC data, we were on the right track before the surge in PPP deposits. Our non-interest bearing deposits have increased substantially. While the industry has seen growth in that area, we have consistently expanded our low-cost deposit base, now reaching approximately 26% to 27% of our total deposits. All of these trends are positive, and I noticed increased activity in markets like the Carolinas in hospitality and restaurants, in contrast to the slower pace in the Midwest and Northeast. Thank you for your patience with my lengthy response.

No, that's okay. That was a good overview. I have one last question for Gary. I believe it was previously asked about the timing of charge-offs or the resolution of some of these credits. Do you have any updates or thoughts on when these might be resolved? Will it be in the first half of 2021, or could there be extensions and restructurings that might prolong the process into next year?

Yes, I would say, Michael, we are very proactive in addressing problem credits and trying to manage them effectively. Regarding expected losses, we've previously mentioned that industry losses are likely to increase as we move into 2021. Therefore, I expect that trend to continue. Looking at the industry in the fourth quarter, it’s probable that we will start to see losses increase due to the current environment, and I anticipate that they will accumulate throughout 2021.

Okay. Thanks.

Thank you. And the next question comes from Russell Gunther with D.A. Davidson.

Hey, good morning guys.

Good morning, Russell.

Just wanted to follow-up on the auto sale. So it makes a ton of sense and there's a culture of derisking at FNB. Wondering if there's opportunity for continued optimization without sacrificing much in the way of earnings power, or was the deep dive review that you guys did in the portfolio this quarter really ring-fence this opportunity, and we should consider this more of a one-off move?

Yes, I would say, we're always evaluating also as you know opportunities. If there's things that come to light, it makes sense to us that are in the best interest of the shareholders and make good financial sense, we'll do it. So we're always looking at all the different elements of the balance sheet. And here this quarter, we had an opportunity to, like I said, with kind of planets lining up to pull some things together and make a smart financial decision that helps boost capital, maybe some buffer going forward and like I said, it creates the ability to buy back shares. So we'll continue to look and there may be other opportunities as we go down the road. So kind of a quarter-by-quarter thing.

Any portfolios in particular where you think you might have a better opportunity as you had continued to analyze that?

Russell, I think we're going to look from a risk perspective as well as the commercial book. We've sold mortgage loans in the past. We sold Regency. So we got out of consumer finance at the right time. I think we're going to continue to evaluate what we have in our portfolio. We're going to look at returns on those assets, and we're going to look at the risk profile associated with holding those assets long-term and we get together and we make decisions about moving certain assets off the balance sheet. I think we've done it very effectively. And I think Gary and his team have done a great job. And Gary and the whole credit team have done a great job of addressing future risks.

On a quarterly basis, Russell, as we always do.

Our goal is to get through this so that we're in a really strong position on the other side of it. So understand that we're here managing through this situation. We understand with a great degree of clarity, what we face. I think we've addressed various elements of it very successfully, and we're going to continue to position the company so that we're in a position of strength post pandemic crisis, the economic side of the pandemic crisis.

Thanks very much guys. I appreciate it.

Russell, thanks.

Thank you. And the next question comes from Collyn Gilbert with KBW.

Thanks. Good morning, guys.

Good morning, Collyn.

Could you please begin by discussing the current loan pipeline and the sentiment among your commercial borrowers? How are they perceiving their businesses and are they considering reinvesting? Additionally, can you provide some insights into the geographic differences, particularly between your franchises in the Carolinas and the markets in Pennsylvania and Ohio?

I believe the commercial borrowers have been a bit more cautious, especially during this election year with potential changes that could affect their businesses amid the ongoing pandemic. This caution has led to a slight decrease in capital investment, which impacts loan demand. However, many sectors not directly affected by COVID-19 are doing reasonably well. The economy outside heavily impacted industries, such as hospitality and restaurants, shows some signs of optimism. Our utilization rates have decreased, primarily because our middle market and small business customers have benefited from PPP funding and other aids, allowing them to reduce their working capital needs without heavily investing in inventory. There's a potential for growth as the economy improves. Geographically, the manufacturing sector appears stable, with the Midwest and Northeast lagging somewhat. In contrast, the Carolinas, particularly Raleigh and Charlotte, are seeing more activity, and Charleston is doing exceptionally well, attracting newcomers at a rate of 32 per day, mainly from the Northeast. This presents opportunities in mortgage and retail banking, along with an increase in business formations in that area. We have also expanded our commercial activities in Asheville and Greenville, where we've noticed positive developments. Overall, the Carolinas are performing strongly, while the Midwest and Northeast remain stable for us in terms of credit and growth. Gary, do you have anything to add?

Yes, Collyn. As Vince mentioned, borrowers are dealing with significant uncertainty at the moment. The election has been a major consideration for some time now, and the ongoing pandemic remains a primary concern. These two factors are crucial to their investment decisions moving forward. However, as Vince also noted, some borrowers are thriving in this environment and are actively investing today, while others have chosen to pause their activities. The commercial line utilization rate has hit a historic low of 32%, indicating that borrowers are opting to pay down debt, hold cash, and approach this uncertainty with caution. This situation suggests that there are plenty of opportunities for industry growth and loan demand once we move past these challenges. We are optimistic about the future as we work through this period.

That's helpful. Gary, I have a question for you. I appreciate the insights you're providing regarding net charge-offs. Unfortunately, this is a part of our models that we need to calibrate with more precision due to CECL. This might explain why we have so many questions about net charge-offs. Looking ahead at potential losses, is it fair to say you're seeing greater near-term pressure primarily in the COVID-related segments? Are you not observing any notable issues or anticipating significant losses in other segments of the portfolio?

I will tell you, Collyn, that the book is holding up very nicely. We're very pleased with the performance of it. The softness as we've discussed today is really in that COVID sensitive area, the hotels, the restaurants. And as I mentioned, I mean, I sat down with the team over that 4-day period and went through these accounts one-by-one. And that total review looked at $3 billion worth of impacted and potentially impacted credits. I walked away from that feeling very good. And the reserve build that we talked about earlier was in the areas where it needed to be. So I think you'll see what losses come through, I think you'll see it in those COVID sensitive areas without a doubt. And again, we think a lot of that book has a lot of positive things happening in already. Occupancy levels are up, very improving. A heavy dose of that is in the Carolinas. We got it through the acquired book. As we've talked, those areas are more active. So we're seeing some positive occupancy levels start to make some headway there. So hopefully that helps answer your question, but it's kind of really concentrated in that COVID impacted sector.

Okay. That is. And then just one final question on that front. Do you happen to have what the average LTV is on your hotel and lodging portfolio, which is around $360 million?

Yes. You're right, that's about 65%, Collyn.

Okay, great. All right. I will leave it there. Thanks, everybody.

Thanks.

Thanks, Collyn.

Thank you. And the next question comes from Matthew Breese with Stephens, Inc.

Good morning, guys.

Good morning, Matt.

Hey, just a few. First, what was the average balance of PPP loans for the quarter? And then, do you have the total PPP related income?

Yes, the average balance $2.5 billion for the third quarter, and kind of the total net interest income, it runs about $21 million a quarter, including the coupon at 1% plus the fees that come in.

Okay. And then, the $508 million of indirect auto loans, what was the yield on that?

Yes, the gross yield was about 5%.

Okay. And then you mentioned potentially selling more of this product. Could you just give us a sense for the overall origination activity over the course of the last year? And if you were to repeat this, how much of that would you like to sell versus retain?

Yes. No, just to clarify, I was saying that in the past, we've been looking at this asset class for a while as far as potentially securitizing or selling the portion. So, at this point, we don't have any plans to sell any additional slugs of it. This was just a result of that review we've been doing for the last year or two. So, just to clarify that.

Got it. Okay. And then, I know you …

Yes. What it does for us is it builds out the infrastructure to service. So it provides us with an opportunity to sell in the future that I think we will.

Yes on a flow basis.

On a flow basis. We're going to look at it from an economic perspective, what's best for the shareholders from a return on capital standpoint, that's how we manage it going forward.

Okay.

Thank you, Matt.

Thank you. And the next question comes from Jared Shaw with Wells Fargo.

Hi, good morning. This is actually Timur Braziler filling in for Jared. Just a couple of follow-ups for me. Maybe starting with, Gary, the 65% loan to value on the hotel and lodging portfolio. I guess, how was that derived? I'm assuming it's pretty challenging to do appraisals right now, given that cash flows are still impacted. So looking at that book, I guess, how comfortable are you with that 65% loan to value? And maybe expanding that to the current allowance level, as we start seeing some incremental losses flow through in the next few quarters, is the expectation that the reserves already established will offset those losses or do you think you're going to have to backfill the allowance to account for the new losses coming in over the next couple of quarters?

We built reserves based on the performance of each credit and their position in the portfolio during the quarter. We reviewed the entire portfolio and adjusted it according to its current standing. We only moved one account to non-accrual status this quarter, indicating it is in a problematic state, and we are addressing it now. I cannot predict whether any specific asset will default, but we feel optimistic about our review. Some credits are more challenged than others, but overall, the outlook for the portfolio is positive. Certain defaults are expected given the current environment. Regarding the loan-to-value ratio, it is based on the original underwriting, and we expect it to decrease over time. With a 65% ratio, we have a good cushion. When considering potential defaults and anticipated decreases in valuation, the losses from defaulted assets should be minimal, but there will be some losses from those assets that cannot be sustained.

Okay, that's good color. Thank you. And then just last one for me. Looking at the commercial real estate growth in the quarter, I guess what industries are you seeing strengthen there? And as you look ahead, is the expectation that balances climb higher or should we expect some sort of retrenchment given how impacted some of the CRE verticals remain?

Yes. And we've seen some strength in the commercial and industrial space. Multifamily has held up well and warehouse as well. So those are kind of the segments. We are not seeing a lot of new activity in the multifamily space by any means, but it's primarily that commercial and industrial warehouse where we have seen some activity. Yes, I would say, we're always evaluating also as you know opportunities. If there's things that come to light, it makes sense to us that are in the best interest of the shareholders and make good financial sense, we'll do it. So we're always looking at all the different elements of the balance sheet. And here this quarter, we had an opportunity to, like I said, with kind of planets lining up to pull some things together and make a smart financial decision that helps boost capital, maybe some buffer going forward and like I said, it creates the ability to buy back shares. So we'll continue to look and there may be other opportunities as we go down the road. So kind of a quarter-by-quarter thing. We have developed a long-term perspective and are currently in the second cycle of our three-year strategic planning process. We have mapped out our capital expenditures and technology investments. We discuss our future goals and create budgets, including our CapEx budget, which we integrate into our forecasts. This approach requires us to consistently support these investments, which we have managed to do. I believe we are well-positioned to continue executing our plan moving forward. We will keep enhancing our digital offerings, and soon we will allow customers to originate a wide range of loans on our website. The depository side is nearly complete, and we are now focusing on the loan side. The final piece involves integrating our fee-based services into that digital platform. Thank you, Matt. Operator, if you could take the next question?

Thank you. And as it was the last question, I would like to return the floor to management for any closing comments.

Thank you. I appreciate the call and all the questions. There were many excellent inquiries, and I hope we provided significant details in response. I also want to express my gratitude to the team, especially the employees who have shown remarkable dedication during this period. Gary, Tom, and the credit team have done an outstanding job navigating what was initially a very challenging environment. We are emerging from this situation, feeling more positive about our position, and we hope to gain better credit clarity as we enter the next quarter and next year, allowing us to refocus on revenue growth. Thank you all for your time, and I look forward to our next call. Take care.

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