Wsfs Financial Corp Q2 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to WSFS Financial Corporation Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I’d now like to turn the call over to your host for today, Mr. Dominic Canuso, Chief Financial Officer. Sir, you may begin. And our first question coming from the line of Michael Perito with KBW. Your line is open.

Hey, good afternoon guys. Thanks for taking my questions.

Good evening, Mike.

I want to ask on the growth piece of it. It seems like you’re obviously a really strong C&I franchise in your core markets, but it seems like other areas like some of your consumer partnerships and new lanes and some of the equipment financing are seeing better growth. And I guess as part of that, because of having a little bit more geographic diversification, I was just curious if you could maybe update us on how you kind of view that element of your loan portfolio today and do you kind of see yourself exploring more of those opportunities in the future to try and enhance growth outside of the Metro Philadelphia, Wilmington area?

Sure. Good question. And a lot there, but I’ll start off. We do see strength in the commercial loans. Obviously as we’ve mentioned, excess liquidity continues to play into the loan demand in our markets and particularly we continue to be disciplined in our pricing and terms, which results in the loan growth you’re seeing here. On the consumer side, we do have various partnerships and avenues generating the appropriate products and services for our customers including a partnership with Spring EQ, which is secondary market mobile-based lending. We have LendKey generating student lending and we’re just launching a new product in the third quarter here, which is unsecured lending with Upstart, which we anticipate to add to the loan growth in the second half of the year.

Yes. And if I could just add on that, Mike, just some historical context. Obviously we’re a regionally focused, commercial-driven C&I bank. I would think that we’ve always liked to have some diversity in our loan book. We’ve kind of targeted that we’d like to have at least 20% of our loans in consumer loans; that may go a little below or a little above, depending upon where things are. But with our investments that we’ve made in a franchise here locally, I would expect that the majority of our growth over time will come from local-based lending with C&I being the leading category for us in the commercial area. Obviously, that’s a little bit challenged right now because of, as Dominic said, the unevenness of the recovery and overall conservatism by a lot of our borrowers. But I think we’ve demonstrated over time the value of those relationships. And I think it's important to point out that many of those relationships are the drivers of some of the deposit growth that we’ve seen, which solidifies the premise of the strategy around full relationships.

Got it. Very helpful. Just two more, I wanted to hit on real quick. Both yourselves and Bryn Mawr Trust had really strong quarters growing the wealth management AUM and revenues. And obviously, I think when you guys announced the deal that was a pretty important element of the pro forma franchise. I’m just curious if you have any — I know you have the broader fee income guide — but I was just curious if you have any more general outlook comments about combining the two wealth platforms, and the type of growth that you think you could achieve once that happens.

So this is Rodger again. I’ll start now and let Art give you a little bit more specificity. I would just tell you that everything that we thought coming into the discussions through our due diligence and since then about the wealth opportunity has been confirmed. We think there’s significant opportunity with our combined franchise. The integration process is going very well. The teams have come together, and the leadership under Art and Jen Fox from Bryn Mawr Trust has really started to put together a very significant integration plan. It’s being very well received by our customers and in the marketplace. I think everybody recognizes the value of the combined wealth businesses. And we see as much, if not more potential than when we did the original modeling. I’ll throw it over to Art for any kind of specific color.

Yes, thanks, Rodger. Mike, this is Art and yes, I’d add maybe three points to that. One is, as Jen and I worked through the integration and getting to know each other, and we look at each other’s strategic plan, we laugh a little bit in that it’s almost like we were looking over each other’s shoulders as we were preparing our plans independently. We’re finding the businesses are very complementary, and the teams are realizing that and seeing the potential, and they’re all very excited. So that leads us to believe that this is going to be a great combination. Secondly, Rick, Steve and I have been working over the last couple of years to really make sure the retail, commercial and wealth businesses are going into market on a more holistic basis, and we’re seeing a lot of good interaction between our ends and our advisors. We have in some cases commercial relationships where the owners are selling the business and we’re getting good referrals. So while we may not get the loan growth, we’re certainly getting the fee benefit from that. We’re seeing the same thing on the retail side with all the excess liquidity and people looking for other places to invest. Thirdly, our corporate trust business is really hitting on all cylinders, partly due to market securitization activity being very high and secondly because our team, with the addition of a new Business Development Officer, has made inroads into new relationships. So that’s really helping and we see a pipeline that continues to be very robust on that front.

Helpful color. Thanks. And then just lastly from me, and then I’ll kick it to someone else. Rodger, this probably a quick answer, I just want to confirm: is it fair for us to assume that once the Bryn Mawr Trust deal closes that your approach to capital deployment will probably near what you guys did leading into the announcement, as it regards to share repurchase appetite and that steady dividend payout?

Yes. There will be no change to our long-term capital philosophy and strategy. Obviously, it’s just paused because of where we’re at in the combination.

Appreciate it. Thank you, guys.

Thank you, Mike.

Now, next question coming from the line of Erik Zwick with Boenning & Scattergood. Your line is open.

Good afternoon, everyone. Are you able to hear me?

Yep. Hey, Eric.

Yes, Eric, it’s Steve Clark. The pipeline is fairly consistent with what it has been over the past quarter or so. Our 90-day weighted average pipeline for commercial is around $235 million and it remained strong and as high as it’s been since the fourth quarter of 2019. So despite the headwinds, we are getting opportunities across our C&I and CRE businesses and feel good about it. Regarding yields on new loans greater than $250,000 for the second quarter, the weighted average yield was 3.52%. We target that mid-threes and feel good about that; that compares to 3.67% in the first quarter, but is fairly consistent.

Yes, this is Rodger. If I could just add to that. Our commercial loan fundings were up in the second quarter, just under $450 million. It’s a challenge right now, candidly, to stay in front of the payoffs for all the reasons that we’ve talked about. We feel good about the momentum; it’s just the churn has been a little greater than we had anticipated, and that’s really what you see reflected in the outlook for the second half of the year.

That’s good color. I appreciate it, guys. Switching gears to credit. If I look back to the press release from second quarter of last year, that hotel portfolio had $247 million of loans that received, I think, risk rating downgrades. This quarter’s 2Q21 press release indicated that total problem assets declined by about $100 million or so mainly due to the hotel portfolio. So, just curious as you look at it today, what is the percentage of those original loans that were downgraded that have yet to be upgraded and what are you seeing within those — any commonalities from geography or hotel type or occupancy, or what are you still watching and maybe what gives you some concern today?

Yes. Last year, of our hotel book, which was about $540 million, we did downgrade and criticize a little over 50% of that book. We thought that was the correct action at that time. As you’ve read, we’ve seen improvement and we have upgraded some of that exposure here in the second quarter. The percent of criticized assets in the hotel book has been reduced down to 39%. All of those borrowers are paying all but $44 million are paying their original contractual payments. The remaining $44 million, which represents four or five properties, are paying interest-only. So the book really has held up and rebounded from where we thought we were back in the second quarter of last year. Occupancies continue to trend upward. About a third of our book is leisure, so at the Jersey Shore or Delaware beaches you cannot get a room this time of year at those locations; very strong occupancy at the leisure hotels. Business travel is coming back and occupancies have continued to increase. I don’t have specifics, but anecdotally one borrower we spoke to just this week has 15 properties, all business-focused, and current occupancies are approaching 70%. That’s one example of the positive trend we’re seeing across the portfolio.

Thanks, Steve. And just last one for me, and then I’ll jump off. Dominic, in your prepared comments you mentioned that you expect the excess liquidity and the drag on the margin to press into 2022. As you look at all of the deposits that have come in from the stimulus efforts across both your commercial and consumer customers, how do you guys try and figure out what might be sticky and ultimately be long-term core deposits and what might flow out the door at some point and relieve some of the pressure on the margin?

Sure. It’s a great question. It first stems from the fact that we focus on relationship-based banking, and I would add that trust and wealth deposits continue to grow as well. That really leads to our outsized and lower loan-to-deposit ratio in the mid-60s. Partnering with customers, speaking to them and understanding their needs helps. I think deposits will trend consistently with overall growth in the economy, GDP and the impact on prices and spending. We do anticipate continued growth and there could be more stimulus that affects deposits. We’re focused on utilizing deposits appropriately. We paid off $100 million of our senior debt in the past quarter, we’ve paid off $0.5 billion of wholesale funding over the last year, and we’ve doubled our investment portfolio while staying within our risk tolerance and liquidity expectations. We’ll continue to do that incrementally over the next quarter and once we close on Bryn Mawr Trust, we’ll optimize the combined balance sheet with the ability to flex down if we see excess liquidity runoff.

Thanks for taking my questions.

Thank you.

Now our next question coming from the line of Brody Preston with Stephens. Your line is open.

Hey, good afternoon, everyone.

Hi, Brody.

I have a question regarding the runoff portfolio. I’ll speak for myself and say it’s a little challenging to model the runoff portfolio on a quarter-to-quarter basis, particularly the residential side. I know you’ve got Bryn Mawr coming up in the beginning of the fourth quarter here, but has there been any thought to potentially selling the residential runoff portfolio and cleaning things up on the loan side a little faster than letting it just run off so that you could maybe reset, and at that point with the deal closing maybe use some of that capital to buy back a bigger slug of shares to plug the earnings hole? I’m trying to think about the puts and takes of pursuing a strategy like that.

Yes. I appreciate that, and I’ll address the residential mortgage specifically. These runoff portfolios, with the exception of residential mortgage, originated with the Beneficial transaction. We thought initially it would take about four years for that to run off; it’s happened sooner, around three years by the end of this year, primarily because of the rate environment. The commercial portfolios will have run off by the end of the year; there’s a very small student loan portfolio left. We don’t see any addition to commercial runoff portfolios from Bryn Mawr Trust. What will be left is the residential mortgage book. This strategy for us predated Beneficial, and we evaluate lots of options, but most of these mortgages are either relationships today or potential relationships because a significant portion were originated through our retail network or our mortgage loan officers who operate within this region. We want to use the opportunity to see if we can enhance those relationships over time. The runoff going forward, including what will come over from Bryn Mawr Trust, is really just the normal amortization of letting them run off. Since we went through a period where rates dropped significantly, we wouldn’t expect to see as much refinance activity although there will be some. That should flatten out to a more normal portfolio mortgage duration and attrition rate. Again, we want to focus on seeing if we can grow those relationships, so I wouldn’t expect in the near term a wholesale transaction as it relates to our residential mortgage portfolio.

Got it. Thank you for that. Maybe as a follow-up, I’m assuming the residential mortgages you’ve pegged as runoff are single-relationship customers who just have their mortgage with you. What products are you trying to cross-sell them into, and what have you been most successful with so far in terms of customers that might have been designated as a runoff loan originally and you’ve converted them into a fuller relationship?

A large percentage of the residential mortgages that came over from Beneficial were single-service relationships, primarily originated through broker and builder arrangements and never actively engaged with. We’ve undertaken an effort to make those fuller relationships. We have a team of people contacting these customers to not only capture refinance opportunities but also traditional banking products because these customers are located in our geographic footprint. The remainder of the loans in runoff were already part of significant relationships, including referrals from our private bank, our commercial group and the broader retail network.

Got it. Thank you for that color, Rodger. I appreciate it. Switching gears, Dominic, there’s another quarter of significant liquidity growth despite the securities build. With buybacks suspended for another quarter and the loan growth guidance coming down a little bit, are you expecting that liquidity to just hang around or are there any near-term deployment opportunities we should be thinking about?

Sure. As I mentioned, we have optimized a significant amount of the excess liquidity over the last year, including the June payoff of the $100 million senior debt, and doubling up the investment portfolio over the last year. We would look to continue to do that, and we’re doing it with an eye towards the Bryn Mawr Trust transaction and the post-combination balance sheet optimization. We see the opportunity to continue to increase the size of the investment portfolio within our framework of acceptable investments — low risk, moderate yield — providing the cashflow and liquidity we expect. You would likely see that continue to increase in the second half of the year.

Got it. One of the slides that stood out in the deck was the digital slide. Given the sustained shift you’ve seen in digital channels for customer interaction, how has your view been shaped over the last year on the branch network? Do you see the digital channel as an additional customer acquisition tool, or is it becoming more of an alternative to physical locations at this point?

Rick?

This is Rick. We’re seeing more rapid adoption of our digital products and services. But we’re never going to be a digital-first company. We think relationships are important and we’re going to do everything to humanize the digital touch. That’s what we’re doing in our delivery transformation effort, and we hope to see more of that hit the market over the next year.

All right, great. Last one for me: could you remind us what percent of the loan portfolio is floating rate? And if there are any floors in place, what percent of the loan portfolio is at or below floor levels?

Sure. We’re running about 50/50 between variable and fixed. We would look to continue to increase the variable portion of the portfolio as we see the runoff of the residential mortgage portfolio and continue to grow the relationship-based C&I lending.

Brody, about a third of that variable rate book has floors in the note. All of our new originations over the past year and a half have floors either at 0% LIBOR floors or a floor of 3% when we can get it.

Got it. Steve, do you happen to know what percent of that third is currently at or below the floor levels?

I think we have to get back to you with an exact answer. My guess is a couple of $100 million at most.

Okay. All right. Thank you very much, everyone. I appreciate you taking my questions.

Thank you.

Now our next question coming from the line of Russell Gunther with D.A. Davidson. Your line is open.

Hey, this is Manuel Navas on for Russell.

Hello.

Hey, just wanted to check in on this. With the efficiency ratio target of the low-60s, do you have what expense run rate we should expect to help achieve that?

Sure. We do anticipate continuing our expense discipline and monitoring the growth rate of the portfolio. We will continue to invest in our delivery transformation efforts, as we’ve outlined, and in franchise growth, particularly in wealth and Cash Connect. We would continue to see some step up in the run rate of absolute dollar costs from the second quarter into the second half of the year, but we intend to maintain positive operating leverage and ensure that revenues grow faster than expenses.

Thank you. You got all the rest of my questions. Thank you very much.

Okay. Thank you very much.

I see no further questions in queue. I would like to turn the conference back over to Mr. Canuso.

Thank you for participating on the call today. Rodger and I will be attending investor conferences and events throughout the third quarter, and we look forward to meeting with many of you then. Enjoy the summer. Thank you.

Thanks, everybody.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.