Earnings Call Transcript - VLY Q3 2023

Travis Lan, Head of Investor Relations

Good morning and welcome to Valley's third quarter 2023 earnings conference call. Presenting on behalf of Valley today are CEO, Ira Robbins; President, Tom Iadanza; and Chief Financial Officer, Mike Hagedorn. Before we begin, I would like to make everyone aware that our quarterly earnings release and supporting documents can be found on our company website at valley.com. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to today's earnings release for reconciliations of these non-GAAP measures. Additionally, I would like to highlight Slide 2 of our earnings presentation and remind you that comments made during this call may contain forward-looking statements relating to Valley National Bancorp and the banking industry. Valley encourages all participants to refer to our SEC filings, including those found on Forms 8-K, 10-Q and 10-K for a complete discussion of forward-looking statements and the factors that could cause actual results to differ from those statements. With that, I'll turn the call over to Ira Robbins.

Ira Robbins, CEO

Thank you, Travis. In the third quarter of 2023, Valley reported net income of $141 million and earnings per share of $0.27. Exclusive of non-core items, adjusted net income and EPS were $136 million and $0.26, respectively. Our quarterly results were highlighted by organic capital growth, sound asset quality metrics, improved core deposit flows, and solid expense control. The current interest rate environment reflective of an inverted curve has challenged traditional banking models, and we have not been insulated from these pressures. That said, while the duration of the current inversion has exceeded original expectations, and is anticipated to continue for the foreseeable future, we do not intend to change our foundational business model. Our net interest income declined at a much slower pace than in recent quarters, and we believe that NII is near the bottom of its decline, all else equal. While the external environment remains fluid, our focus on executing our strategic initiatives remains steadfast. One of our strategic efforts over the last few years has been to transform our core operating environment to allow flexibility in integrating unique delivery channels, enhancing Fintech integrations, and positioning the bank for scalability without the traditional technology expense hurdles. I'm pleased to report that during the first weekend of October, our team worked tirelessly to complete the transformational conversion of our core operating system. This was a massive undertaking which required months of planning, development, and testing. Valley is now operating on a single system with bespoke delivery channels, and I couldn't be prouder of our discipline to execute on this project, which I reiterate, was done in the face of an extremely challenging operating environment. This technology conversion is the natural progression of a cultural evolution that has occurred over the last few years. We have collectively developed a growth-oriented mindset, which has been evident in our recent financial results. To support this mindset, we continuously strengthen and develop our capabilities to bring us more in line with the largest players in our industry. Our bankers now have a more robust infrastructure and we expect to see significant opportunities to leverage these new technologies and drive additional growth as the environment normalizes. Our successful conversion was yet another example of our discipline and proven ability to execute. As we enter 2024, we anticipate generating both expense efficiencies and revenue scale resulting from our common core platform. As we have moved to a cloud-based infrastructure, we're not burdened with the massive hardware costs that are typically associated with this type of technology investments. We are more nimble today than we were a month ago and the opportunities ahead of us remain significant. With that, I will turn the call over to Tom and Mike to discuss the quarter's growth and financial results.

Thomas Iadanza, President

Thank you, Ira. Slide 4 illustrates approximately $300 million of total deposit growth during the quarter. We experienced strong growth in interest bearing transaction accounts and retail CDs, which offset non-interest bearing deposit declines and indirect CD maturities. The pace of non-interest bearing deposit runoff has slowed, but the mix shift to interest bearing products has continued to weigh on our total deposit costs. Slide 5 provides more detail on the continued diversity of our deposit portfolio. During the quarter, we benefited from stability in our branch-based deposits and strong growth in our specialized verticals. Inflows were particularly strong in our national deposits business and through our online channel. These dynamics enabled us to pay off some maturing indirect CDs during the quarter. We also continued to reduce our adjusted uninsured deposit exposure and have significant coverage with cash and high-quality liquidity. Slide 6 further illustrates the diversity and granularity of our deposit base. No single commercial industry accounts for more than 7% of our deposits. Our government portfolio remains diversified across our footprint and is fully collateralized relative to state collateral requirements. Now, turning to Slide 7, you can see an overview of our loan growth and portfolio composition. Annualized loan growth on a year-to-date basis has slowed consistently as the year has progressed. Originations declined meaningfully during the quarter as we require wider spreads on new loans. These efforts continue to result in higher new origination yields. Slide 8 breaks down the diversity of our commercial real estate portfolio by collateral type and geography. As a reminder, we have an extremely granular loan portfolio with an average loan size of roughly $5 million. From a metric perspective, our weighted average LTV remains at 58%. As interest rates have increased, net service coverage ratios have declined somewhat to 1.7 times. We continue to closely monitor pools of maturing and resetting loans and believe that our borrowers are well-positioned to absorb the pass-through of higher rates. This reflects consistent underwriting discipline at conservative cap rates and significant stress testing efforts at origination. The following slide illustrates the continued strong metrics and granular composition of our diverse office portfolio. With that, I will turn the call over to Michael Hagedorn to provide additional insight on the quarter's financial.

Michael Hagedorn, CFO

Thanks Tom. Slide 10 illustrates Valley's recent quarterly net interest income and margin trends. The sequential $7 million decline in net interest income was less than half of the reduction experienced in the second quarter of the year. While asset yields continue to improve, continued pricing competition and mix shift drove funding costs higher. On the second quarter call, we indicated that we were observing signs of net interest income stabilization. During the quarter, monthly net interest income was generally stable and higher than the June level. Our fully tax equivalent net interest margin declined a modest three basis points on a linked quarter basis versus 22 basis points in the second quarter of 2023, and has been generally stable over the last few months. All else equal, we expect fourth quarter net interest income to be relatively in line with the third quarter level. By the end of the quarter, our liquidity position has been effectively normalized. Absent abnormal environmental factors, we expect cash to remain generally consistent with third quarter levels. Moving to Slide 11, we generated nearly $59 million of non-interest income for the quarter as compared to $60 million in the second quarter. Exclusive of approximately $6 million of non-core items, adjusted non-interest income was closer to $52 million for the quarter. The decline was primarily related to lower capital markets fees associated with our slower loan growth. Other business lines were generally stable. On slide 12, you can see that our non-interest expenses were approximately $267 million for the quarter or approximately $264 million on an adjusted basis. Adjusted expenses declined from the prior quarter despite an increase in certain technology costs, partially associated with our successful core conversion. Specifically, we began to see the benefits of recent headcount reductions about midway through the quarter. FDIC assessment costs and outside consulting fees also declined on a sequential basis. We continue to execute on previously identified efforts to slow future expense growth. Legacy Valley and the company have now joined on a common core. After a certain adjustment period, we expect the core conversion to result in the next wave of previously announced cost savings early in the new year. To reiterate, our focus is on controlling expenses in the face of revenue pressures, which have resulted from the inverted yield curve. Turning to Slide 13, you can see our asset quality trends for the last five quarters. Non-accrual loans have been effectively flat for the last three quarters. Early stage delinquencies ticked up during the quarter, but remained well below the average level of the last 12 months. Third quarter net charge-offs declined somewhat from recent levels. On Slide 14, you can see that tangible book value increased approximately 1.4% for the quarter and is up nearly 10% from a year ago. Our balance sheet positioning has enabled us to avoid the significant challenges that other peers have faced related to the OCI impact associated with available-for-sale securities. We manage all risk areas prudently and are proud of our ability to insulate tangible capital from this headwind. Tangible common equity to tangible assets increased to 7.4% during the quarter as a result of our normalized cash position. As loan growth slowed, our risk-based regulatory capital ratios have increased between 16 and 18 basis points as compared to the second quarter of 2023. We continue to prioritize organic capital growth in this challenging environment and are prudently managing our balance to incrementally strengthen our position. With that, I'll turn the call back to the operator to begin Q&A. Thank you.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Frank Schiraldi with Piper Sandler. Please go ahead.

Frank Schiraldi, Analyst

Good morning. Just on the trajectory of NII/NIM, I mean, you talked about the hopeful trough here. In a higher for longer scenario, just thinking out into 2024, do you think there's some stabilization in NIM, and then you get a reversal from there? So, you get a little bit of a trajectory upwards, or is it more sort of like a higher for longer, sort of bouncing along the bottom for a period of time? Just wondering your general thoughts there.

Michael Hagedorn, CFO

Hi, Frank. It's Mike. When we examine the trend of net interest margin in 2023, we've consistently been in the mid to low-290s since April. The cost of deposits increased by 60 basis points from the fourth to the first quarter of 2023, by 49 basis points from the first to the second quarter, and remained steady at 49 basis points going into the third quarter. We're beginning to see a normalization in both costs and net interest margin. In a prolonged high-rate environment, it's likely that we would see a modest increase in net interest income and net interest margin. Throughout 2023, the main factor contributing to the compression of our net interest margin has been the transition from non-interest bearing to interest bearing products. In a sustained high-rate environment, we may reach a point where this trend levels off. Additionally, we saw a significant liquidity build at the end of the first quarter and throughout the second quarter due to the disruptions from earlier bank failures, which has since been resolved by September 30. Looking ahead, as we anticipate deposits to stabilize, the key drivers of net interest margin expansion and increases in net interest income will likely come from the repricing of our earning assets, particularly loans. Our modeling takes into account the repricing of our fixed rate book and the opportunities we have through 2024 with our adjustable rate book. Therefore, we expect these factors to be the primary contributors to net interest margin growth next year.

Frank Schiraldi, Analyst

Okay. Great. Appreciate all the color, Mike. And then just as a follow-up to that, in terms of the brokered balances, it looks like you guys have had some really good success raising customer deposits and so you let these roll off. I guess, do you expect that to continue? And if so, as you look out at the pay at maturation payable, when do you expect or how quickly do you expect brokered balances to kind of fall here?

Michael Hagedorn, CFO

Yes, our current assessment is that we anticipate a continued reduction in our brokered balances, which is one of our objectives. I want to clarify how we've been utilizing brokered funding. Throughout 2023, we used brokered resources to address gaps, especially earlier in the year when we experienced significant loan growth that contributed to our balance sheet expansion. We also focused on ensuring that we were not adversely impacting our core deposit base. Additionally, in these temporary measures, we strategically managed both the duration and rate of that portfolio to support our net interest margin and net interest income. While brokered funding may have a negative perception at times, it has proven to be an effective tool in specific situations and circumstances.

Frank Schiraldi, Analyst

And just lastly on that front, in terms of, as you look at the indirect market versus what you're able to get directly from customers here. Is there much of a difference in terms of pricing, in terms of new brokered versus a new direct?

Michael Hagedorn, CFO

Yes. The inversion of the curve probably is the biggest impact on that. If you're talking about exactly the same duration, I would say the incremental cost of deposits is fairly close to one another. So, there may be a 10 basis point difference, but it's not that remarkably different. So, I think again, I'd go back to my previous comments. You want to use that for both rate and duration, but in the case that you're asking about, you probably want to manage the duration in this inverted curve.

Ira Robbins, CEO

Frank, it's Ira. I would just add to that when we think about the incremental piece of deposits, as Mike alluded to earlier, there was significant demand for us to put some of those incremental deposits on based on the loan growth we were seeing, and that obviously ratcheted up the incremental cost of some of these deposits. As we now scale back some of the loan growth, the demand for those broker deposits and higher CDs has actually come a bit down. And we're still originating core deposits. I think as we spoke about last time on the call, the overall deposit originations for this quarter were around 3.70, 3.80-ish. So, on a blended basis, marginal deposits are coming in much cheaper than what these directs are. And as we curtail the loan growth, we definitely anticipate some expansion on margin based on that incremental loan that's coming on.

Frank Schiraldi, Analyst

Great. Okay. Appreciate all the color guys. Thanks.

Ira Robbins, CEO

Thank you.

Matthew Breese, Analyst

Hey, good morning everybody. Maybe just sticking with the NIM, can you provide what the monthly NIM was across the quarter and is the September NIM a good launch point in the fourth quarter about where it could shake out for the fourth quarter?

Travis Lan, Head of Investor Relations

Matt, this is Travis. It's on a monthly basis, July was 291, August 292, and September of 291. So, when we say it was pretty stable throughout the quarter, I mean, we really mean it. So, you can use it as September end and the quarter with the same number. But, yes, that's a good launch point.

Matthew Breese, Analyst

Thank you. And then I was hoping also for some additional color on near-term loan growth outlook and maybe perhaps when you would feel comfortable reaccelerating loan growth.

Thomas Iadanza, President

Hey, Matt. it's Tom. Yes, the loan growth, the fact is slowing it down is really customer related, the uncertainty of the rate market as well as widening spreads has slowed down their activity. We still service those valued real estate customers when they need it and we continue to grow that portfolio; just had a much slower base. I just want to point out our C&I portfolio has grown 12% over the last year. So our focus is really on that relationship-driven C&I piece. We're still getting higher percent growth in the Florida market and stable growth here in the Northeast. I would expect that growth in the fourth quarter to be in a similar fashion to the third quarter and will be in that range of 7% to 9% for the year.

Matthew Breese, Analyst

Great. Okay. And then, Ira, just acknowledging yours and Valley's relationship with Bank, and first just wishing everybody on your end and on the other end the best as they deal with the horrific events over in Israel. In light of that, I was curious if events overseas will have, because of the partnership, any impact on your bank balance sheet or private client group in any way?

Ira Robbins, CEO

Thank you very much. I appreciate that. For all our employees and clients, it's been a very difficult time. That said, the bank is a significant part of our participation side. We haven't seen any interruption so far. We continue to expect business as usual. It’s definitely challenging for many people, but we believe we will keep progressing without any impact from it.

Thomas Iadanza, President

Yes. Hey, Matt. It's Tom. Just going to give you a little context here. The only direct loan exposure we have is to high net worth U.S. citizens, and it's secured by state of Israel Bonds as a very full portfolio. Otherwise, we help finance domestic subsidiaries of Israeli companies, but it's all done here in the U.S. The back and forth and flow of business slowed down really based on natural economic conditions, but it's business as usual and working with them on partnered transactions.

Matthew Breese, Analyst

Got it. Okay. And then could you give us some update as to where we are in the previously mentioned cost saving plan? I believe it was like $40 million identified? Last we spoke, it was expected to progress over four quarters. How is execution matching up versus planning? And is there anything else you've uncovered as you've kind of looked into this, in terms of additional cost saves?

Travis Lan, Head of Investor Relations

Yes, Matt, it's Travis. In the quarter, I'd say you probably got 20% to 25% of on an annualized basis, what we had anticipated. I don't expect much incrementally in the fourth quarter. Post conversion, we're keeping it stacked up and running. But then as we get into the first half of 2024, I think that's where you hit the next wave which will come from a combination of third-party vendors and some additional resource efficiencies. So, yes, I don't anticipate much in the fourth quarter. But again, once we get to the first half of 2024, I think that's where you see the bulk of what's remaining. We are still looking obviously post-conversion at opportunities that we hadn't previously identified. And so we'll continue to do there.

Matthew Breese, Analyst

And we should be thinking of this expense plan as one that slows down the natural pickup in expenses versus one that dollar-for-dollar lowers the run rate, correct?

Travis Lan, Head of Investor Relations

That's correct. So, I mean, if you think, and this is just high level, I don't mean for these to be numbers to take away, but historically we run kind of high single-digits from an operating expense growth perspective as a growth company. There are obviously headwinds from an inflation perspective, FDIC cost, regulatory perspective on top of that. And then we're just trying to work our way back into kind of that mid-single-digit expense growth level based on these initiatives.

Matthew Breese, Analyst

Great. Last one for me is just, I don't know if you have one or not, but could you just comment if you do on syndicated loan exposure? What's the size of that book? How is it performing? Any other metrics we should be aware of there?

Thomas Iadanza, President

Yes, sure, Matt. It's Tom again. The portfolio is about $1.4 billion, spread over a number of loans. When I think HLT lender is, we don't really have leveraged transactions in there. They're mostly clause deals with a small group of banks, direct contact relationships with any of the borrowers in the rolling market.

Matthew Breese, Analyst

Perfect. I appreciate it. It's all I had. Thank you.

Thomas Iadanza, President

And we lead a lot of those transactions also. We're not a participant. We tend to be the lead bank in over 50% of that.

Michael Perito, Analyst

Hey guys, thanks for taking my questions.

Thomas Iadanza, President

Good morning, Michael.

Michael Perito, Analyst

I apologize. I got on a couple minutes late, so if you guys addressed this already, I apologize for asking again. But just taking into context all the commentary you guys have given around NII and the expense plan kind of execution, is it fair for us to be thinking about the third quarter of 2023 as probably the peak in the efficiency ratio here? And are you guys at this point able to provide any kind of context around the type of year-on-year improvement you're hoping the expense plan can drive, assuming your NII projections kind of play out as you expect them today?

Thomas Iadanza, President

So I don't think there's any banks, CFO, that would say that third quarter would tend to be their peak. I think fourth quarter tends to be the peak for a lot of reasons, right? You have year-end expenses that get pushed through. There are some bonus accrual work sometimes in the fourth quarter that might drive costs up. So I wouldn't necessarily agree with that it's third quarter, but I would point you back to Travis's comments right before that. If it's fourth quarter that's actually the peak, again in the first half of 2024, we expect to realize the vast majority, the remainder in the vast majority of our previously announced cost savings initiatives, which in turn would then drive down our efficiency ratio.

Michael Perito, Analyst

Got it. That's helpful. And then just a couple more quick ones on, I think the kind of New York, New Jersey area of credit commercial real estate dynamics, we probably beat the dead horse on that for quite some time now, but just curious if you guys can maybe provide some context about updated demographics and trends you're seeing in the Florida and Alabama market. I mean, are there similar kind of supply and demand dynamics? Is there still kind of inflow of population growth? And just wondering kind of what the demographics are down there more recently.

Thomas Iadanza, President

Yes, sure, Michael. This is Tom. Yes, the impacts of slowing and higher interest rates are affecting them also. The metrics on the transactions we do aren't any different. They're below 60% loan to value, usually 1.6% or 1.7% debt service coverage. So we're still generating transactions with those similar metrics. We are seeing continued growth in those markets. The population migration has slowed but there's still migration into that Florida market. Our consumer business is strong down there but probably half of what it was in the earlier part of this year. It's still a growth market for us in all cases but you know I'll continue to point out we underwrite very conservatively in all markets. We have floors that are cap rates in all markets. We track those cap rates. We're more suburban than urban. We're not big players in the Miami market. We're more spread around the six or seven other major areas of Florida.

Michael Perito, Analyst

Thanks, Tom, really helpful. And then just the last one for me, just once again, kind of taking into context all your other commentary, is it fair for us to be thinking about the asset base to be pretty stable here for the next several quarters, and then possibly some lift beyond that, assuming the environment is permitting of kind of growth reaccelerating? Is that similar to how you guys are budgeting it, or is there any kind of anything that you would point to that could make a difference?

Michael Hagedorn, CFO

I think you have it generally right, Mike. I mean, I think, end of the third quarter, our cash position was normalized. I think Tom referenced the growth that we anticipate in the fourth quarter, and then kind of picking up maybe somewhat in 2024, but I don't think there's any type of significant other changes that you would see on the balance sheet.

Michael Perito, Analyst

Very good. Thank you guys. I appreciate it.

Thomas Iadanza, President

Thank you.

Jon Arfstrom, Analyst

Hey, thanks. Good morning, everyone.

Thomas Iadanza, President

Hi, Jon.

Jon Arfstrom, Analyst

Maybe a question for you, Mike. On slide 11, you show the fee income numbers in capital markets being down, and you tied it to loan growth. What kind of expectations should we have for capital markets? And then also curious if there's any kind of expense offset, how much bottom line impact there is to lower capital markets fees.

Thomas Iadanza, President

Yes, hey John, it's Tom. Yes, the capital markets for us has really been driven by gain on sale in the consumer revenue space, as well as swaps in the commercial space. We expect that to be flat going forward. We don't expect any lift there. We have other avenues here. We have a tax advisory business. We get this slight uptick in the fourth quarter to get things closed by year-end. We continue to build out our FX trades, which shows progress quarter to quarter, but we're expecting flat into next year.

Jon Arfstrom, Analyst

Okay. Okay, good. Credit looks great, but some of the accruing past dues are up sequentially. Anything to note there, anything that you're thinking about there that we should be aware of?

Thomas Iadanza, President

No, no. I'm looking at it, really, it's coming out of the consumer and residential buckets. On the consumer side, it's primarily our cash surrender value life insurance business. It's a matter of liquidating and collecting on there. So that's not going to be problematic from any potential loss standpoint. On the residential side, I just want to point out, our second quarter levels were abnormally low. We are still below where we were a year ago at this point. We're about $99 million in the third quarter of 2022. We're $79 million in the third quarter of 2023. So we're really gravitating to more normal levels. So, no, we don't anticipate any problems.

Jon Arfstrom, Analyst

Okay, good. And then, Mike, you referenced Slide 4, that upper right chart with the deposit cost increases. And what do you think that looks like in a quarter or two? I mean, you referenced the 49 and 49 for the last two quarters, but is that curve bending at all from the 49?

Michael Hagedorn, CFO

If it's bending, it's ever so slight. I think you'll see the real bend and flexion point happen early next year, but you still see some migration. It's slowed considerably, but you still see some migration from non-interest bearing into interest bearing. From an incremental next dollar cost of deposit funding and more broadly, even liability funding, that is definitely stabilized in that mid-5-ish range.

Operator, Operator

Thank you. I'm showing no further questions at this time. I'd now like to turn it back to Ira Robbins for closing remarks.

Ira Robbins, CEO

Thank you. I just want to thank everyone for taking the time to listen to our call today. And we look forward to speaking to you in three months.

Operator, Operator

Thank you for your participation in today's conference. This concludes the program. You may now disconnect.