Fnb Corp/Pa/ Q4 FY2022 Earnings Call

Good morning, everyone, and welcome to the FNB Fourth 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 Heidi, Manager of Investor Relations. Please go ahead.

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 contains 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 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 Tuesday, January 31 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 fourth quarter earnings call. Joining me today are Vince Calabrese, our Chief Financial Officer; and Gary Guerrieri, our Chief Credit Officer. FNB closed strong in 2022, continuing our streak of outstanding performance and is positioned to capitalize on our momentum as we navigate a complex economic landscape in 2023. FNB's fourth quarter operating earnings per share totaled a record $0.44, an increase of 13% on a linked quarter basis and bringing the full year operating earnings per share to $1.40. The success of this quarter was further highlighted by record revenue, continued strong loan growth, disciplined deposit cost management, and the closing and conversion of the UB Bancorp acquisition in December. The fourth quarter's exceptional performance is captured in its strong profitability metrics with operating return on average tangible common equity totaling 22% and the quarterly efficiency ratio below 46%. In the fourth quarter, total revenue grew 10% linked quarter to $416 million with net interest income as the primary driver contributing to 13% growth. In addition to benefiting from the Fed rate hikes, our net interest income reflects strong loan growth, favorable funding costs, and the strategic steps our team has taken with the asset-sensitive position of our balance sheet. Net interest margin significantly expanded quarter-over-quarter from 3.19% to 3.53%. Operating expenses were well managed, increasing 1.5% linked quarter. The revenue growth and disciplined expense management resulted in strong positive operating leverage and an 18% linked quarter increase in pre-provision net revenue. FNB ended the year with nearly $44 billion in total assets and $30 billion in loans and leases, a 5% increase linked quarter. On an annualized basis, excluding UB Bancorp, period-end commercial and consumer loans grew 14% and 6% respectively, continuing a trend we have upheld throughout the entire year. We saw strong loan growth in markets spanning our whole footprint, once again demonstrating the importance of our diverse geographic coverage and presence in both mature and high-growth markets. The acquisition of UB Bancorp closed on December 9, 2022, with the systems conversion successfully completed and integrated. With the addition of UB Bancorp’s rich deposit needs, which includes 43% non-interest bearing deposits, we ended the year with the total non-interest bearing deposit mix at 34%. This result was in line with the end of 2021, despite Fed funds increasing 425 basis points, demonstrating the strength of our deposit franchise. We are pleased with the financial benefits and dedicated employees in UB Bancorp acquisition have brought to us and expect to generate additional revenue as these customers are introduced to FNB's more robust product set. FNB's impressive fourth quarter and full year results demonstrate our significant success driving value for our clients, communities, employees, and shareholders. I'd like to call out a few of our many accomplishments. FNB achieved operating earnings per share of $1.40, one of the highest levels in company history, led by record revenue of $1.4 billion. Total loans grew by $5.3 billion year-over-year, 21% through a strategic combination of footprint-wide organic growth and the completion of two accretive acquisitions, bringing total assets to $44 billion. Despite the challenging economic environment, we grew total deposits to an all-time record of $35 billion and reported average balance growth in all four quarters of 2022, while also maintaining a favorable deposit mix comprised of 34% non-interest bearing deposits. We currently hold the top five deposit market share in nearly 50% of our MSAs according to data provided by the FDIC. We generated over $1.1 billion of net interest income, up 24% year-over-year, driven by solid loan growth, the favorable deposit mix, and the asset-sensitive portion of our balance sheet. Our team controlled expenses in a high inflationary period, which contributed to FNB's full year efficiency ratio of 52%. FNB reported total shareholders' equity of $5.7 billion and a CET1 ratio of 9.8%. Our growing capital base provided our company with unprecedented flexibility, even after returning $220 million to shareholders with common dividends and our active share repurchase program, which has $175 million remaining. Our strong earnings also resulted in a 40% dividend payout ratio and 34% on an operating basis, providing our company more internal capital to support future growth and capital actions. Credit quality remains solid with consistent prudent underwriting standards throughout the footprint, with total delinquencies ending the year at 71 basis points, net charge-offs at 6 basis points for the full year, and a reserve position of 1.33%. We will maintain our steadfast focus on our disciplined credit culture as we continue to navigate changing economic cycles. We closed and converted two acquisitions: Howard Bancorp at January and UB Bancorp in December, which have enhanced our market position in Maryland, Washington, D.C., and North Carolina. Driven by our continued investment in FNB's digital delivery channel and our dedicated mortgage employees, the Physicians First Program comprised 25% of retail mortgage production in 2022 and grew those high-value households significantly. We continue to expand our eStore platform, which received over 500,000 interactions in 2022, up 104% year-over-year, and introduced online applications for multiple consumer loan and small business deposit products. The success of our digital strategy drove increased adoption across our expanding customer base, including a 17% increase in online applications. Our consistent performance does not happen without the right culture and the commitment of exceptional people. We focus on fostering a positive, productive workplace where engaged employees provide superior service for our clients and attractive returns for our shareholders. Our success in this regard has led to extensive third-party recognition. Since 2011, FNB has received more than 80 prestigious Greenwich Excellence and Best Brand Awards, with 17 in 2022 alone. These results are based on direct feedback from our commercial, middle market, and small business banking partners. Additionally, FNB received approximately 50 awards as an employer of choice, including multiple national and regional honors in 2022, earning a place as one of Newsweek America's Top Workplaces for Diversity in 2023, and most recently named to JUST Capital's list of America's most JUST Companies for the sixth consecutive year with exceptionally high marks for community development, employee benefits, and work-life balance. Our board and leadership team are proud of this year's achievements, and we are confident in our company's continued ability to execute on our strategic plan in 2023. Even in times of economic uncertainty, we are well-positioned given our diversified loan portfolio, investments in technology, strong liquidity position, capital flexibility, and strong historical credit performance. I will now turn the call over to Gary to provide additional detail on our asset quality.

Thank you, Vince, and good morning, everyone. We ended the year with our credit portfolio well positioned, and our asset quality metrics remaining near historical levels. Our performance for the period reflects total delinquency and ended the year at 71 basis points. NPLs and OREO at 39 basis points, rated asset levels remaining essentially flat quarter-over-quarter, excluding UB Bancorp, and full-year net charge-offs at 6 basis points. I will cover these GAAP asset quality highlights for the quarter and full year in more detail, followed by some insight into our credit strategy we use to manage the loan portfolio throughout economic cycles. And finally, we'll provide a brief update on the UB Bancorp acquisition that closed during December. Let's now walk through our credit results. Total delinquency ended December at 71 basis points, reflecting a 12 basis point linked quarter increase coming off historically low past due levels in the trailing quarters. NPLs and OREO at 39 basis points were up 7 bps in the quarter, with nearly 60% of our NPLs in a contractually current payment status. Net charge-offs from Q4 totaled $11.9 million, or 16 basis points on an annualized basis, with full-year net charge-offs for 2022 totaling $16.2 million to stand at a very solid 6 basis points for the year, consistent with 2021 levels also at 6 basis points. Total provision expense for the quarter stood at $28.5 million, which includes $9.4 million of initial provision for non-PCD loans that were acquired from UB Bancorp, with the remainder providing for loan growth, charge-offs, and updated economic forecasts that reflected a softer macroeconomic environment requiring additional reserve. Inclusive of the additional Day 1 PCD gross-up of $1.8 million, our ending funded reserves stand at $402 million, or a solid 1.33% of loans at year-end, reflecting our strong position relative to our peers, with the funded reserve ticking down 1 basis point compared to the prior quarter. Our NPL coverage position remains strong at 354%. I'd now like to briefly update you on our recently closed UB Bancorp acquisition and the successful conversion of this $650 million portfolio during the fourth quarter. Our credit and lending teams continued to diligently review their loan portfolio as part of our standard post-conversion process following an acquisition. The book remains in line with our expectations from due diligence, with no material impact to our overall credit, loan risk profile, or portfolio concentrations at the close of the year. We'd like to congratulate the team on closing another successful transaction and will bring additional opportunities to expand our customer base and support our corporate growth objectives in the desirable Carolina markets. We welcome our new UB Bancorp customers and we look forward to the opportunity to provide our expansive set of banking products and services as we deepen these relationships. In closing, we had another successful year marked by the continued strength and favorable positioning of our credit portfolio moving into 2023, as well as closing two acquisitions to enhance our presence in attractive markets that will further support our loan growth objectives. Consistent with our proactive and aggressive approach to managing risk, rating credits, and positioning potential problem assets, we continue to closely track emerging macroeconomic trends and signs of stress heading into a softer environment. We remain steadfast in our approach to consistent underwriting and managing credit risk to maintain a balanced, well-positioned portfolio throughout economic cycles. I will now turn the call over to Vince Calabrese, our Chief Financial Officer for his remarks.

Thanks, Gary. Good morning, everyone. Now we'll focus on the fourth quarter financial results and offer guidance for 2023. The fourth quarter net income available to common shareholders totaled $137.5 million, or $0.38 per share. After adjusting for $21.9 million of merger-related expenses and $2.8 million of branch consolidation costs, net income reached record levels of $157 million, or $0.44 per share. Full-year 2022 operating earnings per share also represented one of the company's highest levels, coming in at $1.40. The growth in the balance sheet brought assets to $44 billion, with earning assets nearly $39 billion at the end of the year. This was largely driven by the $1.5 billion linked-quarter increase in spot loans and leases, which included organic growth of $824 million, or 11.4% annualized, and the $651 million of UB Bancorp acquired loans as of the December 9 acquisition date. C&I and commercial real estate each grew 6.3% linked quarter. Consumer loans increased 3.4%, reflecting portfolio growth and adjustable-rate mortgages and the continued success of the Physicians First Mortgage Program. Full-year total loan growth was a robust $5.3 billion, or 21.2% on a year-over-year spot basis; roughly half of this growth was related to the previously discussed Howard and UB Bancorp acquisitions, with the remaining half due to strong organic growth, capping off three sequential quarters of double-digit organic growth across the footprint. Average deposits totaled $33.9 billion for the fourth quarter, increasing $301 million, or 1%, including UB Bancorp acquired deposits over the last three weeks of the year. When excluding UB Bancorp deposits, average non-interest bearing deposits declined only 1% linked quarter to $11.7 billion, and we maintained a favorable deposit mix at year-end with 34% non-interest bearing deposits, demonstrating the strength and granularity of FNB's deposit base. Record quarterly revenue of $415.5 million was driven by record net interest income totaling $334.9 million, a linked-quarter increase of $37.8 million, or 12.7%. The net interest margin increased 34 basis points to 3.53%, as the earning asset yield increased 62 basis points, while the cost of funds increased 30. The largest driver was an increase in yields on loans and leases, which increased 68 basis points. In fact, the December loan origination yield was over 6%, the highest since 2009 and approximately 100 basis points higher than the spot portfolio rate at quarter end. With 59% of the loan portfolio repricing, we expect the portfolio rates to continue to increase given the December Federal Reserve rate hike and expected 25 basis point increases in February and March. The fourth quarter also had record positive operating leverage of 29.1%, which we expect to rank in the upper quartile of our peers. On the other side of the balance sheet, deposit costs continue to be a significant focus for our team. Total cumulative deposit betas ended the year at 16.3% below the forecasted 20%; by maintaining the previously mentioned favorable non-interest bearing deposit mix and actively managing interest-bearing deposit costs, we were able to keep the average interest-bearing deposit costs below 1% for the fourth quarter, again demonstrating the strength of our customer relationships. We have been able to effectively manage deposit costs, strategic pricing campaigns supported by our data analytics platform. While competitive pressures on deposit pricing continue to rise, we are forecasting a cumulative total deposit beta to be in the low 20s at the end of the first quarter of 2023. Turning to non-interest income and expense, non-interest income totaled $80.6 million, a decrease of $1.9 million, or 2.2% compared to the prior quarter. Mortgage banking operations income decreased $2.4 million with a decline in mortgages sold in the secondary market and lower gain on sale margins. Insurance commissions and fees decreased $1.3 million, reflecting seasonality in the fourth quarter. Capital markets income totaled $10 million with this strong level supported by an increase in syndications and solid contributions from swap fees and international banking. On a full-year basis, non-interest income totaled $323.6 million, a 2.1% decrease from 2021, primarily reflecting a significantly lower mortgage banking operations income, which was partially offset by several other fee-based businesses, again demonstrating the importance of our diversified business strategy. On an operating basis, non-interest expense totaled $195.8 million, a 1.5% increase from the third quarter and an increase of 8.3% from the year-ago quarter, which is primarily driven by the acquired Howard and UB Bancorp expense basis in occupancy and equipment and outside services. Other non-interest expense increased linked quarter primarily from charitable contributions during the quarter to qualify for Pennsylvania bank shares tax credits. Salaries and employee benefits decreased from the third quarter due to lower medical costs and seasonally lower production and performance-related incentives. Excluding significant items totaling $52.3 million in 2022 and $4.4 million in 2021, full-year operating non-interest expense increased $45.4 million, or 6.2%. The fourth quarter's operating pre-provision net revenue totaled a record $219 million, representing an 81% increase from the year-ago quarter. On a full-year basis, operating pre-provision net revenue was $669.2 million, an increase of 31.7% in 2021. Our capital ratios ended the year at levels that are expected to be at or above peer median. Tangible book value per common share was $8.27 at December 31, an increase of $0.25 per share from September 30, largely from the higher level of earnings and the decreased impact of AOCI by $0.09 per share. CET1 ended the year at a solid 9.8% and the TCE ratio totaled 7.24%. Let's now look at the 2023 financial objectives, starting with the balance sheet. We expect loans to increase mid-single digits on a year-over-year spot basis. Total deposits are projected to end 2023 at a similar level as of December 31, 2022, spot balances as customer growth continues alongside active management of deposit rates in an environment with rising deposit betas. Full-year net interest income is expected to be between $1.34 billion and $1.4 billion, with the first quarter of 2023 between $335 million and $345 million. Our guidance currently assumes 25 basis point rate increases in both February and March with no additional rate actions projected for the remainder of the year. Full-year non-interest income is expected to be between $300 million and $320 million, with the first quarter in the mid-$70 million range. Full-year guidance for non-interest expense on an operating basis is $830 million to $850 million, which assumes an additional $8 million in FDIC deposit insurance costs, reflecting higher assessment rates, which may remain in effect until the deposit insurance fund reserve ratio meets the FDIC's long-term goal of 2%. This expense guidance range implies growth of 7% to 10% in full-year 2022 operating expense figures. At the midpoint of our guidance, the efficiency ratio would be below 50% for full-year 2023. When excluding the FDIC increase in the UL Bancorp acquired expense base, the 2023 expense range would be 4% to 7% on a year-over-year basis. The first quarter non-interest expense is expected to be between $210 million to $215 million as the compensation expense is higher in the first quarter, largely due to normal seasonal long-term stock compensation and higher payroll taxes at the start of the new year. Full-year provision guidance is $65 million to $85 million and is dependent on net loan growth and CECL model-related builds from a softer macroeconomic environment. Lastly, the effective tax rate should be between 20% and 21% for the full year, which does not assume any investment tax credit activity that may occur. With that, I will turn the call back to Vince.

Thanks, Vince. As we start the new year, we remain focused on executing our strategy and serving our stakeholders. We will do this by staying true to our values-based culture and delivering on the financial guidance Vince provided, with a focus on generating positive operating leverage and efficiently deploying capital in the most effective way to optimize risk-adjusted returns for our shareholders. Before we close today, I want to recognize our dedicated team, who made our performance positive. Every employee contributes to the success of the company, and I strongly believe that we will continue to win at FNB because of our outstanding employees and the excellent culture we have developed together. With that, I'll turn the call over to the operator for questions.

Ladies and gentlemen, at this time, we'll begin the question-and-answer session. And our first question today comes from Frank Schiraldi from Piper Sandler. Please go ahead with your question.

Good morning.

Good morning, Frank.

I was wondering if you could elaborate on the geographical areas where you've seen the strongest growth, particularly what percentage of the commercial growth is coming from the Carolina region.

Yeah. I don't know that we have the specifics at our fingertips, but I can tell you just from what we get, the Carolinas have had an exceptional year. They contributed throughout the year in all of those areas and were big contributors to loan growth. They all exceeded their planned objectives for the year and had a tremendous year in cross-selling. So in addition to eliminating loans, they were also able to cross-sell capital markets products, trust and investment products, and insurance throughout that footprint. So they were a significant driver. Pittsburgh has always been a solid market for us, given our market share here. The groups in Pittsburgh were also strong this year. I also want to include our expansion market in Charleston. The team down there has done an exceptional job over the last two years. In the past, the Mid-Atlantic region has been a fairly substantial contributor, but we were able to, through various takeouts, reduce the size of the seating portfolio in that market. So we had a little bit more of a headwind coming into the year. And I will tell you that as we move into next year, the pipelines have softened a little bit kind of globally, but we had two consecutive quarters of pretty solid growth. So we're down about 15% year-over-year, which is typically a seasonal low point. We're being a little more careful as we move into next year due to quite a bit of economic uncertainty, and we are playing it on the conservative side. So very excited about where we sit, though, Frank, in terms of originations because it was fairly geographically spread out. We got some assistance from the Midwest and the Northeast in some of the slower growth markets because they have a heavier industrial base, and there seems to be a little more activity there to offset some of the declines in CRE opportunities in the Mid-Atlantic region. So it all kind of balanced out. And I think as we've said all along, that has been our strategy to have a very long-term growth strategy.

That's great. Thank you for the details. I wanted to follow up on the guidance, particularly regarding fee income. It appears that even if I adjust the other line item for this quarter, you might still reach the mid-70s number, which seems to put you at about the midpoint of your projected run rate for next year. I'm curious if you could share any insights on potential areas for growth in fees and where we might encounter further challenges in 2023.

I could comment, Frank. Just I guess, high level, non-interest income was solid again at $80.6 million for the quarter, down slightly from the third quarter. Mortgage banking income coming down $2.4 million, there's kind of normal seasonality there. One thing I did want to point out too is that the growth in the balance sheet of adjusted for rate mortgages has been higher. We've been portfolioing more loans that we might otherwise have been selling in the past. So, the fee revenue is a little bit lower on the mortgage banking side. Capital markets for the quarter were very solid at $10 million. We had a higher contribution compared to the third quarter, partially offsetting that reduced contribution from mortgage and the second consecutive quarter with strong syndication fees. As you look ahead, some of that revenue sources are lumpy, like the syndication fees are always consistently at the same level; they come in lumpy. The swap piece also can be a little bit lumpy. So, us guiding to mid-70s again, which is what we guided to for the fourth quarter is really just kind of a function of that as well as we made some changes to consumer deposit fees that we had announced in November. That's also kind of rolling through the numbers. So it's kind of a conservative look, I would say, based on kind of what we know today. But the lumpiness you can't predict with certainty as far as some of the kind of capital markets component. So that's why the guide at that kind of mid-70s level.

Hey, Frank. So Chris mentioned that in the Carolinas, over the last three years, the Carolinas produced roughly 40% of our net loan growth.

I appreciate that. I wanted to ask about your approach as you get closer to the 10% CET1 ratio. Will there be any strategic changes once you reach and exceed that level? Specifically, I'm curious if that might lead to increased capital returns or more buyback activity as we progress through 2023. Thank you.

Yeah. I would just say, we expect to build a 10 in the near term here, given the level of earnings that we've been generating really creating that capital flexibility we've never had in the past. So we've stated that our first and best use of capital is, as we've said all along, to deploy it into loan growth. So depending on how strong the loan growth is or how much it slows down, you'll have more opportunity to do buybacks. So it's clearly on the table for 2023. As you know, we remain committed to managing capital in a way to fully optimize shareholder value and to be fully aligned with shareholder interest. So we will be looking at that. We'll be opportunistic as we go through the year. I think in total, we have about $175 million or so of capacity remaining in our former program. So clearly, as we expect to build past that 10% level, the share buybacks are definitely something we'll be pursuing and evaluating on a daily basis.

Great. Okay. Thanks for all the color, guys.

And our next question comes from Jared Shaw from Wells Fargo Securities. Please go ahead with your question.

Hey, guys. Good morning. How are you?

Good morning, Jared.

Can you share how you're using analytics to enhance your deposit base? Your deposit performance has been impressive, and your beta ranks among the best in the industry thus far. How are you achieving this, and do you believe it will remain a sustainable growth opportunity moving forward?

Yes, this is Vince Delie. Steve already touched on this in his comments, and I want to emphasize that we've made a major investment in our capacity to analyze large amounts of data, something we've discussed previously. We possess the data and have an entire team dedicated to governance and systems. Over the past five or six years, we've invested heavily in this area. This team helps us gain a better understanding of our clients and allows us to delve into client behavior and expectations, leading us to offer improved solutions. Regarding deposit stability and growth, I believe we have an exceptional deposit franchise. Our mix is very strong compared to our peers, and the stability of our demand deposit base is robust. The granularity is impressive, indicating that managing a deposit portfolio of this magnitude involves multiple strategies rather than a single solution. We leverage analytics to identify treasury management opportunities within our customer base. We also analyze single product customers who may have a loan but lack a more comprehensive depository relationship with us. Additionally, we tier our clients based on their needs, which helps us allocate our resources more effectively to drive growth. We incorporate analytics with our digital offerings to present products and services to clients while they interact with our online eStore. Our eStore has garnered over 500,000 views on the website and mobile app since it is integrated into our mobile application. This approach enables us to manage deposit betas, outflows, growth, and the composition of deposits effectively. Overall, we have implemented a complex set of strategies, with tactics tailored to enhance performance in our deposit portfolio. I hope this answers your question. That was quite a bit.

That was great color. Maybe looking at margin, you project or you expect a couple more 25 basis point hikes. What's your expectation for DDA diminishment in that scenario? And are you taking any steps to protect margin if we start shifting to more of an expectation for lower rates in the future?

Yeah. I would start with just the non-interest bearing deposits, again, are a big focus in the company. So our ability, as you can see here in my prepared remarks, I mean, earning assets were down 1% or so less for the quarter; that takes a lot of effort. All the tools that Vince talked about analytically and our team on the front lines and our relationships with customers that are very strong. We've created a lot of goodwill going to PPP. We're in that process with existing customers and new customers that we've been broadening relationships with. Those relationships and our customers' willingness to talk to us, if they're looking to move money instead of just moving money, are very valuable. Our team on the front line has been very active throughout the fourth quarter, talking to customers. We have a large corporate initiative that's been on the lending side as well as the deposit side that has been bearing fruit during the quarter. So our goal is to sustain the DDAs and continue to grow them from here. We have a slide in there that shows a percent of full deposits from 16% up to 34%. Our team is incented to work hard to grow those non-interest bearing deposits.

We have a lot of tools at our disposal to drive deposit. The question is, how much margin you want to give up in this environment.

I would say that we, as you would expect, our treasury team studies this on a daily basis. We've been looking at hedging opportunities really for the last year, and we did some small amounts of hedging, I don't know, six months or so ago, but decided not to put more on because of where levels were and what was expected to happen with rates. You don't have to go back that far when everybody was locked in that rates are just going to fall off a cliff one quarter or two quarters into the year, and then the protection became very expensive. So we've put some on. Naturally, our asset sensitivity has been approaching neutral. If you look at the asset sensitivity of our interest rate risk position, you're down to like 1% or so for plus 100, minus 100. So organically, it's been kind of coming down as we've been deploying cash, just from the natural movement of the balance sheet. So we'll continue to monitor it, Jared. But at this point, the price points haven't made sense to us to load up on hedges for the balance sheet. But we'll continue to look at it and we'll be smart about it when it makes sense. If it does make sense to us, we'll put something down. We've done about $1 billion or so of received fixed swaps over the recent period. So we have that component there. But the natural asset sensitivity is coming down, and as you know, net interest income is at a much higher base. So it's kind of coming off of that. So having that lower interest rate risk, a more neutral interest rate risk position is a positive, and as we move forward. We'll continue to monitor and evaluate any hedging opportunities that make sense.

Okay. Thanks. And just finally for me, just on the capital management side. What's the appetite for M&A here? And maybe, Vince, what's your view of sort of the current state of bank mergers overall?

I believe being an investment banker right now would be quite difficult due to the challenging environment. Overall investment banking fees have decreased by 20%, and given the situation with AOCI, it has become tough to find deals that are beneficial without significant relevance. We have consistently made it clear that we do not want to dilute our tangible book value. As Vince mentioned, we have capital flexibility that we have not experienced before, which could imply various strategies, including becoming more aggressive in our share buybacks if loan growth slows down. Our dividend payout ratio on an operating basis has decreased to 34%, which is unprecedented since we previously had an 80% payout ratio. This gives us great flexibility going forward, and we want to ensure this benefits our shareholders. Our main aim is to enhance shareholder returns and make wise capital decisions to drive the stock price up and return appropriate levels of capital. That is our strategy moving ahead.

Great. Thanks for all the color, guys.

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

Yeah. Thanks. Good morning, everyone. Question on the funding strategy. So the guide outlines about $1.5 billion of loan growth with deposits flat. Just wanted to understand what's the outlook for funding that loan growth, be it bond book or borrowings?

I would say we still have some excess cash to invest. We plan to deploy that throughout the year. If you look at the loan-to-deposit ratio based on our guidance and plan, we expect it to reach around 90% or 91% by the end of the year, which is still a comfortable level for us. We'll combine deploying the cash with possibly some borrowing towards the end of the year. Overall, we're very comfortable with those loan-to-deposit ratio levels.

Okay. Very good. And just I guess as a follow-up to that is, what is a comfortable mid-cash position for you guys as well as what is too high a loan-to-deposit ratio?

Well, I mean in the past, I remember when we got up to about 97%, we started to get uncomfortable. We took some actions at that point; some promotional CDs were opened and those types of things to kind of bring it down. So I'm not saying that's the level, but our prior history, that was when we decided to start doing things. So I think if you got up to 95-ish or 97%, we would look at other options or strategies we should deploy at that point.

We have many tools at our disposal to drive deposits. The question is how much margin you want to give up in this environment.

Okay. Very good.

Casey, just to clarify, I don't have a figure in front of me. So there's $1.2 billion if you look at our balance sheet at the end of the year of interest-bearing deposits. So that cash being deployed to support the loan growth would be the best fit moving forward.

Yeah. Understood. Okay. And then apologies if I missed it. Any updated cumulative beta is coming in very nice surprise positively versus what you were expecting this year? Any updated thoughts on where cumulative beta ends up?

Yeah. In my prepared remarks, I mentioned kind of low 20s at the end of the third quarter. Overall, I would say, a few comments on betas: our team has done an admirable job in the field strategically managing interest-bearing deposit costs while we're building non-interest bearing. It's a lot of effort, as you would expect. It's a daily effort talking to customers, managing the relationships, being smart about rating rates for customers that have kind of full relationships. So it's been a very active process. It will continue to be an active process for us. We ended the year, as you saw on the slide, at 16.3, getting down into the low 20s by the end of the first quarter. By the end of the year, the cumulative total beta will be in the high 20s, as we're kind of projecting as we sit here today versus about 24% in the last hiking cycle.

Okay. Got you. So apologies if I missed that. So high 20s through the cycle is what you're thinking?

At the end of the year, yes, that's pretty much on track.

Okay. All right. Just last one for me, maybe one for Gary. So the provision guide of 65 to 85. You guys do mention a softer macroeconomic environment. We're all kind of struggling with CECL modeling. Just wondering if any color on and you can provide on how softer that macro is, be it unemployment rates, GDP, etc.

Yeah. It's pretty much across the board, Casey. And during the quarter, we also saw some softer economic forecasting in our CECL models, which impacted the provision to the tune of about $8 million. So we've got that built in through 2023. So that is a pretty good portion of where we've guided to across the year.

The other factor is loan growth as a driver. Loan growth will influence those numbers slightly within that range, as we've mentioned previously.

Thank you.

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

Thank you. Good morning, everyone.

Good morning.

Sorry, I just wanted to clarify that last comment, Gary. Did you say that the $8 million reserve build is what was built into your assumptions for the 2023 provision?

No. I'm sorry. The $8 million was CECL macroeconomic forecast changes in Q4.

Okay. I apologize. All right. Terrific. Do you have a thought on kind of how much reserve build is in the guidance relative to what would be just loan growth or charge off activity?

Yeah. CECL impact is about a third. Loan growth is about half of it.

Thank you. I'd like to discuss the margin further. While we've focused on deposit betas, I'm curious about your perspective on the pace of the margin. We can estimate what the rest of 2023 will look like based on your guidance, but I'm particularly interested in whether you expect margin expansion in the first quarter and how much contraction you anticipate after that.

Yeah. I can comment on that, Dan. The outlook just to restate again includes an additional 50 basis points of hikes in February and March and then no additional Fed actions for the rest of the year. Our guidance would imply a slight increase in margin from the 3.53 level that we were at in the fourth quarter, peaking maybe in the second quarter, and based on what's in our plans, but we're talking single digits of basis point movement there. So there's still some upside to that level. Similarly, on the other side, it comes down a little bit from that peak, but we're tucking in a single basis point type level. So that's what's baked into that.

I appreciate it. I wanted to clarify an earlier comment. I think you mentioned that the midpoint of your expense guidance would imply an efficiency ratio of under 50% in 2023. I want to confirm that I understood correctly. Additionally, how likely do you think it is that you will remain under 50%? Assuming your expenses align with your expectations, would it be accurate to say that you expect to be under 50%?

Yeah. Using the midpoint of our guidance kind of across all the different categories, that's an accurate statement.

Okay. And is that kind of becoming a longer-term goal for the bank to stay under 50% efficiency ratio, or if we get into a lower rate environment, do you think that might drift back over?

I would say our goal would be to continue to reinvest in the company. And with the changes in the margin based upon macroeconomic factors, it could swing back and forth over 50 or under 50.

Yeah, low 50s, I would say, would be a reasonable longer-term kind of target.

But I will tell you that there will be capital investment required as we move forward, particularly in technology, for us to stay competitive, for us to maintain margins in the future and to keep doing what we're doing with the betas. And it's not a pre-pass forever. So we have to keep watching what we do, and we're going to have to manage the margin. We're in a very good period for our organization, and for this time, we're benefiting. But obviously, the world is going to change. So we are being diligent on expense control, and we continue to reinvest in the help.

Sorry, I didn't.

Terrific. Thanks for all the color. That's all for me.

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

Good morning. I appreciate you answering my questions. You've covered most of the key points already. I have a couple of quick ones to finish up. Vince, regarding your geographic footprint, you mentioned some pipelines and areas like the Carolinas. As we look at the bank today, are there specific opportunities or areas of focus for 2023 that we should be aware of? Perhaps something like Philadelphia, where many mid-cap players have exited in the past few years. Is there anything like that on your radar that you could share with us?

Yeah. I mean, I will tell you that we have studied Philadelphia from a commercial lending perspective. We do have an office there. Our plan is to continue to expand it. We think there's some opportunity there in the middle market, large corporate space. I also think Philadelphia, when we ran our model, we looked at MSAs because of the number of companies domiciled there and the competitive climate. It scored now pretty high. The dynamic keeps changing. There are fewer competitors, right? Basically, we're seeing it as an opportunistic area to expand. There are several other markets that we launched into that will continue to produce. We've had tremendous success in Charleston. Our plan is to continue to grow there. We are looking at de novo expansion in Richmond. We've studied opening a loan production office commercial only and Atlanta. Those are pretty much the areas that we're focusing on, but nothing earth-shattering or there’s no movement in retail de novo expansion. There are opportunities for us to extract additional high-quality growth in our existing footprint, where we may not have the density. The other thing that we've done strategically was to substantially increase our ATM rollout. What we found is that that's helped us immensely with the retention of customers growing DDA and expanding small business opportunities. We've done that through both branding opportunities and direct placement of ATMs and ITMs. Our ATM network grew more than 30% across our footprint. We have 1,200 ATM locations, with 250 of those rolled out in North and South Carolina and then another 250 in Maryland, Virginia, and Baltimore, Washington, D.C., Northern Virginia. We're trying to supplement our physical delivery channel for branches with other channels to distribute cash. Then we're marketing our eStore which enables individuals and small businesses to open accounts online. Anyway, that's the strategy. I think there’s plenty of opportunity within our existing footprint for us to continue to grow.

It makes sense that, from an external perspective, particularly along the I-95 corridor, such as in Virginia and Philadelphia, many competitors seem to be more heavily leveraged and likely less inclined to lend, with higher deposit betas and smaller balance sheets. It appears that you have a compelling value proposition for attracting lending professionals in those regions, especially from the West and South, rather than from the New York area, where balance sheet limitations are more pronounced.

Yeah. I think our treasury management offering, at least as it scores out through surveys, is pretty well respected. So that enables us to go in and garner deposits as well. We go in, we become the principal bank. We get the operating accounts in cross-sell treasury management services. I think we've proven moving into the Southeast that our products stand pretty well; if you look at the non-interest income growth of the company, a lot of that was driven from our expansion into the Southeast. And there was quite a bit of skepticism about our ability to compete. I think we've put that to rest. If you look at the growth in various categories, it's been fairly substantial and very robust. We have the product capabilities as well to go into some of the markets that we don't have density within our existing seven states footprint.

Great. Thanks for that. And then just last for me, just on the effective tax rate guide, it says it assumes no investment tax credit activity. Can you just remind us quickly what the activity looked like last year? And just also, if you do move forward with any transactions there, what you guys typically look at from an opportunity standpoint?

I guess it’s Vince C to answer. Go ahead.

No, I would just say, I mean, it's a line of business for us, but we don't have some transactions each year. In '22, I don't think we had one in '22; we had maybe a couple in '21. So, I mean, there's an active business process there, and we may have some this year. We just don't want to put it into guidance if we do; then it's a positive additive to the guidance there.

Is that like housing income tax credit stuff, though, or is it like more like what?

Renewable energy tax credit typically sold may have a long gestation period. It takes a long time to get to the finish line. So even some supply chain issues with the solar panels has elongated some of those projects.

Perfect. Thank you, guys.

Thank you.

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

Good morning, everyone. Congratulations on a successful quarter. I have a clarification question. Vince D, you mentioned the pipeline; can you clarify if it's around 15%? I'm unsure if you were referring to commercial or consumer. Could you provide an update on those pipelines? I understand they might be a bit softer, but I'm trying to connect the dots regarding their trends.

This is Vince Delie, and I was specifically discussing the commercial pipeline, excluding consumer activities. We had two very strong quarters of production, which typically leads to a reset. As we enter a slower seasonal period, our pipelines are declining. When you consider this on a comparable basis, removing seasonality, we're still seeing a decrease of 10%-15%, and the pipeline is being rebuilt. This reflects the current economic situation. There's a lot of uncertainty, and it seems our borrowers are waiting to see what unfolds. It may take some time before we see that recovery.

Got you. Yeah, in to second quarter. And then on the consumer side, how is that trending today?

Yeah. Consumer pipelines, there's seasonality there as well. So it's tough to say. I think the pipelines in general have been pretty consistent with where they've been seasonally, maybe down a little bit. Mortgage, there's more production coming online in terms of opportunities for us to take on adjustable-rate mortgages on our balance sheet. So we're seeing growth in that category. Direct consumer, we're seeing a little bit of lowness in the small business space now. But that tends to build back up again as we move through the normal housing sales fees on the home improvement season that starts to kick up here at the end of March. So it's tough to tell. Small business is up. Small business is up pretty much across the board. We have some good momentum in the number of markets that we've entered.

Thanks for the information. I have one or two additional questions regarding the fee income guidance. What are your thoughts on the mortgage sector, which has reached a low point this year? As you look ahead to next year, could you share your high-level perspective on mortgage activity based on what we've experienced throughout the year?

I will hand things over to Vince shortly. Regarding the mortgage business, we have consistently monitored global expectations from various statistical sources to gauge where the market is headed. Our performance tends to exceed typical forecasts significantly, which I attribute to the geographic diversity of our originators. We've seen considerable success in specific areas, such as the Physicians program, which has grown to exceed $1 billion. While we target certain niches, we also focus on markets that generally have stronger housing conditions than our traditional markets, like the Carolinas and the Atlantic regions. With our originators spread across these areas, I expect we will likely outperform the overall market again this year. Additionally, our servicing portfolio has served as a beneficial hedge for us financially, contributing to our earnings as well.

The production overall for the fourth quarter was $967 million, seasonally down in the third quarter, but now 16%. To Vince's point, the high-level industry forecast right now is for production originations to be down 24%, baked into our expectations and our guidance is more like a down kind of 14%. So we would expect to outperform the industry like Vince said, and we have done that in the past, and we continue to do that.

Got you. Okay. So a little bit lower. You're talking about 14% year-over-year is kind of what you're looking at there, right, Vince?

Yeah, full year to full year, right.

Okay. Perfect.

Just one more thing. I mean, with the lowering of the 10 year interest rate, we have seen a pickup in lockup volume in both mortgage and in the consumer space. Just saying that.

Yeah. No, that makes sense. And just to remind me, I guess, on the deposits, there's been a lot of talk about the beta. What did you guys exit the quarter on the cost of deposits? I guess I know you talked about the betas where they tried to, but for the month of December, where were you guys there?

Yeah. Total deposit costs ended December at 79 basis points, and interest-bearing deposits ended the year at about 1.14%.

Got it. Okay. Perfect. My last question is about the deposits. You mentioned that the guidance is relatively flat, just a change in the mix. I understand you discussed the effort required to maintain the current deposit levels. Where do you currently stand on the DDA as you look ahead for the year? Do you anticipate that number decreasing a bit, or is that part of your forecast? Or do you believe the efforts you have made will help you sustain the level you've adjusted to?

We're going to work hard to maintain and grow that in source of funding for us, honestly. I mean there's been some mix shift into CDs as you would expect, more particularly in the municipal and commercial side. I mean there's been some shifting into CDs. The key is that it's still kind of staying in the house. So it's moving around a little bit. The non-interest bearing deposits, like I said earlier, it's a big focus in the company with existing clients, but also bringing in new clients.

But we have to see how things play out throughout the year. I mean, there's going to be pressure on non-interest bearing deposits with the higher rates in the existing book as we move into a period of extended high rates, Brian. We're going to have to work really hard, but I think we've outperformed at least what we've seen reported recently, and we're going to keep doing what we're doing to maintain those balances to the best of our ability because that really drives our profitability through the mix. You are right.

And you're at a much higher base now with all the efforts you guys have had here over the last year or two, and the money you've taken in.

There's considerable granularity in that interest-bearing deposit base. So we have some hope there, Brian.

I got you. Okay. Thanks, guys. Nice quarter.

Thank you very much. Appreciate it.

And our next question comes from Emmanuel Navis from D.A. Davidson. Please go ahead with your question.

Hey. Good morning. Most of my questions have been answered, but could you just give me a reset on the Physicians First Portfolio? You said it's about just over $1 billion, kind of like the year-over-year growth? What are like new loans coming in on? Any kind of extra color there would be great.

I'll start out with the program itself, so you understand. We have a dedicated team that originates mortgage loans in the space. They've done a terrific job. We've built out on our eStore platform a digitized product offering that bundles a set of products for physicians. So that's been offered electronically on the eStore, and we use that eStore to promote the product digitally and we've done very, very well. I can tell you the CAGR on this portfolio is fairly significant, 65% since we started in 2018, so it's grown nicely. We started with the originators first and then supplemented their efforts with the digital offering and set up the campaign. If you just look at households with physicians, we're up 66% in Eastern North Carolina and the Mid-Atlantic region alone. So we've had some good success in that market. The full year production was over $0.5 billion. The portfolio stands at $1.2 billion at year-end. So the program has worked very well for us, and those are high-value households in that we feel confident that with our digital capabilities and our analytics we'll be able to continue to penetrate that household with additional products and services. It's a good program for us, and the credit quality is stellar in that portfolio.

We're also rolling out, as we speak, the small business side of that equation for the physician practices. That's something that we're working on as we speak, and we'll start to see some activity there as we get into 2023, with this guidance-based growth.

And ladies and gentlemen, with that, we'll end today's question-and-answer session. I'd like to turn the floor back over to Vince Delie for any closing remarks.

Well, I'd like to just thank everybody for your interest and the good questions we had today. It was a tremendous year. We really hit on all cylinders. I think the company is in a really good position moving into this year, and that doesn't come without a tremendous effort from our employees. So I'd like to thank all of our employees and the executive leadership team and the Board of Directors for their support and confidence. I think over the last four or five years, we've proven that we can execute on a number of levels, and this company keeps exceeding my expectations in terms of what we deliver and what our employees deliver in the field. So I want to thank them and thank our shareholders for sticking with us and supporting us, and we're really looking forward to the coming year. So no matter what the challenges are, we're going to get there, and we're going to win together. Thank you very much.

And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.