Earnings Call Transcript - PEBO Q1 2024

Operator, Operator

Good morning, and welcome to the Peoples Bancorp Inc. Conference Call. My name is Danielle, and I will be your conference facilitator. Today's call will cover a discussion of the results of operations for the quarter ended March 31, 2024. This call is 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 or future events. These statements are based on management's current expectations. The statements in this call, which are not historical fact, are forward-looking statements and involve a number of risks and uncertainties detailed in Peoples' Securities and Exchange Commission filings. Management believes the forward-looking statements made during this call are based on reasonable assumptions within the bounds of their knowledge of Peoples' business 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 required by applicable legal requirements. Peoples' first quarter 2024 earnings release was issued this morning and is available at peoplesbancorp.com under Investor Relations. A 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 15 to 20 minutes of prepared commentary, followed by a question-and-answer session, which I will facilitate. An archived webcast of this call will be available on peoplesbancorp.com in the Investor Relations section for 1 year. Participants in today's call will be Tyler Wilcox, President and Chief Executive Officer; and Katie Bailey, Chief Financial Officer and Treasurer, and each will be available for questions following opening statements. Mr. Wilcox, you may begin your conference.

Tyler Wilcox, CEO

Thank you, Danielle. Good morning, everyone, and thanks for joining our call today. I want to start off by thanking Chuck Sulerzyski for his service over his 13-year tenure with the bank as he retired effective March 31. Chuck was instrumental in moving us into the future. Cleaning up our credit quality after the Great Recession, driving shareholder value through improved performance, both organically and through acquisitions; advancing our technology to match that of our largest competitors, and probably the most important part of his legacy, leaving behind a culture that promotes the well-being of associates, which creates a better customer experience and focuses on giving back to our communities in a meaningful way. Thanks, Chuck, for everything you've done. Moving on to our first-quarter performance. Earlier this morning, we reported earnings of $29.6 million, while our diluted earnings per share were $0.84 compared to $0.96 for the linked quarter. As we noted in our last quarter, we have annual expenses that we recognize during the first quarter of each year, which included employer contributions to health savings accounts and stock-based compensation expense for certain retirement-eligible employees. These additional costs totaled $2.6 million and negatively impacted diluted EPS by $0.06 for the first quarter. We had many positives for the quarter and are pleased with our results. Our net interest margin compressed only 5 basis points compared to the linked quarter; excluding the impact of accretion income from acquisitions, we had stable fee-based income as annual performance-based insurance commissions offset declines in lease income. Our noninterest expense was down compared to the linked quarter, excluding the annual first-quarter increases for stock-based compensation and employer contributions to health savings accounts. Our loan-to-deposit ratio declined to 84.7% compared to 86.1% at year-end. Deposit balances increased 2% compared to year-end and were largely driven by retail CD growth. Our tangible book value per share improved $0.23 and was $18.39 at quarter end. We announced an increase to our quarterly dividend for the ninth consecutive year, and we completed another $3 million share repurchase during the quarter. Moving on to our credit quality. Our allowance for credit losses grew to 1.05% of total loans at quarter end. The increase in our allowance was driven by moderate deterioration in the macroeconomic conditions in our CECL model, higher reserves on our individually analyzed loan portfolio, and loan growth. Our net charge-off rate for the quarter declined slightly compared to the last quarter and was 22 basis points annualized for the first quarter. While consumer indirect and leasing net charge-off trends are elevated compared to prior year quarters, they are more consistent with historical pre-pandemic averages, and we remain satisfied with our risk-adjusted returns on these businesses. Nonperforming assets grew to 50 basis points of total assets at quarter end compared to 43 basis points at year-end. Most of the increase was related to higher non-accrual balances. The portion of our loan portfolio considered current at quarter end improved to 98.7% from 98.6% at year-end. Criticized and classified loans both increased during the quarter and were driven by the downgrade of 2 acquired commercial and industrial loan relationships. We view our credit quality as a strength despite some specific downgrades this quarter. The collateral and guarantor support on the loans in question are strong, and these relationships are not indicative of an overall trend in our commercial credit quality. Our portfolio strength is evidenced by the low delinquency rates this quarter. As far as loan concentrations, we continue to have no material exposure in commercial office space, hospitality, or assisted living. Our multifamily loans remain relatively unchanged from year-end as these loans stood at $522 million at quarter end compared to $520 million at year-end. As we have noted before, these properties are primarily located within growth markets with strong economic metrics and notable sponsor support. Compared to year-end, our total loan portfolio grew $44 million or 3% annualized. Most of the growth was driven by increases in our commercial real estate, premium finance, and commercial and industrial loan balances, which were up $112 million in total. This growth was partially offset by declines in construction loans, which were down $49 million, and our consumer direct and consumer indirect loans also combined for a $31 million decrease compared to the linked quarter end. Part of the decline in loan balances was driven by the renewal cycles of acquired Limestone loans that were paid off. At quarter end, our commercial real estate loans comprised 36% of total loans, nearly 40% of which were owner-occupied, while the remainder were investment in real estate. At the same time, our total consumer loans, which include residential real estate and home equity lines of credit, were 28% of total loans. Commercial and industrial loans were 20%, specialty finance totaled 11%, and construction loans for 5%. At quarter end, 48% of our total loans were fixed rate, with the remaining 52% at a variable rate. I will now turn the call over to Katie for a discussion of our financial performance.

Katie Bailey, CFO

Thanks, Tyler. For the first quarter, our net interest income declined 2% mostly due to lower accretion income, net of the amortization expense from our acquisition. Improvements in loan and investment income offset higher deposit expenses for the quarter. Our net interest margin was 4.27% for the first quarter compared to 4.44% for the linked quarter. The change in net interest margin was driven mostly by the decline in accretion income, which contributed 32 basis points to our margin this quarter compared to 45 basis points last quarter. For the fourth quarter, we have refinements in our fair value marks for Limestone that contributed an additional 7 basis points to margin. We continue to expect our accretion to normalize in the coming months as some of the initial noise around refinements to fair values and portfolio activity subsides. The small remaining decline in net interest margin compared to the linked quarter was mostly due to excess cash on hand during the quarter, which negatively impacted margins by 6 basis points. For liquidity purposes, we are holding cash on our balance sheet that we have previously held off balance sheet. We continued to run CD specials in the first quarter of 2024. We will evaluate our position and look for opportunities to lower our rates while keeping the duration of term on our retail CDs on the shorter end to retain flexibility. Moving on to our fee-based income. We were down 1% compared to the linked quarter, which is driven by declines in our lease and electronic banking income and partially offset by higher insurance income. We typically recognize higher insurance income in the first quarter of each year due to annual performance-based insurance commission, which totaled $2.2 million compared to $1.5 million for the prior year quarter. As it relates to our noninterest expenses, they were up slightly compared to the linked quarter. However, when excluding the additional cost of $2.6 million related to employer contributions to health savings accounts and stock-based compensation expense for certain retirement eligible employees, our noninterest expenses were down compared to the linked quarter. Compared to the prior year quarter, noninterest expense grew 21% and was heavily impacted by the larger footprint and ongoing operating costs of the additional offices from Limestone. For the first quarter, our reported efficiency ratio was 58% compared to 56% for the linked quarter. When adjusted for non-core expenses, our efficiency ratio was 58.1% compared to 54.9% for the linked quarter. The increase was related to higher noninterest expenses mostly due to our additional annual first quarter expenses, coupled with lower net interest income due to declined accretion income. Moving on to our balance sheet. Our investment securities portfolio to total assets was relatively stable compared to year-end and was at 20.1% at March 31. At the same time, our loan-to-deposit ratio declined to 84.7% from 86.1% at year-end. We continue to have a healthy level of liquidity and have been holding more cash on our balance sheet in recent months. We mentioned last quarter that we utilized the Federal Reserve's bank term funding program, and while additional funding has been restricted, we currently have $163 million outstanding that we anticipate holding until maturity in January of 2025 as long as rates continue to make this advantageous. From a deposit perspective, we grew our balances 2% from year-end. We were able to increase our retail CDs by 16%, governmental deposits by 14%, and money markets by 11%. We implemented a deposit pricing strategy last year, utilizing short-term higher-rate CD offerings for customers which continued to bolster our CD balances into the first quarter. While we want to retain the deposits we have generated, we also want to control our long-term deposit cost. The increase in governmental deposits during the quarter was related to seasonal influxes of cash. Our demand deposits declined to 35% of total deposits at quarter end compared to 38% at year-end and has been impacted by our retail CD growth in recent quarters. At quarter end, our deposit composition was 76% in retail deposit balances which included small businesses and 24% in commercial deposit balances. Our average retail customer deposit relationship was $24,000 at quarter end while our median was $2,800. Moving on to our capital position. We are confident in the value of our stock and repurchased another $3 million of shares during the first quarter. Additionally, we remain confident in our performance and raised our quarterly dividend by $0.01 this morning, making this the ninth consecutive year of a dividend increase. Our $0.40 dividend represents a yield of 5.6% per share. At quarter end, our capital ratios remained strong. Our common equity Tier 1 capital ratio was 11.7%. Our total risk-based capital ratio was 13.4%, and our leverage ratio was 9.4%. Our tangible equity to tangible assets ratio improved to 7.4% compared to 7.3% at year-end due to increased retained earnings. This calculation has been negatively impacted in recent quarters by the excess cash we have been holding on our balance sheet. For several quarters, our accumulated other comprehensive losses have reduced this ratio, which stood at $109 million at quarter end. Our tangible book value per share grew to $18.39 at quarter end compared to $18.16 at year-end. Finally, I will turn the call over to Tyler for his closing comments.

Tyler Wilcox, CEO

Thank you, Katie. As we move forward into 2024, our main goal is to continue making progress on our strategic initiatives. We intend to invest in our infrastructure and technology, remain unwavering in our high-quality credit standards, take care of our clients and communities, focus on our associates and being a great employer, drive shareholder value by consistently providing solid performance and total return on our stock, and continue to be acquisitive when it benefits us in the future. As it relates to our financial performance for 2024, we anticipate net interest income to benefit from the full-year impact of the Limestone merger. We expect our quarterly net interest margin to be between 4.1% and 4.3%, assuming that there are no significant short-term interest rate changes in 2024. We believe our fee-based income growth will be between 6% and 8% compared to 2023. We expect quarterly total noninterest expenses to be between $67 million and $69 million for the second, third, and fourth quarters of 2024. We believe our loan growth for 2024 will be between 6% and 8% compared to 2023. As we noted last quarter, we anticipate an increase in our provision for credit losses with the anticipated loan growth and return of some of our net charge-offs to pre-pandemic levels. As we move through the year, we are expecting a full year net charge-off rate of around 20 basis points. Our first-quarter earnings continue to beat expectations, and our diluted EPS of $0.84 exceeded the consensus analyst estimate of $0.80 for the quarter. I could not be more proud of what our associates and teams have accomplished in recent quarters in terms of preparing for expected growth, implementing new technology, integrating our most recent merger, and driving organic growth while taking care of each other and our clients. We will continue to build upon our successes into 2024 and beyond, all with the goal of making Peoples' the best community bank in America. This concludes our commentary, and we will open the call for questions. Once again, this is Tyler Wilcox, and joining me for the Q&A session is Katie Bailey, our Chief Financial Officer. I will now turn the call back over to our call facilitator. Thank you.

Operator, Operator

The first question comes from Brendan Nosal from Hovde Group.

Brendan Nosal, Analyst

Maybe just to start off here on an update for the internal preparation for $10 billion in assets. Just kind of curious what inning you're in? How much more run rate costs do you need to bake in? And then maybe some early thoughts on the Durbin impact as well.

Tyler Wilcox, CEO

Yes, Brendan, thanks for the question. I would say from an inning perspective, we're in the ninth inning, and we're ready to go. If the correct opportunity came by, we feel confident in the investments that we've made and the preparation we've done, both in Peoples' systems and preparation for the regulatory environment. So from that perspective, it's just a matter of finding the right opportunity to cross. I believe the second part of your question was related to the expenses.

Katie Bailey, CFO

Yes. And I think the expense base for the first quarter includes all of the expenses we would anticipate. There are some minor enhancements we'll make as it relates to risk management and so forth, but nothing from a material perspective yet to be added in the expense base.

Brendan Nosal, Analyst

Okay. Fantastic. Got it. That's helpful. Maybe to pivot over to the deposit side of things. Just kind of curious for your latest thoughts on where noninterest-bearing balances might bottom out. I know it's hard to pinpoint, but any color there would be helpful.

Katie Bailey, CFO

Yes. As you saw, we had some decline in the first quarter. What I can say is we expect to experience a little more continued runoff as we proceed through 2024, nothing significant. And the good news to date for the month of April, we're actually showing some stability in that category. So we'd like to see that trend continue. But from a forecast perspective, I think we still expect some migration out of noninterest-bearing deposits as we proceed through 2024.

Brendan Nosal, Analyst

All right. Perfect.

Operator, Operator

The next question comes from Daniel Tamayo from Raymond James.

Daniel Tamayo, Analyst

First on the NII and the NIM guidance. Maybe, Katie, if you could give us an idea of what's baked into that 4.1% to 4.3% NIM guidance? What may push you towards the lower end versus the higher end? And then if you have any more thoughts or detail on how much pressure you're expecting on accretion, that would be great as well.

Katie Bailey, CFO

Yes. The main factor affecting the net interest margin is deposits, particularly the migration and the costs associated with retaining them, which would push us towards the lower end. Regarding our rate forecast, as mentioned earlier, we are in a relatively neutral position with our balance sheet. Thus, we can effectively manage a couple of 25 basis point changes to maintain that range. That's the primary driver. In terms of accretion, we recorded a 33-basis point impact for this quarter. Last quarter, I suggested a range of 30 to 35 basis points, and I believe we will stay within that range for the second quarter. However, we might drop slightly below that in the latter part of this year as loans continue to reprice or renew either within our portfolio or outside of it.

Daniel Tamayo, Analyst

Okay. But fair to say you're still expecting, I guess, some core NIM pressure in your baseline assumptions?

Katie Bailey, CFO

I anticipate some pressure in the form of compression that we might face next quarter, though not nearly as severe as what we experienced this quarter. Unlike the fourth quarter, we didn't have a true-up in accretion this quarter. From an accretion standpoint, I believe we'll remain within the 30 to 35 basis points range. It seems likely the deposit cost will contribute to a slight increase in compression, but nothing substantial from my point of view.

Daniel Tamayo, Analyst

Got it. Okay. And then in terms of the excess cash on the balance sheet, what's the plan for how long that sticks around?

Katie Bailey, CFO

Yes. Some of that will migrate off as we have public funds balances roll off, as we've noted before, seasonally in the first quarter. Public funds are at a high watermark. And those are collateralized through investment securities being pledged to them. So as those migrate off, we'll be able to reduce the pledged securities and thereby maintain some of that liquidity off balance sheet through unpledged investments. That will be one of the strategies. So you'll see some of that come off in the second quarter, and we have some other activities we're deploying that we expect to see benefit as we proceed through the third quarter.

Daniel Tamayo, Analyst

Okay. But that's all kind of contemplated in the high-level net interest margin path you were talking about.

Operator, Operator

The next question comes from Terry McEvoy from Stephens.

Terence McEvoy, Analyst

Just kind of big picture, Tyler, in the release, you said demand for C&I loans and leasing remain strong. And then later in the release, there was an increase in the provision connected to a deterioration in the economic conditions. So Tyler, can you just talk about the healthier markets? And where you're seeing the C&I loan growth in particular?

Tyler Wilcox, CEO

Sure, Terry. So a couple of thoughts just to make some distinction there. The provision release did include some macroeconomic considerations where we take into consideration employment nationally. We take into consideration a queue factor there of commercial real estate nationally. I would distinguish that with our view on our book of business. We see the growth coming from a broad-based segment of our markets. One of the reasons why we are satisfied with our overall loan portfolio and our production is because of the breadth of geography that we have and the breadth of different businesses that we have, that portfolio of businesses approach that we've developed. So notwithstanding some of the small ticket leasing having a slight uptick in the credit issues, we see demand nationally in the leasing businesses. We saw good growth and we expect to continue to see good growth in the national premium finance business. And then on the C&I and CRE side, we continue to have that broad-based market of Louisville, Lexington, Washington, D.C., Columbus, Cleveland, Cincinnati, and so forth. So the confidence in that 6% to 8% guidance comes from the strength of the pipeline that we're seeing today. Historically, we've seen a little bit slower out of the gate, but if you look at the raw production, we think we have a chance to hit those numbers and that's pretty realistic.

Terence McEvoy, Analyst

Appreciate that, Tyler. And then as a follow-up question on commercial real estate, specifically the non-owner occupied. What's the amount that matures over the next year or 2 years? And how have you stress tested that just to prepare the borrower for higher interest rates?

Tyler Wilcox, CEO

Yes, we are quite satisfied with our processes for stress testing our portfolio. Over the past couple of years, we have maintained strong discipline in this area. In the upcoming year, we have approximately $185 million maturing, followed by about $130 million in 2025. This is a very manageable amount. Our internal credit practices include assessing the borrower's strength, evaluating debt service coverage ratios, and adhering to our financial guidelines to reach these conclusions.

Terence McEvoy, Analyst

Appreciate the forward-looking financial guidance provided earlier.

Operator, Operator

The next question comes from Tim Switzer from KBW.

Timothy Switzer, Analyst

The first one I have is with your NIM guidance, assuming no meaningful changes to short-term rates. What would be the impact if, in late 2024 or early 2025, we start to get a series of rate cuts, say, 3 to 4, 25 basis point cuts? How do you think the NIM would trend over the next year? Is it down initially as loans reprice lower? And then maybe some relief as deposits start to reprice? How are you guys thinking about that?

Katie Bailey, CFO

Yes, I think that's right. I think as long as they stay in 25-basis point increments and don't do a meaningful change in one meeting, which is our expectation going forward. I think the impact will be relatively minimal, maybe somewhere around 5 basis points, not significant to the extent if they keep it to 25 for a couple of meetings. And to your point, I think as we proceed through time, we'll be able to recover some of that back through margin to the point you made on deposits. So our retail CD production is relatively short term. We won't get the immediate benefit of those repricing lower. But in relatively short order, we'd be able to see some benefit and relief on that funding.

Timothy Switzer, Analyst

Okay. That's helpful. And your expenses this quarter were a bit better than your guidance to be above that $67 million to $69 million range. Is there an opportunity, do you think, for the rest of the year for you to be on the lower end of that $67 million to $69 million range in your guide? And what would drive the better trends there?

Katie Bailey, CFO

Yes. I think there's a chance for a quarter or two, we might be on the lower side. I think we'll be somewhere in the midpoint of that range pretty consistently through the year. I think some of the main drivers is medical costs for us in the first quarter came in a little softer than we had anticipated, which isn't a bad thing. But generally, those tend to grow as we proceed through the year, which is why I don't think we'll see that benefit we saw in the first quarter each quarter going forward.

Timothy Switzer, Analyst

Okay. Got it. And then the last question for me. Your noninterest income guidance of up 6% to 8%. Is that excluding net gains and losses?

Katie Bailey, CFO

Yes. That excludes gains and losses on investment security sales and as well as any other assets we would sell.

Operator, Operator

The next question comes from Manuel Navas from D.A. Davidson.

Manuel Navas, Analyst

Just a follow-up on that fee guide. It's a little bit lower than before. Can you just talk about the drivers there?

Katie Bailey, CFO

Yes. I think the big driver for that is electronic banking income. I think we've seen, consistent with what we've seen in industry publication, some compression or some reduction in electronic banking income, which is probably the main driver in that category. And couple that with a little bit softer mortgage market than what we had anticipated, although I think we see some signs that we might get some relief in that in the coming quarters, but those are the two main drivers.

Manuel Navas, Analyst

You mentioned the increases in criticized and classified loans. Am I correct that this is primarily related to acquired loans? Any additional insights would be appreciated.

Tyler Wilcox, CEO

Sure. I'll take that one. We have two commercial and industrial loans that are acquired loans. We're quite confident about the acquired portfolio. One of these loans is part of the equine portfolio from the Limestone acquisition and is well secured by property and inventory. We believe we can manage this one effectively. The second loan is linked to a senior living facilities operator, which also has strong collateral and support from a guarantor. We consider these to be isolated incidents, especially when compared to the performance of our core portfolio and the other acquired loans, which are meeting our expectations.

Manuel Navas, Analyst

Okay, that's really helpful. In the last quarter, you provided some nice ranges for larger moves in Fed funds regarding NIM and NII. Do you have any updates on that? If not, I can move on, but I'm just curious if there's any information on a steeper decline in Fed funds.

Katie Bailey, CFO

Yes, in response to the earlier comment, if we see a decrease of 25 basis points over the next few quarters, I believe that guidance will remain applicable. Our balance sheet is relatively neutral, so I don't anticipate a significant impact whether rates change by 25, 50, or 75 basis points in upcoming meetings.

Manuel Navas, Analyst

Okay. So as long as there's no increase in pace, you can adjust to it. That makes sense. My last question is you talked about potentially being acquisitive when beneficial. How would you term M&A discussions currently? Just kind of what you're hearing in the market. And what would you look for to be beneficial?

Tyler Wilcox, CEO

Thank you for the question. I have a few thoughts on that. The right partnership would involve the right price, size, and geography. There are several factors that could make it suitable. Ideally, many believe that a single large acquisition would allow us to leap ahead. However, the pool of banks in the $1 billion to $2 billion range is limited. We would be open to opportunities if large banks are willing to collaborate with us to surpass that $10 billion mark. Additionally, if there are two or three banks in the $1 billion to $2 billion range, we would consider making successive acquisitions, as we have demonstrated the ability to successfully execute such transactions in the past. Both options are definitely viable. There are numerous discussions happening across the industry, and we remain actively engaged in conversations regarding potential acquisitions. We will continue to be opportunistic when the right opportunity arises.

Manuel Navas, Analyst

I appreciate that. Thank you.

Operator, Operator

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

Tyler Wilcox, CEO

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

Operator, Operator

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