Earnings Call Transcript - NWBI Q3 2024

Operator, Operator

Thank you for joining us. My name is Calin, and I will be your operator for today's conference. I would like to welcome everyone to the Northwest Bancshares Inc 3Q 2024 Earnings Call. All lines have been muted to avoid background noise. Following the speakers' presentations, we will have a question and answer session. I will now hand the call over to Joseph Canfield, Executive Vice President and Chief Accounting Officer. You may begin.

Joseph Canfield, Executive Vice President, Chief Accounting Officer

Good morning, everyone, and thank you, operator. Welcome to Northwest Bancshares' third quarter 2024 earnings call. Joining me today are Louis Torchio, President and CEO of Northwest Bancshares Inc, the holding company for Northwest Bank; Douglas Schosser, our Chief Financial Officer; and TK Creal, our Chief Credit Officer. During this call, we will refer to information included in the supplemental earnings release presentation, which is available on our Investor Relations website. This presentation includes our forward-looking statements and other data, including non-GAAP measures. Please note that actual results may differ materially from the forward-looking statements made today, October 29, 2024. These statements will not be updated after today's call. Thank you. And now I'll hand it over to Lou.

Louis Torchio, President and CEO

Good morning, everyone. Thank you for joining us to discuss our quarterly results. We delivered solid returns, and I'm pleased with our core financial performance, which Doug will cover momentarily. I'm particularly pleased with our net interest margin expansion, quarter-over-quarter revenue growth, and continued improvement in our efficiency ratio. This clearly demonstrates that we are delivering on prior commitments made. Though modest, we continue to see deposits rise even with the near best-in-class cost of funds. In addition, we continue to see positive results from the security portfolio restructure executed last quarter, which continues to positively position Northwest for the upcoming quarters and years ahead. I want to thank every team member for their talent and dedication in producing these results. I'm proud of your hard work and focus on our customers and communities. I'd like to take a moment to discuss the increasingly dynamic M&A environment within our markets. As previously stated, Northwest and our Board are steadfast in our commitment to responsible growth, both organically and through acquisitions. I'm in frequent discussions with other bank leaders and investment bankers positioning Northwest advantageously for future opportunities. Our leadership team remains dedicated to enhancing our performance thereby strengthening our financial standing and bolstering our acquisition potential. Finally, as we have for the past 120 quarters on behalf of the Board of Directors, I'm pleased to declare a quarterly dividend of $0.20 per share to our shareholders of record as of November 8, 2024. Now it's my pleasure to introduce Doug Schosser, Northwest Bank's Chief Financial Officer, who will take us through our financial results.

Doug Schosser, Chief Financial Officer

Thank you, Lou, and good morning, everyone. Before we dive into today's presentation, I'd like to welcome Joe Canfield, who you already heard from at the top of the call. Joe recently joined Northwest as our Executive Vice President and Chief Accounting Officer. Additionally, we've named a new Treasurer this quarter, Sean Moro, who's been with the firm for over 7 years and was formerly our Assistant Treasurer, and was promoted with Jeff Maddigan's departure. He was unable to join this call but will be on future calls. Let's begin on Page 4 of the earnings presentation, where I'll highlight Northwest financial results for the third quarter of 2024. We reported net income of $33.6 million, or $0.26 per diluted share. Our net interest margin expanded by 13 basis points for this quarter to 3.33%, aided partially by an interest recovery on a nonaccrual loan, which added 4 basis points to that margin. We continue to see our margin increase due to our continued pricing discipline across our balance sheet, including our deposit portfolio and our newly originated loans, supported by a more favorable interest rate environment. Compared to the same quarter last year, our loan portfolio was essentially flat and deposits grew by 3.2%. Excluding a $39 million loss on the sale of the securities as we repositioned our balance sheet, noninterest income decreased by $3 million due to a loss on an equity method investment, lower gains on the sale of SBA loans, and a loss on the sale of some bank-owned real estate acquired from past acquisition activity. Noninterest expense decreased by nearly 2%, or approximately $2 million from the second quarter. Credit quality remains strong overall, with allowance coverage slightly increasing to 1.11% of loans from 1.10% last quarter and the year-ago quarter. Finally, our capital position remains strong with an estimated Tier 1 capital to risk-weighted assets of 13.7% at 9/30. Now let's delve into additional details. On Page 5, you'll see that our commercial and industrial loans grew by 2.8% since last quarter and 25.7% year-over-year, while residential mortgages declined by $190 million or 5.5% since last year. This shift underscores our focus on commercial banking transformation. Our commercial real estate portfolio shrank by just 1% since last quarter, reflecting a more desirable loan mix with a higher share of C&I compared to CRE. Our loan yields have steadily increased over the last 5 quarters, now standing at 5.6%. Moving to Page 6. Deposits remained largely flat since last quarter, and up 3.2% year-over-year. Our cost of deposits only increased by 2 basis points, the lowest rate in the past 5 quarters. Most deposit growth occurred in interest-bearing demand products, with modest growth in consumer savings and money market accounts. The current cost of deposits stands at 1.78%, which is near best-in-class relative to our peers. On Page 7, we cover the net interest margin, which now stands at 333 basis points, a 13 basis point improvement from the second quarter and 10 basis points higher than the same quarter last year. Fully tax-equivalent net interest income grew by approximately 4% from $108 million last quarter to $112 million. This marks our second consecutive quarter of net interest income growth and NIM improvement, reflecting reduced borrowings, higher loan yields, and no growth in our cost of funds. We ended the quarter with a cost of funds at 2.39%, 1 basis point lower than the prior quarter. We have included some additional information on the margin on the next few slides. Now moving to Slide 10. Noninterest income decreased for the quarter ended September 30, 2023, due to a $3 million decrease in income from bank-owned life insurance, resulting from death benefits received in prior periods. Excluding the $39 million loss on the sale of securities last quarter, noninterest income decreased by $3 million from the prior quarter due to a loss on the equity method investment, lower gains on the sale of SBA loans, and a loss on the sale of real estate that was part of some previously acquired banks and was largely vacant. On Slide 11, details of our noninterest expense. Our efficiency ratio improved to 64.8%, reflecting a nearly $2 million reduction in expenses for the quarter. We continue to in-source work previously handled by more expensive third-party firms to reduce overall costs and increase the quality of that work. We remain focused on finding additional cost reductions without impacting core operations or diminishing the service levels our customers expect. Regarding credit quality on Page 12, our allowance to loan coverage increased slightly to 1.1%, with net charge-offs at just 18 basis points for the quarter. Page 13 shows that overall credit performance remained strong, with an improvement in nonperforming assets, while 30-day loan delinquency saw a slight increase of 70 basis points; classified loans also increased slightly to 2.83% of total loans. Slide 14 highlights our commercial loan concentration, showcasing a diverse portfolio. Strong underwriting has helped us avoid many CRE-specific issues, and we have minimal exposure to large metro areas, large metro offices, or rent-controlled markets. Finally, let's discuss our outlook for the remainder of the year. We will continue to focus on responsible and profitable loan growth in the commercial space, particularly C&I lending. We anticipate low single-digit loan growth and expect deposits to remain largely flat. We will manage deposit costs while balancing client expectations and market pressures, allowing for modest net interest margin expansion. We expect noninterest income to grow by the mid-single digits off of the 9/30 base, given some of the one-time items this quarter. We continue to keep expenses in the low single-digit growth per quarter, positively impacting our efficiency ratio. Both our tax rate and net charge-offs are expected to normalize closer to the third quarter rate for taxes and towards our long-term average for charge-offs. On behalf of the entire leadership team and the Board of Directors, thank you for joining us this morning. I will now turn the call over to the operator who will facilitate the live Q&A session.

Operator, Operator

Our first question comes from Daniel Tamayo with Raymond James. Your line is open.

Daniel Tamayo, Analyst

Maybe first, just starting on the fee income guidance. Just curious, it looks like it's a little bit lower number than what I was looking for, and then you had the losses in the mark-to-market in the fourth quarter within the other. So I'm curious if that is still a good number kind of going forward, that $1 million, given you're talking about the guidance off of the $27 million, $28 million number in the third quarter going forward as kind of we get into 2025 or if that's going to go back to a number similar to what we saw in prior quarters, maybe in the $2 million or $3 million range per quarter.

Doug Schosser, Chief Financial Officer

Yes. We'll provide more guidance for 2025 when we go through the full fourth quarter results sometime in January. So we'll update that guidance. But for now, we're just guiding to sort of a more normalized level after you account for some of the one-time losses that we had for the fourth quarter.

Daniel Tamayo, Analyst

So just to be clear then, you're expecting a number similar to the $1 million level in the fourth quarter?

Doug Schosser, Chief Financial Officer

Yes. I would say we're expecting a number closer to where we were in the third quarter after adjusting for the security losses. So again, if you're going to rebound back to mid-single digits, you're going to see an increase of a couple of million dollars on that line, ranging from $1.5 million to $3 million. Therefore, we should expect to return to that core level of around $29 million to $30 million.

Daniel Tamayo, Analyst

When you mention mid-single digits, you're not referring to an annualized figure; you're talking about the stated mid-single digits from the third quarter. I believe that might cause some confusion. Understood. Additionally, regarding the credit side, it seems your normalized net charge-off guidance has increased compared to last quarter. I'm curious about what led to that change and whether there is any visibility on how you expect to reach that guidance. When you mention trending toward that, does it imply that there's something immediate influencing that or is it more of a general expectation to attain that at some point?

Doug Schosser, Chief Financial Officer

Yes, we're focusing more on what a normalized level of charge-offs will be for the firm in the long run. Currently, we are in an excellent credit quality environment, and many banks are expressing similar views. We anticipate that this environment will return to long-term averages. We're not implying that any specific quarter will deviate significantly from this trend. Instead, you may notice some fluctuations as individual credits can introduce variability at these low levels.

Daniel Tamayo, Analyst

And in terms of the increase in the normalized guidance from last quarter, what was the driver there?

Doug Schosser, Chief Financial Officer

I was seeking clarification from credit partners about what the long-term normal would look like. Last quarter, we provided guidance that was somewhat lower, which remains accurate. Our credit outlook hasn't fundamentally changed, though the guidance is slightly higher now. This is not reflective of a single quarter but rather of a broader long-term trend. We're aiming for consistency with our internal projections. As we continue to shift towards more commercial, you can expect a different profile moving forward. However, I want to emphasize that we're discussing long-term trends, not a specific quarter for which I'm providing guidance.

Operator, Operator

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

Manuel Navas, Analyst

Can you remind us some of your targets in M&A kind of financial hurdles, geographies that you might be finding intriguing and size of targets and opportunities that you're looking for? Just kind of reset that for us.

Louis Torchio, President and CEO

Yes. Similar to last quarter, we're primarily focused on our four-state region. The opportunities we are seeing can be categorized into different types, including end-market deals, particularly in the Columbus and Indianapolis growth markets where we are active. Additionally, some opportunities may be more strategic, related to product or diversification. However, the key factor for us is how beneficial these opportunities are. We are highly aware of the costs involved in acquisition. Strategically, given that we have not made an acquisition since the COVID pandemic, we want to pursue something we are confident we can successfully implement. We aim for deals that are highly beneficial and typically within the $1 billion to $3 billion range, which we believe we can execute effectively. Regarding Columbus and Indianapolis, our two fast-growing markets, we are commencing strategic planning soon and assessing new branch strategies and expansions in these areas. We have already hired commercial lenders and business bankers and are evaluating the feasibility of investing capital to grow in these key markets. As mentioned earlier, the market is improving, and I have been engaging with other bank CEOs for discussions. However, we will proceed carefully, ensuring that any transaction we pursue will be highly beneficial.

Doug Schosser, Chief Financial Officer

And Manny, the only thing I would add, too, is we are looking for similar low-cost granular deposit basis as well. So we'll be looking for deals that will add to the strengths that we already have within this franchise.

Manuel Navas, Analyst

That's interesting about the LPO development, that leads to kind of my next question is, can you go into where you had strength on the commercial side kind of business line and regionally and kind of where do you have strengthened commercial regionally?

Doug Schosser, Chief Financial Officer

Yes. I mean I would say that the overall model for commercial continues as we've done our expansion. So I think we've talked about it before. So we have some new verticals that have come online. Several of them actually started this year. So you've got sports finance, you've got sponsor finance, franchise finance. We've got a corporate finance team, and we have equipment finance. So as you continue to see all of those businesses mature, equipment finance, corporate finance being the longest term ones, you're just starting to see our folks build pipelines and get more advance, which we expect that progress to continue. So in talking a little bit to J.D. Marco, he's seeing his pipelines grow anywhere from 10% to 20%. That's in the highly probable categories. And again, I think it's just a matter of maturation as these businesses are on the ground longer as our credit teams and business leaders are out getting more confidence in the type of deals that will get approved, you're going to start to see some more consistent growth. So I would say it is relatively broad-based across all of those verticals, and we continue to look forward to those particular verticals maturing over the course of 2025.

Manuel Navas, Analyst

Any reason stand out more than others?

Doug Schosser, Chief Financial Officer

I don't know that I've seen any major concentration in any one of our regions in terms of opportunities or actual credits that we've approved.

Manuel Navas, Analyst

And then just a quick follow-up on the NIM. What are you kind of assuming in terms of initial deposit betas in your guidance or initial loan betas for the fourth quarter? And where can they go on the full cycle? Just kind of talk through that a little bit.

Doug Schosser, Chief Financial Officer

Yes. Again, I think we'll provide a little bit more color on that going into 2025 in terms of what our margin guidance will be. I will just say that this last rate cut, some of our deposit pricing changes didn't go in until the very end of September, like literally on the 27th of September. So we still have some opportunity there. And we're not suspecting that there is going to be significant additional Fed cuts this year. We have 125 basis point cut in November in the guide that we provided. But again, we're still going to pick up benefit from the last cuts that had some deposit changes that came late in the cycle.

Manuel Navas, Analyst

How successful were you to lower deposit rates? Do you have like an end-of-period deposit cost level to disclose? How are you doing into October? Has there been push back on deposit declines? Yes. So we're not providing an end-of-month guidance. As you've seen, we had very, very low deposit growth this quarter, deposit cost growth, given the fact that I just said we had rates that went in as of 9/27, you can expect that, that deposit costs will continue to trend down next quarter. We have been pleasantly surprised and comfortable with the deposit renewal rates that we've been seeing in the book and in our ability to maintain our deposits with this pricing. So again, I believe we kind of continue to have a very reasonable pricing stance within our markets and against our competition. And we have seen our customer base respond accordingly without having significant levels of runoff as a result of those in line with market price changes that we made.

Operator, Operator

And your next question comes from the line of Matthew Breese with Stephens Inc. Your line is open.

Matthew Breese, Analyst

I was hoping you could help me out with a couple of things. The first one is just, could you break out for us what pure floating rate loans are as a percentage of total loans, meaning priced off super for Prime? And if you have it, what the yield is on that book versus everything else, the adjustable and fixed rate book.

Doug Schosser, Chief Financial Officer

Yes. If you refer to our presentation on Slide 8, we provided information on the fixed and floating percentages across our earning assets. The overall distribution shows 24% floating and 68% fixed, and it is detailed by category. We also included additional information regarding the funding mix and how it may respond over time.

Matthew Breese, Analyst

I'll just go here. Do you have any idea on the fixed rate, what the duration is or how much do you expect to reprice over the next, call it 12 months?

Doug Schosser, Chief Financial Officer

Our residential mortgage portfolio is our largest, and like others in the market, it has a long tenure and relatively low yields. Following that, our next largest segment is in commercial real estate. Additionally, in the consumer category, we have a substantial auto loan portfolio, which generally consists of fixed-rate loans, albeit at lower rates and shorter durations.

Matthew Breese, Analyst

Could you talk a little bit about the pace of C&I growth? Obviously, that's kind of been the lion's share of growth where it comes recently. Should we expect this kind of pace to continue, kind of mid- to high single digits on a quarterly basis? And where do you want to place C&I loans to as a percentage of total loans? Where do you feel like the appropriate levels?

Doug Schosser, Chief Financial Officer

Yes. I don't know that we have a specific target of where that level would be. I think we like the C&I business. We've made some significant investments in that business over time. We plan to continue to grow the C&I portfolio as a percent of total. Again, we have a pretty significant amount of runoff in that consumer book that we would like to replace with some more commercial loans. And I would generally say the commercial real estate book, although we're still in that market, we don't tend to significantly grow that. So the bulk of our commercial growth will be into C&I, and we would tend to run down and support the funding of that by rundown of sort of mortgage home equity and consumer just as natural cash flows in that portfolio occurred.

Louis Torchio, President and CEO

And I would just add to that, this is Lou. While we don't really have a target percentage, we are looking for balance. We're also interested in the additional economics that will be meaningful to us from both fees and deposits to help us grow deposits. We are under-indexed in the commercial deposit space, and we are focused not just on providing loans in the commercial and industrial space that consume capital. Our strategy is to gather deposits. Many of our businesses, such as the sponsored finance and franchise businesses, come with deposits and fees, creating full deposit relationships. This is strategic because we want a stronger revenue stream, more balanced economics, and a loan portfolio that remains stable through different economic cycles. Therefore, you'll continue to see this remixing, but ultimately, we will reach an equilibrium that produces much better financial results for us.

Matthew Breese, Analyst

Last one for me. Just along those lines as we continue to remix into C&I. Is it fair to assume the reserve as a percentage of loans increases as well? We haven't seen it really, at least on that metric very much year-over-year, but I'm curious if kind of goes on whether or not that reserve will creep higher?

Doug Schosser, Chief Financial Officer

Yes, we are closely monitoring the remixing process, and you are correct that we will see an increase in our reserves over time. We have established the necessary infrastructure for this transition and have a solid understanding of the risk-adjusted returns involved in shifting from residential mortgages to commercial and industrial lending. We have implemented a robust risk enterprise framework, including three lines of defense, and we are investing in Moody's risk rating software to support our efforts. This approach is integral to our overall strategy. Additionally, we have recruited experienced senior leaders who are well-versed in this area, making this transition familiar for us. We recognize the risks associated with this shift, and our prudent reserving will reflect that understanding.

Operator, Operator

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

Frank Schiraldi, Analyst

You guys have obviously seen some pretty good commercial growth here. And I think, Doug, as you talked about continued runoff on the consumer side of things. Just wondering, just thinking about 4Q, is the level we saw in terms of runoff in the consumer book in the third quarter, that a reasonable place to think about contraction in 4Q. Just trying to think about getting to that low single-digit loan growth in the fourth quarter, given the consumer side of things. Is it further ramp-up in commercial? And any color you can just kind of provide there in terms of quarter-over-quarter growth.

Doug Schosser, Chief Financial Officer

Yes. If you recall, overall vehicle sales were lower in the third quarter due to a few factors, including a technology issue and general decreased demand. We are reviewing our pricing strategy on the consumer side to improve it and stimulate more consumer loan growth. Ideally, we want to see the rate of decline slow down so we can achieve the modest loan growth we are currently forecasting. This will depend on the overall economy and market conditions. We are taking steps to remain competitively priced, which we hope will reduce the runoff and make the net change in our portfolio less negative, allowing us to reach our quarterly loan growth guidance of 0% to 2%. I hope this answers your question.

Frank Schiraldi, Analyst

Overall, credit appears to be in good shape. There has been an increase in classified loans, particularly in the healthcare segment. I'm curious if this increase is a result of any internal review this quarter or if you have any additional insights to share.

TK Creal, Chief Credit Officer

Sure. Yes. No, this is TK Creal. Thanks for the question, Frank. We are reviewing that majority of that portfolio quarterly. So the risk rating changes are reflective of that. That said, as we noted, we had a nonperforming asset, nonperforming loan payoff, that was within that same portfolio. So what we're seeing is the transition of the portfolio through the criticized and classified and then we are seeing a market for these is that nonperforming loans exited, the developer is able to find a suitor for it. So we do feel positive about the overall market slowly improving the sector, and then we actually had more number of loan upgrades than downgrades. It's just a couple of the downgrades were a larger one. So the dollar actually increased.

Frank Schiraldi, Analyst

And then just lastly, I just want to make sure just a clarification on part of the guide. When you guys talk about the low single-digit growth in NIM linked quarter into the fourth quarter. I just want to make sure, I don't know if it's to fine a point, but anyway, you mentioned, Doug, before basis points on the interest recovery on the nonaccrual loan. So is that low single digits off of the reported number off that $3.33?

Doug Schosser, Chief Financial Officer

No, it would be up to $3.29. That's why we wanted to highlight the 4 basis points like despite we had an interest income as we cleared that nonaccrual loan from the books. So you would adjust that down to $3.29 and then you do low single-digit off of that.

Operator, Operator

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

Daniel Cardenas, Analyst

Just a quick question in terms of thoughts on any additional balance sheet restructuring efforts coming into the fourth quarter or into 2025.

Doug Schosser, Chief Financial Officer

Yes. We don't have anything planned. I mean, we're always evaluating the opportunities that the market would give us. But I think right where the current portfolio stands. We also, as I mentioned at the beginning of the call, right, we had a change in our treasurer. So again, I think you should not expect to see anything dramatic from us in terms of restructures or things that we would be doing in the next quarter or two, but we'll keep an eye out for opportunities. And if one becomes economically advantageous to us, we'll consider doing it.

Daniel Cardenas, Analyst

Going back to credit quality briefly and noting the increase in classified levels, should we assume that provisioning might rise slightly if these classified levels do not decrease? Is that a reasonable expectation as we approach Q4?

Doug Schosser, Chief Financial Officer

So the provisioning has occurred for those credits quarterly migrated. At this point, I would not expect material increases in the provisioning for the long-term health care portfolio.

Daniel Cardenas, Analyst

Wonderful. And then how many credits made up that increase?

Doug Schosser, Chief Financial Officer

Made up the classified loan level? Here actually. Net-net, it was about 5 credits. But again, there were some that came in and some that went out. So we actually had more upgrades than downgrades.

Daniel Cardenas, Analyst

And any geographic concentration in those 5 credits?

Doug Schosser, Chief Financial Officer

No.

Daniel Cardenas, Analyst

One more question regarding potential new locations in Columbus. Historically, what has been the breakeven period for new locations in your experience?

Doug Schosser, Chief Financial Officer

Yes, I think we need to revisit that topic. Currently, we are evaluating our strategy, and as mentioned previously, we've added York Bower to our team, who specializes in PNC consumer banking for the long term. We want to allow him some time to examine the de novo strategy and provide insights on its execution. We are also contemplating hosting an Investor Day sometime next year, where we can discuss these plans in a more comprehensive manner. For now, we'll hold off on answering that question and will provide more details once we are better prepared to share our strategy.

TK Creal, Chief Credit Officer

Just to clarify my response on those numbers and classification, that was within the long-term healthcare portfolio. So follow up with other total migrations.

Doug Schosser, Chief Financial Officer

Great. Thanks.

Operator, Operator

And there are no further questions at this time. This does conclude today's conference call, and you may now disconnect.