Fnb Corp/Pa/ Q3 FY2022 Earnings Call

Good morning, everyone, and welcome to the F.N.B. Corporation’s Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today’s event is being recorded. At this time, I would now like to turn the floor over to Lisa Constantine, Manager of Investor Relations. Ma’am, you may begin.

Thank you. Good morning and welcome to our earnings call. This conference call of F.N.B. Corporation and the reported files with the Securities and Exchange Commission also 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 compatible GAAP financial measures are included in our presentation material and in our earnings release. Please refer to these non-GAAP and forward-looking statement disclosures contained in our related materials, 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 Wednesday, October 26 and the webcast link will be posted to the About Us Investor Relations section of our corporate website. I will now turn the call over to Vince Delie, Chairman, President, and CEO.

Thank you, and welcome to our third quarter earnings call. Joining me today are Vince Calabrese, our Chief Financial Officer and Gary Guerrieri, our Chief Credit Officer. FNB’s third quarter operating earnings per share totaled a record $0.39, increasing 26% on a linked quarter basis. The success of this quarter was highlighted by record revenue, high-quality loan and deposit growth, digital technology enhancements, and continued positive credit quality performance. We were also pleased to receive all regulatory approvals for our pending merger with UB Bancorp and anticipate the merger to close and convert in December of this year. We are looking forward to welcoming Union Bank employees and clients to FNB. We are confident that they will benefit from our deep product suite and robust digital tools. Revenue totaled $380 million, led by 17% growth in net interest income, driven by solid loan growth, favorable deposit mix, and the asset-sensitive position of our balance sheet. Our fee-based businesses contributed over $82 million, once again demonstrating the importance of our long-term strategy of building diversified sources of income. Record revenue coupled with well-managed expenses led to our historically low efficiency ratio of 49%, as well as double-digit positive operating leverage for the third quarter. As we planned for 2023, we remain keenly focused on risk management, expense control, diversification of revenue, and continuing to generate positive operating leverage. FNB again delivered double-digit annualized linked quarter loan growth with total loans ending at nearly $28.5 billion. Consumer loans grew by $547 million, driven by adjustable-rate and Physicians First mortgage funds. The Physicians First mortgage product continued its success and accounted for 39% of the linked quarter growth as we leverage our investments in the e-store with the digital Physicians First implementations. Commercial loans increased by $189 million during the quarter with annualized growth of 9% and 2% in C&I and CRE respectively. While growth was spread across the entire FNB footprint, the Cleveland and North Carolina markets contributed the largest increases. Deposits increased by $413 million during the quarter or 4.9% annualized. We ended the quarter with non-interest-bearing deposits accounting for 35% of total deposits and Union Bank will enhance our overall position by contributing a higher proportion of non-interest-bearing deposits. Another area of continued success this format was with our digital channels, where e-store visits increased over 120% year-over-year in September. Monthly visits averaged over 37,000. We continue to expand our digital offerings for both our retail and business customers as we launch e-store online deposit applications for multiple business deposit products beginning in November. Next year, we will introduce enhancements to our mobile application, including real-time alerting capabilities and an update to our card control service. Both features enhance our customers' ability to manage their account balances. Lastly, it is important to highlight the strong position of FNB’s balance sheet in a time when leading indicators point to potential economic softness. Our credit culture has been consistent, maintaining uniform underwriting standards through all parts of the economic cycle. That same credit culture served us well during the Great Recession when our loss rates meaningfully outperformed our peers. The credit team monitors the portfolio not only through typical historical analysis, but also uses prospective trends and analytics to identify any emerging risks. They also run various stress tests during their comprehensive reviews to evaluate our risk management systems and portfolio performance. Further mitigating risk and supporting our growth strategy is the geographic diversity of our footprint. Our presence in seven states in the District of Columbia provides FNB access to high-growth metropolitan areas and a variety of high-quality opportunities. Our numerous markets allow FNB to meet our growth objectives while still adhering to our conservative underwriting standards. This key risk management objective has been an important driver for our expansion strategy, as well as our unique business model. We continue to prudently manage our capital levels. As of last quarter, our CET1, TCE, and reserve coverage ratios all ranked at or above peer median. While it is too early to know this quarter's results for our peer set, we expect that we will continue to maintain capital and reserve coverage ratios at or above the median, once again demonstrating our solid position within the banking industry. FNB is well-positioned for a potential economic slowdown with conservative management of our diversified loan portfolio and the strength of our reserve coverage and capital ratios. I will now turn the call over to Gary to provide additional details of our asset quality.

Thank you, Vince, and good morning everyone. We had a solid third quarter with our credit portfolio favorably positioned following stable performance both on a quarter-to-date and year-to-date basis. Our key credit metrics ended September with delinquency remaining at very favorable levels, while we saw further reductions in non-performing and classified credits. Additionally, net charge-offs remained low and continue to track well following two consecutive quarters of very favorable results. I would like to cover the GAAP asset quality highlights for the quarter and then provide a brief update on the upcoming UB Bancorp acquisition scheduled to close in Q4. Finally, I'll offer some color around the macroeconomic environment and the steps we're taking to proactively manage risk in our credit book to better position us as we look to the quarters ahead. Let's now review our third quarter results. Total delinquency ended September at 59 basis points, remaining nearly flat compared to last quarter's historically low level, up only 1 basis point. The increase was driven by early-stage past dues tied to the runoff of the PPP credits still in process. Non-accrual levels improved by nearly $5 million on a linked quarter basis with NPLs and OREO down 3 bps, ending September at a solid 32 basis points, which reflects the tireless efforts of our workout teams to aggressively address and resolve problem assets. Net charge-offs for the quarter totaled $2.8 million or 4 basis points annualized, with year-to-date net charge-offs through nine months of $4.3 million or 2 bps annualized. Funded provision expense totaled $10.1 million, up $3 million linked quarter to support strong loan growth, as well as some model builds tied to updated macroeconomic factors and a continued decline in forecasted prepayments. Our reserve at the end of September totaled $385 million or 1.34%, down 1 basis point versus the prior quarter as credit quality results remain favorable. Our NPL coverage position further strengthened to 440%. Now turning to the UB Bancorp acquisition that is scheduled to close in the fourth quarter, we remain on track with our established conversion process, and we continue to closely track and monitor the loan portfolio and its credit performance through legal day one. We do not anticipate any material impact to our corporate credit metrics or loan risk profile, as the portfolio remains in line with our expectations from due diligence. As we welcome the team from UB, we look forward to deepening our relationships with the UB customer base and the product offerings available to meet their banking and lending needs. Let's now switch gears and discuss the evolving macroeconomic environment, specifically some of the measures we've taken to manage credit risk and position our book moving forward. As I've shared in the past, our credit philosophy is to take a holistic approach beginning with consistent and prudent underwriting across the footprint and throughout economic cycles. As we continue to execute on our loan growth strategies and our lending pipelines convert, we actively monitor our concentrations of credit and asset mix on a continuous basis to maintain a diverse and balanced loan book that fits within our desired loan risk profile. With the ongoing investments we've made in our credit systems and expansion of our risk analytics, we can make strategic data-driven decisions to better manage and mitigate risk in the book. Furthermore, our bankers remain in close contact with our customers to understand the challenges and headwinds they face, allowing us to identify signs of stress resulting from ongoing elevated inflation, rising interest rates, and the standing labor supply chain and energy-related challenges across various industries and markets. These factors are carefully analyzed and addressed as underwriting as macroeconomic and market-specific conditions continue to evolve, with our core credit philosophy remaining front and center. Closing, we are very pleased with the continued strength, consistency, and favorable positioning of our credit portfolio following a successful third quarter. As we look to finalize the UB Bancorp acquisition in the months ahead and close out the year strong, we remain vigilant of the evolving macroeconomic conditions and will continue to proactively and aggressively manage our credit portfolio each and every day. As we look ahead, we remain committed to our consistent approach to underwriting, which has proven itself well throughout prior economic cycles. I will now turn the call over to Vince Calabrese, our Chief Financial Officer for his remarks.

Thanks, Gary. Good morning, everyone. Today I will focus on the third quarter's financial results and offer guidance for the remainder of the year. The third quarter net income available to common shareholders totaled a record $135.5 million, or $0.38 per share. After adjusting for $2.1 million of merger-related expenses, net income reached $137.2 million, or $0.39 per share. The growth in the balance sheet, driven by loans and investment securities that were largely funded through deposit growth, brought assets to $43 billion at period end. Investment securities totaled $7.2 billion with a fairly even split between AFS and HTM. During the quarter, we largely reinvested our securities cash flows, which was around $100 million per month, while staying in the 3.5 to 4.5 duration area. Period-end total loans increased $736 million linked quarter, or 10.4% annualized, including an increase of $547 million in consumer loans and $189 million in commercial loans and leases. Commercial loans saw another quarter of healthy production with year-to-date activity 7.5% higher than the same period in 2021. With such strong production, the 90-day pipeline has softened a bit relative to last quarter. Consumer loan growth was driven by strong organic residential mortgage activity across our footprint with particularly strong growth in the Carolinas and Mid-Atlantic regions. The Physician's First mortgage program accounted for $141 million, or 39% of the increase in the mortgage balances on a linked quarter basis. Indirect auto lending increased 10.5% linked quarter, as we saw more seasonal activity in that space, as well as an increased supply of vehicles. Total deposits ended the quarter at $33.9 billion, an increase of $413 million linked quarter or 4.9% annualized. The deposit mix continues to be favorable with non-interest-bearing deposits comprising 35% of total deposits at quarter end. Long-term debt increased by $347 million following the August 2022 issuance of $350 million in three-year senior notes. We plan to use the net proceeds from the offering for general corporate purposes, which excludes the extinguishment of debt. On the income statement, net interest income totaled a record $297.1 million, an increase of $43.4 million, or 17.1%, reflecting growth in average earning assets and benefits from the higher interest rate environment as our net interest margin increased 43 basis points to 319. Managing deposit costs continues to be an ongoing focus. While the cost of interest-bearing deposits increased 29 basis points from last quarter, they remained fairly low at 57 basis points. In terms of deposit betas year-to-date, we have a cumulative beta of 12.5% on total deposits. As the Fed continues to increase rates, this creates competitive pressure on deposit pricing and we are currently anticipating our deposit costs will increase in the fourth quarter, bringing the total 2022 cumulative deposit beta to around 20%. Turning to non-interest income and expense, non-interest income totaled $82.5 million, a slight increase from last quarter. Capital markets income increased 12% linked quarter to a total of $9.6 million with solid contributions from syndications, international banking, and swap fees. Service charges increased $1.3 million linked quarter, largely due to growth in treasury management services, interchange fees, and higher customer activity. Mortgage banking operations income decreased $1 million as sold mortgage volumes declined to $111.2 million or 34.2% as consumer preferences shifted to adjustable-rate mortgages we are holding on balance sheet. On an operating basis, non-interest expense increased $2.2 million or 1.2%, compared to the prior quarter, excluding merger-related expenses of $2.1 million and $2.0 million in the third and second quarters of 2022, respectively. Salaries and employee benefits increased $2.8 million, reflecting reduced vacancy rates and higher production and performance-related incentives. Marketing decreased $1.4 million due to the timing of digital advertising and campaigns for our Physicians First program in the prior quarter. Overall efficiency ratio came down to a record 49.4%, a significant improvement compared to the second quarter ratio of 55.2% and the year-ago quarter's result of 55.4%. Tangible book value per common share was $8.02 at September 30, a decrease of $0.08 per share from June 30. This change reflected the impact of AOCI reducing the current quarter’s tangible book value per share by $1.8, compared to $0.72 at the end of the prior quarter, which was largely mitigated by the higher level of earnings for the quarter. The increased unrealized losses in the AFS portfolio due to rising interest rates will accrete back into capital over time as securities mature or prepay. Lastly, as Vince mentioned, we are expecting the UB Bancorp acquisition to close and convert in December of this year. Their balance sheet continues to trend within our expectations and we are excited to add their low-cost deposit base in a higher rate environment. Now let's turn to guidance, which excludes the announced UB Bancorp acquisition. We increased our full-year guidance for loans to mid-teens growth with underlying organic growth in the high-single to low-double digits on a year-over-year spot basis. Total deposits are projected to grow mid to high-single digits on a year-over-year spot basis. Full-year net interest income is expected to be between $1.10 and $1.11 billion with the fourth quarter between $315 million to $325 million. Our guidance currently assumes a 125 basis points of rate increases for the fourth quarter. We are increasing non-interest income to be between $317 million and $322 million with the fourth quarter in the mid to high-$70 million area. The revised full-year non-interest income guidance is due to higher-than-projected third quarter income. Full-year guidance for non-interest expense was only revised to provide a tighter range of $768 million to $773 million on an operating basis, while maintaining our previous guide of $190 million to $195 million for the fourth quarter. This does not include the one-time expenses associated with acquisitions and branch consolidations. Full-year provision guidance was also revised to a tighter range of $25 million to $35 million, which does not include the initial $19.1 million of provision related to Howard and is dependent on net loan growth and macroeconomic factors during the fourth quarter. Lastly, the effective tax rate should be between 20% and 21% for the fourth quarter, which does not assume any investment tax credit activity in the quarter. With that, I will turn the call back to Vince.

Thank you, Vince. We are pleased with this quarter's record revenue and earnings per share, as well as our loan and deposit growth and our current level of non-interest-bearing deposits. Our asset quality continues to perform favorably with a low delinquency rate of 59 basis points and only 4 basis points of net charge-offs. We continue to stay focused on changes to the economic environment and remain confident in our ability to manage through potentially challenging macroeconomic conditions. Our FNB employees have performed admirably throughout uncertain times, and I know that they will remain dedicated to fulfilling our commitment to all of our stakeholders. To them, I extend my sincere gratitude, as their collective efforts are what drives our performance, and I look forward to working alongside our dedicated team as we close out 2022.

Ladies and gentlemen, with that, we'll begin our question-and-answer session. Our first question today comes from Jared Shaw from Wells Fargo Securities. Please go ahead with your question.

Hey guys, good morning.

Hey, Jared.

Good morning, Jared.

I would like to start by discussing asset sensitivity and the outlook as we move into 2023. Do you have any thoughts on how to potentially reduce that asset sensitivity with the UB deal coming up, which you mentioned will increase DDA? How should we consider your strategies regarding portfolio decisions and possibly adjusting rates as we develop our models?

Yes, I would say a couple of things, Jared. I mean, over the course of 2022 with various strategies since our exposure to downside rates, we have reduced our cash position, added asset duration in the loan side to mortgage and securities books, plus we've executed about $1 billion or so in receipt fixed swaps to protect us on the downside in the midst of looking at potential other opportunities to put some more derivatives on potentially to protect us from downside interest rates next year as expected. It happened organically outside of that $0.5 billion, and I think the way we're positioned today, there's still a good amount of benefits to come from the expected movement in rates as we get into the fourth quarter and then into next year. We'll capture that, obviously, in the guidance for ‘23. But there's still upside to the margin and to net interest income as you look into the fourth quarter for sure, given the overall asset-sensitive position of the balance sheet. And I would just say again to that, over time, we've kind of foregone some short-term earnings to kind of position the balance sheet, so that we would get that benefit from rising rates when it ultimately did come. We've stayed short on our investment portfolio. We have consistently had a 50-50 split between AFS and HTM, which helps on the AOCI impacts that everybody is experiencing right now. So I think some of those tactics that we've taken in the past and strategies are benefiting us as we sit here today and as we look ahead from here.

Thank you, and regarding deposits, we had excellent beta performance this quarter. Can you provide an update on the deposit growth this quarter? Is there any seasonality that we should be aware of? What were the spot rates at the end of the quarter, and looking ahead, what do you anticipate the beta could be for the overall blended deposit base with UBS?

Yes. I would say a couple of things. I mean, we do have seasonality in our municipal business that we have every year and swings, I'd say $300 million to $500 million as you go, kind of from peak to trough and go through the year, and that still builds through October into November. So that's kind of normal seasonality there. But on top of that, we continue to have good success adding new accounts on the retail side, as well as on the commercial side with the markets we're in. We continue to win not just lending side, but also bringing in the operating accounts. So that's clearly a benefit to the overall deposits growth. Our DDA's have continued to build over time and has been a focus. There's a new slide that we added. We look back from 2009 forward from 16% up to 35%, and it's been continuously moving up, it's a big focus in the company for sure. As far as the betas, I mean, the liquidity and banking system is still there. We still have $1.8 billion in excess cash on our balance sheet. As like others, we're starting to see more pressure on deposit rates as the Fed continues to move. At this point, there's been very limited movement of our retail deposit rates, but definitely more frequent conversations with municipal business clients, where we've been making adjustments, particularly for those that have a full relationship with us. We have not lost any clients, which is important. I think the commercial customers and municipal customers are having conversations with us aren't just closing accounts and moving somewhere else. So I think it speaks to the relationships that people have built up over time. Currently, our cumulative beta for total deposits was at 12.5% at the end of September. Our forecast is to be around 20% for total deposits at the end of the year.

Okay, great. And then I guess just finally for me, on the expense side, as we look into ‘23 any more update on sort of the hiring pace of hiring in the D.C. Northern Virginia area. Is that going to be an area of continued growth and potentially enrichment with that how you did down there?

Yes. Our hiring in D.C. has been ongoing, and we don't anticipate a significant decline in that area. Several retail locations are becoming operational, which may lead to a slight increase in expenses, but it won't be substantial compared to our overall base. In terms of expenses, we've been engaged in a multi-year initiative to reduce costs. We've set specific targets and have consistently met them over the past three years, and we plan to maintain this focus. There are still opportunities to manage our expenses, allowing us to counterbalance some of the natural increases we may face due to inflation. As for occupancy, our vacancy rate has been reasonable and within historical ranges. The company culture fosters employee satisfaction, and we have taken steps to enhance salaries and care for our workforce. We didn't provide guidance for next year's expenses. I'll turn it back over to Vince, in case he has anything to add.

Yes. I would like to add to Vince's point that over the last four years, including this year, we have achieved $70 million in cost savings. This is always a focus each year as we determine our targets. It comes from continuously renegotiating with vendors, optimizing our space, and implementing various process improvement initiatives. We maintain a disciplined focus on this, which will continue. As you can see from our consistent guidance this year, we expect to manage expenses within the range of $190 million to $195 million. This focus allows us to create positive operating leverage, which was in the double digits this quarter and we anticipate will remain strong in the coming quarters.

Great. Thanks, Vince. Thanks for taking the questions.

Sure. Thank you.

Our next question comes from Daniel Tamayo from Raymond James. Please go ahead with your question.

Thanks, guys. Good morning. Maybe just following up on the margin discussion, I know you gave a lot of color on deposit betas and expectations there. But if I could just get your thoughts, I guess, on maybe where the margin may peak in relation to when we get the last rate hikes and kind of your thoughts around what happens once we get the peak margin, if we get a decline or stabilization or maybe another floating up? Thanks.

Yes. I would just say that, as I mentioned earlier, there is still potential for margin improvement with the continued actions from the Fed. Our team has done an excellent job managing deposit costs across the retail, commercial, and municipal sectors, which is a key focus for us given the excess cash on our balance sheet. We actively review our pricing weekly to determine the optimal rates. When we provide guidance for next year, we'll include a full-year outlook and quarterly projections, but I believe there is still potential for margin and net interest income to increase. Additionally, we've implemented measures to safeguard against the eventual decrease in rates, although the timing of such changes is uncertain. It’s worth noting that our guidance incorporates an additional 125 basis points in rate hikes for the fourth quarter, which is factored into our outlook.

Okay. Shifting gears here then over to credit quality. Obviously, that's been really strong for you so far, things looking very clean in the numbers. Your comments are very positive based on what's available now. But where are you kind of most concerned or looking at most closely in terms of the loan books given what we're expecting here going into the next cycle?

Yes. I think, Daniel, one of the focuses of our team today is on the economically sensitive areas. We feel that those are the small business portfolio, as well as the indirect portfolio on the consumer side. Those books of business have continued to perform really well. Delinquency flat quarter-over-quarter in both of them. Charge-offs did tick up a little bit with car prices coming down in the indirect book as expected, but those are the areas of focus at the moment. And like I said, we're pleased with how they've held up to this point and expect them to perform well even though there are headwinds in those areas.

We've also been emphasizing interest rate sensitivity within the commercial real estate portfolio.

Yes. And across the C&I book as well. I mean, we're pretty aggressive with our interest rate stresses, I mean, we're underwriting CRE transactions today at north of 7.5%. And then we're stressing it from there. So we've got some pretty heavy stresses built into the front side of the underwriting equation and the oversight management of the book and the stresses that we place on those portfolio.

And we've said this before on other calls, I mean, Gary stated it in the prepared comments, we manage credit risk consistently through cycles. We don't go crazy during the good times in loosening structure, and we don't tighten in a crazy way during the bad times. Conservative underwriting upfront, better LTVs. If you look at the consumer book, the credit scores and the LTVs are very solid, I'd say, in most cases.

Yes. I mean, the average or average there is in the high 700s.

Essentially, this approach safeguards against potential losses as the market fluctuates. While others may be returning capital and reducing their assets, we find opportunities to strategically expand our balance sheet. This was evident in the previous cycle, where we experienced several quarters of loan growth even as the industry contracted, and our credit performance was quite strong. I have great confidence in our team. We are aware of the uncertainties ahead and actively monitor our portfolios. We employ various analytical methods and stress tests and are diligent in accurately and rapidly assessing our credit quality. What you're observing from us reflects our efforts to provide the most current information possible. Overall, I believe the situation is stable at the moment, and Gary's team is proceeding with caution as we look ahead.

Terrific. I appreciate all that color. And then, kind of, just a related follow-up on reserves. How much would you say the qualitative side is impacting the level of where you are right now in reserves? Just kind of thinking how changes in macro forecasts could impact reserves going forward? Thanks.

Yes. The qualitative piece of the reserve today annual is right at about 25%. We would expect that to move down slightly as we go forward and some of the other quantitative models take effect. During the quarter, as I mentioned in the remarks, the loan growth naturally took some provision expenses, a pretty good chunk of it. We did see slower prepayment speeds, which are naturally extending the lives of some of those portfolios and naturally, the impact provision there from a CECL standpoint. Our economic forecasts have seen some softening. These are quantitative models in our model around CRE and housing variables, so that did take a little bit of provision expense as well. That all said, those builds were on that side of the equation were primarily offset by improvements in credit quality, which ultimately drew the reserve down 1 basis point at 1.34 as mentioned. So all told, credit quality continues to be a driver there. And loan growth is going to drive the provision going forward.

Our reserve position relative to our peer group is still very positive, very favorable. And I attribute that to, you know, gradation, you know, staying on top of the credits, making sure we're understanding where we are from a risk perspective and a gradation standpoint. I don't know, Gary, do you want to talk about ...

No, I would agree with that. I mean, we viewed the pandemic as not something that was finite and totally ending. So we were a little cautious around that. And I go back to 1.5 years back when we were really starting to get worried about the inflationary signs that we were seeing. We've managed it, I think, appropriately and accordingly, and we're pleased with the strength of it today.

That’s great color. Thanks for all that. That’s all from me. Appreciate it.

Thank you.

Our next question comes from Casey Haire from Jefferies. Please go ahead with your question.

Yes, thank you. Good morning, everyone. I have a question for Vince C. The mix of non-interest-bearing deposits has been quite strong. I'm curious whether the 35% level can be maintained moving forward or if you're anticipating some decline as you approach your 20% cumulative beta by the end of the year.

Casey, this is Vince Delie. We have historically focused on growing that position. If you review the chart in the presentation, you will notice that the deposit mix has improved significantly. This has been a multi-year effort, and such changes are now part of our fundamental approach. We have incentivized our team to concentrate more on gathering low-cost deposits, and they have actively worked to establish treasury management relationships. We are optimistic that the 35% will remain stable. However, I realize that in a rising rate environment, there is pressure on non-interest-bearing deposits, which is reflected in the deposit beta guidance we provided. Additionally, our small acquisition will contribute positively, as their deposit mix has a higher percentage of demand deposits, averaging 42%. This will enhance our position as we enter a period of higher rates.

Okay, understood. And then on the cash position, I think you mentioned excess cash of $1.8 billion. What is sort of like the bare minimum that you want to run at just a reminder there, so we get a sense as to when that does run low, a little bit more like the use of wholesale borrowings becomes more prevalent?

Casey, that's really what we would consider excess cash to $1.8 billion. We have a certain core level of cash on the balance sheet that you would typically see. But that $1.8 billion that I referenced is truly the excess cash. So that can go down to zero.

Okay. Alright. So a decent cushion from here. And then just lastly on the loan pipeline, obviously, a strong result here. It sounds like the pipeline is a little bit softer. Just wondering if there's any a little more color on any verticals? Or is it just a little bit lighter after a strong production quarter? And then also, the indirect auto has had very nice growth over the last two quarters. Is that seasonal in nature? Or is that going to slow down? Or is that momentum going to continue?

Well, I'll answer the question. The first question about the overall pipeline, I'll let Gary talk about indirect auto. The pipelines in general, they were fairly robust leading into the last two quarters, actually. And we've been able to produce some pretty significant loan growth as we close out those transactions the pipeline has contracted, which is pretty natural. We're at a point in the cycle where you typically don't see a surge in commercial borrowing requests seasonal period basically. From a cyclical perspective, I wouldn't expect to see a surge in demand, particularly in the C&I book as we move towards the end of the year. I think those pipelines will refill. I mean, they're not terribly low. They're at a decent level, they've just been reduced because of all the stuff we closed in the 90-day bucket. So my hope is that we're able to go out, given the size of our footprint, the fact that we have a fairly significant share across seven states and the District of Columbia, I would expect us to be able to go out and continue to generate high-quality earning assets. That goes for both consumer and commercial. Our regional presidents, while they face a very significant amount of competition quarter-after-quarter, we are very optimistic about their ability to execute in the markets that they're in. Gary, I don't know if you want to comment on indirect auto?

Yes, sure, Vince. The second and the third quarters are seasonally high periods for us. So we do normally see that type of spike in volume during the middle part of the year. We've really been focused over the last month and a half on enhancing our margins in that business. I would expect, as we move through Q4 here that we'll see lower volumes there. Again, we're focused as always on high-quality paper. So I would expect that to seasonally dip for those couple of reasons, as well as our focus on enhancing those margins.

Okay. Understood. And just one last housekeeping question. The tax rate guide has increased slightly from 20% to 21%. Should we assume this rate will carry into 2023?

What I was going to say is it will always depend on the level of investment tax credit activity that we execute, and we will continue to be active in those types of transactions. However, I don't expect any activity in the fourth quarter. That's why we anticipate a normalized rate of 20% to 21%, excluding those types of transactions.

So 20% to 21% with a benefit provided that there's some taxes in transactions.

Yes. We anticipate that something we had planned for the fourth quarter will occur next year. This will result in some advantages for that rate.

Understood. Thank you.

Alright. Thanks for the clarification.

Thank you.

Our next question comes from Michael Perito from KBW. Please go ahead with your question.

Hey, good morning everyone. Thanks for taking my questions.

Good morning, Mike.

Hi, Mike.

I wanted to ask if you could provide a quick refresher on the Physicians First mortgage program, including its structure and use cases, as it has clearly experienced significant growth recently. Could you give us an overview of how that product works?

We started with a mortgage product that had a more favorable loan-to-value ratio, aimed at physicians and medical professionals who are often burdened with student loan debt as they begin their careers. To support these physicians in purchasing homes, we made adjustments to the underwriting process. We transitioned from a traditional physical origination method to a digital origination method, combining several products into what we call our Physicians First bundle. This includes a medical practice loan, which is a small business loan, a student loan refinance option, and the first mortgage product. This bundle is available on our digital e-store, which serves as our e-commerce website that I mentioned in my earlier comments. We leverage this platform with our originators to target physicians, and the performance of this portfolio has been outstanding, showing notable growth over time.

Yes. I mean, delinquencies in that portfolio were very near zero high FICO scores, very solid debt-to-income ratios. I mean, it's a high-quality book of business, and we continue to see good opportunities there. The bundling of the programs and the opportunities in that small business practice lending business, I think, are ahead of us, as well as some of the student loan refinance opportunities there. So we expect that to continue to bear fruit as we move forward with that program.

Got it. That's helpful, thank you. Yes, it is very thorough.

900 visits a month. Now look at our website. Just to keep that in perspective. I mean, that's 900 positions we would normally see most likely. So helps build awareness and supports our brand.

And then just lastly and unrelated, just on the capital markets fees, which were pretty solid in the quarter. Is it reasonable to think that in the current environment, there's room for that to, kind of, continue to be elevated with rates moving and some of the economic uncertainty and everything you're seeing? Just love a little extra color there, if you don't mind.

It's a great question. I mean, I think we're a little bit of an anomaly, right? Because we have a pretty broad offering for our size. So we have a debt capital markets group that participates in bond economics, they support our large corporate calling activity, our large corporate bankers. We have a syndication effort that's outsized, I think, for a bank our size. In fact, our syndications revenue is double and it's more than doubled over the last year. So it's a sizable contributor. We do hedging, we throw international into the mix because we do some hedging for international clients, and that's grown nicely. The derivatives business is a core business for the company, that's more volatile because of the changes in interest rates and demand from a loan perspective. But we have a very strong team and have had great success structuring products for clients to protect them in both up and down interest rate cycles. So sure, I mean, I'm bullish on our capital markets platform in general over the long-term. I believe there's significant upside over the long-term. In the short run, you're going to see variability. It's lumpy because of the changes in rates. But ...

I believe the capital markets are still in the early stages. There is potential for growth in syndication, even though we had an exceptional year. Opportunities persist in the debt capital markets, particularly due to the activities of our larger borrowers concerning debt issuance and bonds, excluding bank debt. As we have expanded as a company, our appetite for holding positions has increased. To compete effectively against larger rivals and regional players, we have enhanced our syndication capabilities. We have a robust corporate bank with excellent bankers throughout the organization. With 35 years of experience in the industry, I have faced competition from every significant player over the decades. Our team is strong, and their expertise will drive growth in capital markets. The stronger our bankers are, the more opportunities we can capitalize on in this arena. For this reason, I maintain a positive outlook for this sector, despite potential economic challenges.

Got it. Makes sense, it’s good to see the momentum this year. Thank you guys for taking my question.

Yes. Thank you. Appreciate it.

Our next question comes from Brandon King from Truist Securities. Please go ahead with your question.

Thank you. Good morning.

Good morning.

Yes. So I just had one question really on loan yields. I was just curious what the loan yield was for new loans in the month of October? And also wanted to know if you can give us color on what you're seeing from a loan spread dynamic? Are you seeing more competitive pressures? Or are you actually seeing an expansion in loan spreads given, kind of, what you've been able to price out there in the market?

I can comment on the mids and then maybe ask Gary to comment on spreads on current loans. The new loans made during the third quarter amount at a yield of 4.38%, which is up significantly from 3.53% in the second quarter. If you look at kind of the overall spot portfolio rate, it increased 87 basis points to 4.53% after increasing 46 basis points in the second quarter to 3.66%. So the new rates where they're coming on, as you would expect, are significantly higher, which bodes well for my comments earlier about kind of the margin as you get into the fourth quarter and continue building net interest income.

Yes. In terms of the spreads, we are seeing them strengthen. So we're seeing some benefit pretty much across the board. High-quality paper is naturally bringing very, very low rates in terms of the strength of investment-grade credits, but that has also moved up. So I would tell you that everything is up 20 to 25 basis points upwards of 50 basis points from a spread standpoint, depending upon the asset class.

Yes, we do not prioritize high yields. Our main focus is on credit quality. While some transactions may offer lower pricing, our ability to perform well through different market cycles is closely linked to the creditworthiness of our borrowers. We aim to take advantage of higher yields in various asset classes, and recently, many of the commercial and industrial credits we've added are larger and more creditworthy, which means the credit spreads on those deals are narrower. I wanted to highlight this in our commercial and industrial and consumer portfolios. We tend to pursue higher quality borrowers, which affects our overall credit spreads and our view on those spreads. In other words, we are not engaging in high-risk private equity transactions that involve significant leverage; that is not part of our portfolio.

Brandon, just a further comment to your question. So the 4.38 that I mentioned, that's the rate for new loans for the entire third quarter. If we look at the month of September, loans came on at 4.94 relative to the 4.38 average for the quarter. So kind of responsive to your question about kind of more current rates. That's where we ended the quarter for the month of September.

Got it. Got it. Thanks for taking my question.

Alright. Thank you.

Our next question comes from Manuel Navis from D.A. Davidson & Company. Please go ahead with your question.

Good morning. I believe most of my questions have been addressed, but could you explain any regional differences you're noticing in loan and deposit pricing? You mentioned strong loan growth in Cleveland. Can you elaborate on the competition regarding pricing for both loans and deposits?

Yes. We're in some pretty intense markets. Our core markets are actually extraordinarily competitive. People think it's the opposite. But Cleveland, Pittsburgh, and even Baltimore are very competitive markets. Cleveland has always been a tougher market to price. As you move into the Southeast, while there are more competitors, there tends to be more activity. So it kind of buffers the competitive environment slightly. But if you look overall, the variations are not that great, but there are variations. I just pointed them out, but I think that goes for both loans and deposits. As you look at the State of Pennsylvania where we compete, as you move across the state into Philadelphia, credit spreads tend to narrow as you get closer to Philadelphia because it is more competitive, even more competitive in that area. We're really focused as a company on gathering demand deposits. This is a very strong deposit franchise. It's evident in the results. You can see it in the trend that we've presented. Our objective here is to be the principal operating bank for our clients. We're not out buying deposits to fund our operations. So what that means is the commercial bankers are out, they're selling treasury management services. We're getting the principal disbursement accounts. So we have balances that are typically used to pay for services or are sitting for liquidity purposes for the company and demand deposit accounts. On the consumer side, we strive to be the principal bank for the consumer. So I mean that's how you're able to maintain pricing and produce better betas and all the things that follow.

No, I appreciate that. Thank you.

Thank you very much.

And our next question comes from Brian Martin from Janney Montgomery. Please go ahead with your question.

Good morning, everyone. I appreciate the opportunity to ask a question. I would like to follow up on the loan yields. Vince, you mentioned a 4.94 yield for September. Could you provide some insight into the commercial yields, either for the quarter or the month, and discuss where new production is coming from?

I don't have that handy, that level of granularity.

I can tell you, I don't think we have that at our fingertips. But when you look at the deals that are coming in, typically, a middle market commercial deal is anywhere from $1.75 to $2.50 in credit spread.

Got you.

And that's been fairly consistent. If you want to convert that to a fixed-rate yield, you'd have to look at the yield curve. We focus on credit spreads in that space and kind of manage the groups that way versus looking at outright yield. They may look at fixed-rate loan, they may do a variable or adjustable-rate loan. So we're kind of keying in on that credit spread. But I would say credit spreads have broadened slightly across the board. I don't know what ...

No, they have. I mean they’re up, like I said, 25 basis points to 50 basis points in some asset classes.

And then that new origination, the reason it’s difficult to put your finger on what the yields would be in the commercial book is because we run the broad spectrum of the market from small business up to large corporate. So if we book a large corporate deal at LIBOR plus about 50 or about 25, that's your spread, right? So it’s going to reduce the yield in that quarter, but we look at it more broadly from a portfolio perspective and trying to manage it that way. I hope that we’re expecting credit spreads to continue to broaden as we move through a difficult period in the cycle.

Got you. No, that's helpful. And then maybe just the reinvestment rates for securities today, where are they at? I guess, whether for the quarter or for September, just kind of how you're thinking about next quarter?

Yes. I would say just to make a few comments on that. The reinvestment rates averaged 3.83 for the quarter. For the third quarter, it was up from 3.27 last quarter, 1.90 in the first quarter. As we know, the freights haven't moved up. So the 3.83 compares to a roll-off rate of 2.04. That kind of gives you a reference point there. The duration of what we invested during the quarter was still in that kind of 4, 4.2 level. If we look at where we're investing today, we continue to take advantage of the market yields. We've been investing at about 4.80 as we sit here so far in October, with the duration just a little bit South of 4.

Got you. Okay, that's helpful. So perfect. How about this one for Gary? Regarding the concentration levels in commercial real estate, are there any areas you are avoiding for lending right now due to increased regulatory focus on commercial real estate? Or any thoughts on what you are staying away from and the current concentration levels?

Yes. We've been very cautious for the past year and a half, and even longer in the retail sector. Our volume in retail commercial real estate has been minimal. Occasionally, we find strong transactions featuring long-term leases with creditworthy tenants, and we will continue to select those opportunities. In the office space, we remain particularly careful. We recognized early in the pandemic that this sector carries extended risks. Much like retail, we will pursue transactions that involve long-term leases with highly reputable tenants, but overall, our volume remains very low.

We have very little hospitality. The portfolio is time.

Yes, the hospitality we don't. We haven't made a hospitality loan in five, six years.

I believe that in all my time in banking, this portfolio is well-positioned as we move through the current cycle, and I credit that to Gary and his team. While the goal is to grow the portfolio and revenue, being in a stable position during uncertain times like this is advantageous. We have addressed the risks in the portfolio and maintain a conservative approach. What Gary didn’t mention is that we don’t have many large urban office buildings; instead, we primarily own smaller suburban office buildings that have not faced the same level of vacancy. Therefore, I feel we are well-prepared. The industry may encounter a slowdown next year if it happens, but if we perform as we have in past cycles, we will be in excellent shape. We have the same team, which allows us to manage through this situation more effectively and outperform others. I'm available for any further questions you might have.

No, I think that answers mostly on the real estate. Just to address your general questions about loan growth, while we are not providing a specific outlook for 2023, are you noticing increased caution? It appears that there is more caution among commercial customers, given the current economic cycle. Should we interpret this to mean that as we progress further into this quarter and provide updates next quarter, this cautious trend is what we are observing among our commercial customers?

Yes. I believe clients are being more conservative as we navigate through a significant turbulent period. The pandemic has had a profound impact on many people and businesses, making them approach the current cycle with caution. Economic challenges like inflation and supply chain disruptions are very real, and our commercial customer base seems to have realistic expectations for revenue as we head into next year. This mindset will affect fixed charge coverage and loan performance. I am optimistic that our strong and prudent customer base will manage their businesses effectively to overcome these tough times. On the consumer side, consumers seem to be in decent shape overall. While there are economic stressors, our portfolio performance shows low delinquency and charge-off rates, which are lagging indicators. Their cash positions appear healthy, although I anticipate some depletion over time due to inflation. We are well-positioned entering this next cycle, and we are maintaining a cautious stance. We manage our pipelines diligently with upfront credit reviews, making our pipeline health contingent on the broader economic landscape and the impacts on other capital providers. It’s challenging to predict pipeline trends, but I feel positive about our current position. Although pipelines have softened, much of this is due to the transition in deal flow, and I believe we will still see reasonable levels heading into next year. We'll have to wait and see what unfolds.

And just an additional note Brian, just this within the last week, I've been pulled into three new transactions and all of them extremely strong. So the pipelines can build rather quickly based on some of the transactions that we're able to look at these days. And I was very pleased with those three discussions, and they're all moving forward.

Got you. No, that's helpful. My last question is about capital. Are there any changes in the outlook regarding capital levels at the end of the fourth quarter after the union deal? How are you approaching the buyback and managing capital levels currently?

Yes. No change in our strategy there. We continue to target CET1 ratio around 10%. The 9.8% estimated for this quarter is up from 9.7%, as you saw on the slide, the strong earnings more than supported the asset growth for the quarter, and the dividend payout ratio is at a very attractive level. We would expect to build CET1 ratio to 10% in the near term and then gradually build that ratio in '23, just given the higher earnings generation levels as we benefit from the asset-sensitive positioning. Regarding the buybacks, it's still the same philosophy, Brian. I mean, our first and best use of capital is organic loan growth. The level of buybacks would be dependent on that. We did not buy back any shares this quarter, but we will be opportunistic as we go forward given we still think there's significant value in our relative PE to the peers, and we've outperformed the peer significantly in recent periods, and we think there's still room for that PE to expand relative to the peers. So we will be opportunistic. But the overall philosophy is still the same.

Got it. I’m not sure if this was asked earlier, but regarding the positive operating leverage, is the efficiency ratio being below 50% a sustainable level considering the outlook with margins continuing to trend higher in the coming quarters?

I would say that for the fourth quarter, we will provide guidance in January for the upcoming year. As I mentioned, there is still potential for an increase in net interest income included in our guidance, and we will continue to manage our expenses carefully as we always do. There is still potential for improvement in that ratio in the next quarter, and we will address that when we provide our guidance for next year.

Great. Got you. Okay, thank you for taking the questions guys.

Alright.

Thanks, Brian.

Ladies and gentlemen, with that we've reached the end of today's question-and-answer session. At this time, I would like to turn the floor back over to Vince Delie for any closing remarks.

Yes, first of all, I'd like to thank our team. This was an exceptional quarter, but it's been a series of exceptional quarters. That doesn't happen without a lot of hard work, focus, and I really appreciate what our team has done, all of our employees have really stepped up. Very proud to work here; it shows in the results. So thank you, and thank you, Gary and your team for keeping us moving along here and deploying capital through a cycle. I think that's going to be very positive. I think we've shown that there's a tremendous amount of positive momentum. The business model is working. We're looking forward to continuing to drive results for our shareholders. So thank you, and I look forward to our next call. Take care, everybody.

Ladies and gentlemen, with that, we'll be concluding today's conference call. We do thank you for joining. You may now disconnect your lines.