Peoples Bancorp Inc (PEBO) Q3 2023 Earnings Call Transcript

Good morning and welcome to the Peoples Bancorp Inc.'s Conference call. My name is Anthony and I will be your conference facilitator. Today's call will cover a discussion of the results of operations for the Three and Nine Months Ended September 30, 2023. Please be advised that all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. This call is also being recorded. If you object to the recording, please disconnect at this time. Please be advised that the commentary in this call will contain projections or other forward-looking statements regarding Peoples' future financial performance and future events. These statements are based on management's current expectations. Statements in this call, which are not historical facts are forward-looking statements and involve a number of risks and uncertainties detailed in Peoples' Securities and Exchange Commission's filings. Management believes that the forward-looking statements made during this call are based on reasonable assumptions within the bounds of their knowledge of Peoples' businesses and operations. However, it is possible actual results may differ materially from these forward-looking statements. Peoples disclaims any responsibility to update these forward-looking statements after this call, except as may be required by applicable legal requirements. Peoples' third quarter 2023 earnings release was issued this morning and is available on peoplesbancorp.com under Investor Relations. Reconciliation of the non-Generally Accepted Accounting Principles or GAAP financial measures discussed during this call to the most directly comparable GAAP financial measures is included at the end of the earnings release. This call will include about 25 to 30 minutes of prepared commentary followed by a question-and-answer period, which I will facilitate. An archived webcast of this call will be available on peoplesbancorp.com in the Investor Relations section for one year. Participants in today's call will be Chuck Sulerzyski, President and Chief Executive Officer; Tyler Wilcox, Chief Operating Officer, and Katie Bailey, Chief Financial Officer and Treasurer. And each will be available for questions following opening statements. Mr. Sulerzyski, you may begin your conference.

Thank you, Anthony. Good morning and thank you for joining our call today. We are starting to realize the benefits of our Limestone merger along with our strong organic growth, which is evidenced in our record earnings for the third quarter. Compared to the linked quarter, our net interest income grew 10% and our fee-based revenue increased 3%. Our return on average stockholder equity improved to 12.6% for the quarter, while our return on average tangible stockholder equity was 23%. Our return on average assets also increased to 1.44% for the third quarter. Our net charge-off levels remained low and were 15 basis points of average loans on an annualized basis. We had strong loan growth of $110 million or 7% annualized compared to the linked quarter end. We had increases in our deposit balances of $78 million compared to the linked quarter, which was mainly due to our successful campaign for retail CDs during the quarter. Our loan to deposit ratio stayed flat compared to the linked quarter at 86%. We generated positive operating leverage compared to the linked quarter, prior year quarter, and first nine months of 2022. Our earnings for the quarter totaled $31.9 million and increased 51% compared to the linked quarter and 23% from the prior year quarter. Diluted earnings per share were $0.90 and were negatively impacted by $0.15 of one-time cost during the third quarter, which included: Limestone acquisition related expenses of $4.4 million resulting in a $0.10 decrease in diluted EPS; a $2.4 million pension settlement charge associated with the final termination of our pension plan, which negatively impacted diluted EPS by $0.05. We will no longer be recognizing any future ongoing cost or settlement charges related to our pension plan as a result of this final termination. Moving on to our credit quality. Our allowance for credit losses represented 1.03% of total loans at quarter end. A higher allowance compared to the linked quarter was attributed to several factors including loan growth during the quarter, updates to our prepayment, curtailment and funding rates, and deterioration of macroeconomic conditions used within our CECL model. All of these increases were partially offset by a decline in our reserve for individually analyzed loans. The reduction in our reserves for individually analyzed loans was largely due to the payoff of a single commercial real estate relationship. This relationship totaled $5.3 million at June 30th and was on non-accrual and included in our criticized and classified asset balances at the linked quarter end. We also recorded a $110,000 charge-off on this relationship at payoff during the third quarter. Non-performing assets remained flat compared to the linked quarter and were 48% of total assets at September 30th. A portion of our loan portfolio considered current at quarter end was 99%, which is flat compared to June 30th. For the quarter, our annualized net charge off rate was 15 basis points consistent with the prior year quarter and an increase from 9 basis points for the linked quarter. On a year-to-date basis, our annualized net charge-off rate was 13 basis points for 2023 compared to 15 basis points for the first nine months of 2022. Criticized loans declined to 3.5% of total loans at quarter end, while our classified loans increased and were 2.05% of total loans. As it relates to commercial office space, which is a very small portion of our loan portfolio, our total outstanding balances were $136 million at quarter end and represented 2% of our total loan portfolio. We continue to see high demand and successful project execution with our construction portfolio. There have been occasional construction delays. However, these projects have generally been leasing up at appropriate speeds and often at higher rents than projected. We typically work with high-net-worth individuals who are able to withstand increases in interest carrying costs and delays in timing. We have witnessed a number of construction projects achieving certificate of occupancy in the third quarter and more are likely in the fourth quarter. As a result, construction loans saw a decline in outstanding balances at quarter close. The current portfolio has $374 million in outstanding balances compared to $689 million in commitments. Land development remains a small percentage of the portfolio, representing $106 million or 1.7% of total loans at quarter end. Our multifamily balance continued to grow as projects come through the construction phase and now rest at $501 million. This sector has advanced not only due to construction seasonality but also from the Limestone merger, which had outstanding balances of $235 million at the end of the first quarter. Our top 10 multifamily loans accounted for 38% of the funded multifamily portfolio, six of which are in the construction phase. These projects are located within growth markets with strong metrics and notable guarantor support. Hospitality loan balances were $192 million at quarter end and comprised 3% of our total loan portfolio. Our hospitality loan balances have grown in 2023 due to the Limestone merger. However, we were able to exit an out-of-market hotel in the third quarter that was acquired through the Limestone merger. The Limestone acquisition shifted the geographic distribution of our hospitality portfolio. Six of our 10 largest exposures are located in the State of Kentucky, including the suburbs of Cincinnati, Ohio. Other hotel projects span throughout our footprint with a concentration in Ohio. The top 10 funded loans with flag hotels represent 47% of the hospitality portfolio at quarter end. Occupancy trends within the portfolio generally remain above market competitors with trailing 12- and trailing 3-month occupancy reported at 76% and 82% respectively. We continue to be highly selective in this segment and are working with high-net-worth individuals that provide sponsor support including liquidity. We do not plan to increase our hotel exposure as a percentage of total loans in a meaningful way and we'll continue to manage our portfolio exposure where we can. Specific assets are anticipated to be sold or refinanced in the fourth quarter, which will shift the overall project mix. We continue to closely monitor our dealer floor plan portfolio and are assessing the potential impact of the United Auto Workers' strike on the portfolio. At quarter end, we had $340 million of exposure to vehicle dealers, 30% of which was to domestic franchise auto dealers and another 7% with specialty vehicle dealers who are supplied by the domestic manufacturers. The remaining 63% of the portfolio was evenly distributed among independent auto, foreign franchise auto, commercial truck and RV dealers. Our domestic franchise dealers are currently well stocked with new vehicle inventory, so the strikes have not yet had a meaningful impact on vehicle sales. We believe our larger clients have liquidity positions to withstand short-term delays in the delivery of vehicles should the strike persist. Our largest 11 floor plan clients have an average debt service ratio of 3.3x with a trust position approaching 2x. Our top 5 floor plan commitments totaled $87 million, while the top 11 covered nearly $150 million in commitment. Compared to the linked quarter end, our total loan balances grew $110 million or 7% annualized. The largest contributor of our growth compared to June 30th was our commercial real estate loans, which grew $118 million while our specialty finance businesses provided over $51 million in growth. Consumer indirect loans were up $14 million while we had some declines in construction and commercial and industrial loan balances compared to the linked quarter end. At quarter end, our commercial real estate loans comprised 36% of total loans, nearly 40% of which were owner occupied. At the same time, our total consumer loans were 29% of total loans, commercial and industrial loans were 19%, specialty finance totaled 10% and construction loans were 6%. At September 30th, 48% of our total loans were fixed rate with the remaining 52% at a variable rate. Additionally, while our premium finance loans are fixed rate, these loans operate similar to variable rate loans and they reprice every nine months. I will now turn the call over to Tyler for additional details about our fee-based income, deposits and the Limestone systems conversions.

Thanks, Chuck. Our fee-based income saw a 3% improvement from the previous quarter, a 15% increase year-over-year, and a 13% rise compared to the first three quarters of 2022. These gains were attributed to the additional accounts from the Limestone merger, leading to higher service charge income from deposit accounts compared to the previous quarter and the same period last year, as well as increased electronic banking income. Our insurance income has significantly grown this year, primarily due to our client acquisition efforts and the strengthening insurance markets. We also recognized a debt benefit of about $400,000 related to our bank-owned life insurance in the third quarter of 2023. Additionally, we recorded $1.3 million in operating lease income, which contributed to the increase in other non-interest income. However, our lease income decreased by $1.8 million from the previous quarter as we accounted for the unwind of a residual premium linked to two leases from the Vantage acquisition, which were paid off during the quarter. The residual premiums were connected to the fair values recognized under the acquisition accounting for Vantage. Regarding our deposits, we raised our balances by $78 million compared to the end of the previous quarter. Our retail CDs increased by $248 million thanks to our recent campaigns, which effectively balanced out the decline in our non-interest-bearing deposits. Typically, we experience seasonal growth in our governmental deposits during the third quarter, which added $56 million. As we indicated last quarter, we have been utilizing brokered CDs recently as a funding strategy since they offer lower costs than FHLB borrowings and do not require us to pledge collateral. Our demand deposits made up 39% of total deposits at the end of the quarter, down from 42% at June 30th. At the close of the quarter, our deposit composition was 79% retail deposit balances from consumers and small businesses, and 21% commercial deposit balances. The average customer deposit relationship stood at $29,000 as of September 30th, with a median of $2,400. In August, we successfully transitioned the Limestone system to our core system, which enhances coordination among our business lines and fosters collaboration to improve our offerings to new clients. We are also focused on expanding our business model in our new areas. Upholding our culture and core values, we prioritize helping our communities, with over 65% of our associates contributing a portion of their paychecks to local food banks, totaling around $200,000 in annual contributions. Another core value is providing our associates with an excellent workplace; therefore, we are proud to be recognized by Energage as one of the top workplaces in the financial services industry for the second consecutive year in 2023. I will now pass the call to Katie for further details about our financial performance.

Thanks, Tyler. Our net interest income continues to grow as we benefited from a full quarter of the Limestone merger, organic growth, high market interest rates and our controlled funding costs. Compared to the linked quarter, net interest income was up 10% and net interest margin expanded 16 basis points to 4.70%. During the quarter, our net interest income and margin increased as we refined the fair value marks from our Limestone merger and related accretion income, net of amortization expense. This resulted in an additional $1.9 million in accretion income from May and June being recognized during the third quarter of 2023. For the third quarter, accretion income totaled $9.8 million and positively impacted our net interest margin by 49 basis points. A higher accretion income for the quarter benefited our loan yields and helped offset increases in our funding costs. As Tyler mentioned, we had retail CD growth from our recently advertised specials. However, we controlled the rates we offered and held the increase in our funding costs relatively low for the quarter. Our total deposit cost was 128 basis points for the third quarter, compared to 87 basis points for the linked quarter. Excluding brokered deposits, our total deposit cost for the quarter was 94 basis points compared to 63 basis points for the linked quarter. Compared to the prior year quarter, our net interest income grew 39%, while our net interest margin expanded 53 basis points. On a year-to-date basis, our net interest income increased 37% and margin grew 93 basis points. Since the beginning of 2022, the Federal Reserve has increased rates a total of 5.25% and over the same time period, our interest-bearing deposit rates have gone up 1.45% and are up 1.1% if you exclude brokered CDs. At the same time, our deposit betas have moved 28%. Moving on to expenses. Our total non-interest expense increased 2% compared to the linked quarter. Our acquisition-related expenses for the quarter totaled $4.4 million. We recorded a pension settlement charge of $2.4 million and we recognized a full quarter of operating costs from the expanded Limestone footprint. Compared to the prior year quarter, total non-interest expense increased 37% and was 29% higher on a year-to-date basis. The comparison to these prior periods have been impacted by the acquisition-related expenses, the Limestone merger and on a year-to-date basis, the Vantage lease acquisition. Our reported efficiency ratio improved and was 58.4% for the quarter, compared to 62.7% for the linked quarter. When adjusted for non-core expenses, our efficiency ratio was 52.5%, compared to 53.3% for the linked quarter. This quarter was our best adjusted efficiency ratio in decades. For the first 9 months of 2023, our reported efficiency ratio was 54.2% compared to 59.6% for 2022. Moving on to the balance sheet. At September 30th, our investment securities portfolio declined to 19.7% of total assets compared to 21.3% at the linked quarter end. We utilized cash flows from our investment portfolio during the quarter to fund a portion of our loan growth. We believe the investment portfolio continues to be well positioned for potential movements in interest rates. We will benefit from higher rates and should not be significantly impacted by falling rates. We intend to be opportunistic as it relates to our investment portfolio and potential restructuring. Our capital levels continue to be strong and increased compared to the linked quarter end. The improvement was a result of our higher earnings which included a full quarter of Limestone. At quarter end, our common equity Tier 1 capital ratio was 11.5%, our total risk-based capital ratio was 13.1% and our leverage ratio was 9.5%. As I had mentioned in our call last quarter, our leverage ratio was inflated due to the Limestone merger and is now at a normal level. Our tangible equity to tangible asset ratio was 6.9% at quarter end and declined compared to 7% at the linked quarter end. This ratio continues to be impacted by our accumulated other comprehensive losses, which grew this quarter and was driven by the higher market interest rates. I will now turn the call back to Chuck for his final comments.

Thank you, Katie. We continue to have strong earnings, asset quality, and many other positive metrics compared to prior periods. We believe in our business model and work hard to execute our strategic initiatives daily. We have consistently mentioned how we are positioning ourselves to cross $10 billion in assets. We are making many investments in systems, associates, and processes in order to have a successful transition. Along those lines, we have hired senior talent that will allow us to execute our plan. As far as the cost, we estimate that we have already incurred more of that expense at this point than we have left to pick up. We continue to make investments in our systems in order to have best-in-class systems. These include the current process of implementing a new customer relationship system and replacing our email and communications software with Microsoft. Moving on to our expectations for the full year of 2023, excluding acquisition-related expenses, we anticipate our net interest income and margin will experience some compression in the fourth quarter compared to the third quarter, but we still believe it'll be between 4.5% and 4.7% for the full year. Excluding the acquired Limestone loans, we believe our annual organic loan growth will be between 6% and 8%. We expect fee-based income percentage growth to be in the low to mid double digits compared to 2022. We are still anticipating a 22% to 24% increase in our total non-interest expenses for 2023, excluding acquisition-related expenses compared to the full year of 2022, which continues to assume we achieve our anticipated cost savings associated with the Limestone merger. This assumes our fourth quarter non-interest expense is between $65 million and $67 million. We still expect our efficiency ratio excluding one-time expenses to be between 55% and 57% for the full year, including Limestone. We expect our net charge-off rate during 2023 will be relatively consistent with 2022. For the third quarter, the analyst consensus estimate of our core diluted EPS was $0.93 per share. Excluding our acquisition-related expenses and pension settlement charges, we exceeded this expectation by $0.12. We have exceeded the quarterly consensus estimates 13 of the last 14 consecutive quarters. For the one quarter we missed in 2021, if you exclude the acquisition cost in day 1 provision for credit losses related to the Premier acquisition, we would have beaten estimates. The current core consensus estimate for 2023 diluted EPS is $3.87. We continue to expect to beat the consensus estimate for the full year of 2023, excluding acquisition-related expenses, pension settlement charges and one-time provision for credit losses for the acquired Limestone loans. I would like to give some high-level guidance for 2024, which is preliminary. We expect higher net interest income as we will see the full year benefit of the Limestone merger. We believe our fee-based income growth will be in the low double-digit percentages compared to 2023. We expect quarterly non-interest expense to be between $67 million and $69 million for the second, third and fourth quarters of 2024 with the first quarter of 2024 being higher due to our annual expenses we typically recognize during the first quarter of each year. We believe our loan growth will be between 6% and 8% compared to 2023. As a result of this projected growth, we're also anticipating an increase in our provision for credit losses excluding the one-time provision recorded for the Limestone merger in 2023. We will update this guidance in January at our next call. We are looking forward to capitalizing on our recent successes and will continue to develop our relationships with our clients. Our lines of businesses are focused on working together to identify client needs and improve our overall client experience. With that being said, the current core consensus estimate for diluted EPS for the full year of 2024 is $3.61. At this time, we feel confident in our ability to achieve this estimate. This concludes our commentary and we will open the call for questions. Once again, this is Chuck Sulerzyski and joining me for the Q&A session is Tyler Wilcox, Chief Operating Officer; and Katie Bailey, our Chief Financial Officer. I will now turn the call back into the hands of our call facilitator, Anthony.

We will now begin the question and answer session. Our first question will come from Daniel Tamayo with Raymond James. You may now go ahead.

Good morning, guys. Thanks for taking my questions. Maybe we start on the margin and particularly the loan yields, which remained very high. Obviously, you had the one-time benefit from accretion in the third quarter. But just curious if you think we're nearing a peak there? Or if not, kind of how that plays out assuming rates are relatively stable here over the next few quarters? And if you could just fill us in on your thoughts on accretion as well going forward?

I'll start with the yields and I'll have Katie talk about accretion. Our yields weighted average for the quarter were 8.5%. We think there's still some room to improve there, a little bit, but we're nearing the top. Your guess is as good as mine on rate increases. I wouldn't be surprised if there is another rate increase in the next quarter or two. But if there is, we'll see even higher yields.

Yes. And Daniel, as it relates to accretion, so as noted in the script and in the earnings release, there was a true-up in the third quarter, which $1.9 million of that should have been recorded in the second quarter, but we used an estimate in the second quarter. And as we refine the purchase accounting, we are finalizing some of those numbers. So, I would say as quoted in the script, it was 49 basis points of accretion was the benefit in the third quarter. If you take out that piece that related to the second quarter, it would have been closer to 40 basis points impact. And I think we can expect 35 to 40 in the first quarter of benefit. If we go back to kind of day 1 purchase accounting for the Limestone acquisition, about 85% of our mark on loans was related to interest rates, and the other 15 related to credit. So again, the rate environment created a much bigger discount than we've seen in prior deals when rates were relatively low and stable. So we'll continue to see some higher accretion numbers as those loans continue to pay down. I would say we haven't seen a lot of payoffs in that portfolio. So much of that is just the normal accretion that we'll get on a quarterly basis as that portfolio matures and has principal payments.

I'm curious about the CD maturities you have on the books. Are any of them set to mature in the next few quarters? I apologize if you already mentioned this. Also, do you have any overall thoughts on where the margin might land next year as it comes down from a high point?

Yes. The CDs we've been offering have had terms ranging from 7 to 14 months, and they will start maturing in the upcoming quarters. We are actively engaged in marketing and adjusting our pricing for these yields. Regarding margins as we approach the fourth quarter and 2024, we expect some compression in the fourth quarter, but we believe it will stabilize after reaching a low point. We previously guided that for the full year 2023, margins would be between $4.50 and $4.60 to $4.70, and we anticipate slightly lower margins for 2024.

Our next question will come from Terry McEvoy with Stephens.

Katie, maybe a question for you. Could you just talk about managing the size of the balance sheet? Will you continue to pay down short-term borrowings and are there additional actions within the securities portfolio for additional restructuring?

Yes. Short-term borrowing is influenced by loan growth and deposit flows, and we will manage that on a daily basis as we have traditionally done. Regarding investment securities, as mentioned earlier, we are always assessing opportunities to restructure that portfolio. You may remember that we made significant changes in the first quarter, resulting in a loss of about $2 million at that time. If we identify securities with gains, we will likely use those to offset some of the lower-yielding securities and mitigate the loss. We will keep evaluating that trade, considering the loss we are prepared to accept in the quarter and the expected payback, which we anticipate to be around 1.5 to 2 years for the payback related to the investment security restructuring option.

Thanks for that. And then just Limestone, I know this was touched on throughout the call, but are cost savings tracking in line with expectations, anything to comment on deposit or loan runoff? I think you said on the lending side that hasn't happened. And any maybe early comments on business synergies between some of the businesses and products that you bring to the table with those new customers?

Costs are tracking, probably slightly, maybe above where we expected them to be at this point in time. The loans as you indicated are where we thought they would be. Deposits coming back together, we may be in the beginning saw a little bit more run out than we would have. I'm not so sure if it's related to the deal or related to the market situation. And in terms of synergies, with the leasing and the investments and the insurance stuff, I think we see more each passing week as the newer associates become more familiar with what we do and how we do it.

Our next will come from Tim Switzer with KBW.

Hey, I'm on for Mike Perito. Thanks for taking my question. I wanted to ask a quick follow-up on the net interest margin and your guidance for it to be lower on a full year basis compared to '23, which makes sense given the compression we’re observing. However, in Q4, you are growing loans in the mid to high single digits, and I assume a lot of that is due to the leasing portfolio. Can you help quantify how the net interest margin trajectory should look throughout '24, assuming the Fed maintains interest rates? How many basis points of expansion do you expect over the course of the year?

I mean from a quarterly basis, I think we could see 5 basis points to 10 basis points of expansion from beginning to end on a quarterly basis.

Like 5 basis points to 10 basis points each quarter?

No, I'd say more in total, so a few basis points each quarter.

I understand. For the comparison of Q4 to Q4, that's useful. If we consider a situation where the Fed lowers rates next year, and this occurs after deposit costs have adjusted due to the rate increases, do you have any insight into how sensitive your balance sheet might be to that, and what the net interest income would be in that scenario?

Yes, I would say we have positioned our balance sheet to be relatively neutral. We have taken much of the benefit from rising rates into our base case scenario and therefore have hedged on the lower side, predominantly through the investment securities portfolio and what we have put on over the last few quarters.

Okay. That's helpful. And what are like the economic assumptions you have for your loan growth expectations next year? And which categories should be the leaders and maybe what are the risks of not achieving that, given the macro environment?

We anticipate some growth in real estate as construction projects finish, but we don't expect the same level of new commercial real estate business as before. Our commercial and industrial customers are not slowing down, so we expect to see solid growth in that area. We anticipate modest growth in the auto sector as well. Typically, leasing businesses perform better in higher interest rate environments or slower economies, and we expect that trend to persist. We are very optimistic about our premium financing team achieving over 20 percent growth. Overall, we see many small initiatives across various portfolios contributing to our performance. There are opportunities, such as working with a significant McDonald's franchise lender in Ohio, and we plan to expand into Kentucky through the acquisition. This detailed focus within our portfolio is beneficial for both origination and risk management.

Our next question will come from Manuel Navas with D.A. Davidson. You may now go ahead.

Good morning. Regarding your NIM expectations for next year, what do you anticipate for deposit costs, especially if interest rates remain stable? What are your assumptions regarding deposit beta?

Yes, I think historically we've set our deposit betas have run all inclusive, non-interest bearing and otherwise, about 25%. I don't think we have in our projections getting quite to that high, but we definitely have us getting pretty upwards of 18% to 20%.

What are the CDs coming on at, the kind of the promotional CD rate? And I apologize if you said it during the prepared comments.

No need to apologize. We didn't say it. Some of the tenors that we've put out there have a 5% handle.

Are you seeing most of the CD funding coming from current customers? Are you gaining some new customers? What is your strategic thinking regarding this?

Yes. We're seeing a significant portion of the production in CD specials coming from new clients. I would estimate that between 40% and 45% of it is new money, which may not always come from entirely new clients but is still fresh capital for the institution.

And historically, you have pretty strong metrics that those turn into nice cross-sells and more permanent customers.

Yes, that is the strategy.

Can you walk me through the earn back on the securities transaction this quarter? It sounded like it was even a faster earn back than you kind of target usually? But it's within a year, right? Or did I misread it a little bit?

In the first quarter, we sold approximately $97 million in balances, resulting in a loss of about $2 million. At the time, we indicated that this would pay back within the calendar year, which means we expect a payback in less than a year for that strategy.

And you're willing to kind of play around up to 2 years if you see opportunities and the balance sheet needs it?

Correct. And we'll be confident that the securities would stick around for those 2 years to make that earn back hold true.

Leasing has been in really strong trends. Can you just focus in on that for a moment, just what are your expectations next year? You talked about with higher rates, more folks are interested in leasing. And also just kind of big picture, credit expectations there, just kind of a reset on expectations for that business?

We operate two leasing companies. The first focuses on small ticket leases, with an average deal size of around $50,000, and the yield on these originations is currently over 19%. We anticipate growth in this segment. The second leasing business, which I will discuss shortly, is expected to yield more than 20%. At 19%, we account for some potential charge-offs, which have been below 1.5% over the last couple of years but could rise to 3% to 4% in the next two years. Nevertheless, we believe we are well compensated for this risk. Our second leasing business, Vantage in Minnesota, has an average deal size of about $270,000 and focuses on technology. Many of its clients include publicly traded companies, well-established school districts, and leading hospitals across the country. We have a very low expectation of charge-offs from this business and anticipate minimal charge-off activity over the next two years. Currently, the yields on originations in this sector are about 9%.

And there's some seasonality here, right? Is there a seasonality towards the end of the year with those two businesses?

There is a slight amount of seasonality, but it's not significant enough to make a noticeable impact.

And I'm just making sure I confirm that, 19% yields and 9%, right?

Yes. More or less.

Our next question will come from Daniel Cardenas with Janney.

I may have missed this, I joined a little bit late here. But on your leasing income for the third quarter, I noticed a significant drop. Can you give us a little bit of color as to what drove that and what's the potential for a bounce back in leasing income in the fourth quarter?

That relates to the purchase accounting associated with the Vantage transaction we completed last year. They have residual values on their books, and during the purchase accounting process, we needed to adjust those along with the entire balance sheet to fair value. This resulted in a premium related to that portfolio. As those leases come to term, we must recognize that premium against any gains that would otherwise be recorded. In the third quarter, you see about $1.8 million to $1.7 million in premium amortization. In previous quarters, this amount has not been as significant, but it can vary each quarter based on when those leases expire.

And then on the credit quality front, good to see some improvement in the nonperformers, but did notice that your 90 days past due were up a bit there. Can you give us some color as to where that was coming from categorically?

Yes, the majority of that is coming from this small ticket leasing business.

And then how are trends, how are watchlist trends looking for that business?

Look, the trends in delinquencies are increasing. The charge-off rate, we do expect it to increase. As I mentioned earlier, we've had multiple years with like 1.5% or less charge-off rates. Obviously, at a 19% yield, you're not going to get over a cycle 1% to 1.5% charge-off rates, and we're very comfortable. We frankly price that stuff to a 4.5% charge-off rate. We do not see ourselves getting near that 4.5% charge-off rate. But if it creeps up to the 2s and the 3s, we're perfectly comfortable with that.

Thank you for the guidance for 2024 regarding lending. Are there any areas where you might be slowing down growth in those portfolios? Additionally, how should we consider your provision going forward?

How should we approach our provision? We have never particularly favored hotels. We are interested in acquiring hotels and aim to optimize that segment. However, if someone has developed a profitable hotel with reliable sponsors, we will certainly consider it, but it's not our preferred sector. Overall, we are open for business, and we believe we are reaping benefits from that. We notice some competitors are retreating due to liquidity challenges. With an 86% loan to deposit ratio, we have capacity. Therefore, we anticipate seeing the advantages of that throughout 2024.

Yes. And as it relates to provision, I think, it's safe to assume that we'll follow what the forecast does. So that to the extent the forecast worsens, we will likely be building reserves. And otherwise, we'll just be reserving on the growth that the rates are kind of at, that you see on as it relates to the coverage ratio.

And then last question, I guess with competitors pulling back somewhat, is that being reflected in current yields?

I believe that the impact will be more evident in future yields rather than current ones. We haven't seen a significant increase in business from competitors pulling back during the first three quarters. However, this trend appears to be growing, and I anticipate that it will persist.

At this time, there are no further questions. Sir, do you have any closing remarks?

Yes. I want to thank everybody for joining our call this morning. Please remember that our earnings release and the webcast of this call will be archived at peoplesbancorp.com under the Investor Relationship section. Thank you for your time and have a great day.

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