Wsfs Financial Corp Q1 FY2024 Earnings Call

Thank you for joining us, and welcome to the WSFS Financial Corporation First Quarter Earnings Conference Call. I would now like to hand the call over to your host for today, Mr. Art Bacci, Chief Wealth Officer and Interim Chief Financial Officer. Please go ahead, sir.

Thank you, Rob. Good afternoon, and thank you for joining our first quarter 2024 earnings call. Our earnings release and earnings release supplement, which we will refer to on today's call can be found in the Investor Relations section of our company website. With me on this call today are Rodger Levenson, Chairman, President and Chief Executive Officer; Steve Clark, Chief Commercial Banking Officer; and Shari Kruzinski, Chief Consumer Banking Officer. Before I turn the call over to Rodger for his remarks on the quarter, I would like to read our safe harbor statement. Our discussion today will include information about our management's view of our future expectations, plans and prospects that constitute forward-looking statements. Actual results may differ materially from historical results or those indicated by the forward-looking statements due to risks and uncertainties, including, but not limited to, the risk factors included in our annual report on Form 10-K and our most recent quarterly reports on Form 10-Q as well as other documents we may periodically file with the Securities and Exchange Commission. All comments made during today's call are subject to the safe harbor statement. I will now turn the call over to Rodger.

Thank you, Art, and everyone else for joining us on the call today. WSFS had a good start to 2024, continuing to demonstrate the strength of our franchise and diverse business model. Our first quarter results included a core earnings per share of $1.11, core return on tangible common equity of 19.2% and a core return on assets of 1.31%. Our results continue to reflect the benefits of the investments we are making in our company and our unique competitive market position. Highlights for the quarter included gross loan growth of 2% linked quarter or 7% annualized. This growth was spread across our commercial mortgage, consumer and C&I books. Quarter end customer deposits were up 3% linked quarter after excluding expected trust activity and a short-term commercial deposit withdrawal. Average deposit balances increased 4.9% annualized linked quarter. Deposits remain well diversified across our Commercial, Consumer, Wealth and Trust businesses with 30% of average deposits in noninterest-bearing demand accounts. The core net interest margin was 3.84% for the quarter with interest-bearing deposit beta of 47%. While our average cost of funds increased 17 basis points during the quarter, the increase mostly occurred early in the quarter, and the rate of increase in cost of funds declined meaningfully in March. Excluding the income from our equity position in Spring EQ of $3.5 million in the fourth quarter of 2023, core fee revenue increased 2.7% linked quarter. As a reminder, Spring EQ was acquired effective year-end 2023, and we will therefore no longer recognize income from this investment. Our core fee revenue ratio was 30.3% in the first quarter. The core efficiency ratio stood at 58.6% for the quarter. Noninterest expenses in both the fourth quarter of 2023 and the first quarter of this year included a number of nonrecurring adjustments. Normalizing for these items, expenses increased $7.2 million or 5% linked quarter, with Cash Connect external funding costs representing $5.2 million of the increase. Cash Connect added 4,336 service non-bank ATMs during the quarter due to the previously discussed exit of a large industry participant. We anticipate opportunities for additional unit growth during the second quarter. Expenses were higher in the quarter due to one-time onboarding costs and increased use of external funding. Asset quality remains stable. Problem loans and delinquencies were flat at 4.41% and 81 basis points of gross loans, respectively. NPAs declined to 33 basis points of total assets, primarily due to the resolution of two nonperforming C&I credits. Net charge-offs decreased to 27 basis points of average gross loans, including a net recovery, excluding the upstart and leasing portfolios. The ACL coverage was 1.48%, as we continue to build reserves for potential future credit losses. In summary, we remain well positioned to deliver top quintile financial performance in 2024. We are tracking well to the full year outlook communicated in January. Thank you. I will now have Art facilitate Q&A.

Your first question comes from the line of Russell Gunther from Stephens.

I wanted to circle up on Cash Connect, and I appreciate some of the puts and takes you just discussed, Rodger. But can you guys share where the market share is mostly coming from? Who the competitor is that left the space? How you kind of quantify for us what the market share gain opportunity can be? And then you touched on this just a bit a moment ago, but how we should think about the modeling dynamics around related expenses?

Yes, Russell, this is Art. We previously communicated that U.S. Bancorp exited in the fourth quarter of last year. Overall, we've added nearly 12,000 units between the first and fourth quarters of last year, which is about 75% to 80% of what we anticipate onboarding. We have a few more cash purchases planned for the second quarter. The expenses and lower profitability in the first quarter were largely due to the necessary transitions, as we had some additional non-earning cash held in our vaults. To ensure a smooth transition without confusion for carriers regarding cash access, we exclusively used our external funding source during this time. As we continue with cash purchases, we will start to optimize our cash usage by considering the distances between various vaults and ATMs, which will help us return to a more balanced funding mix between our internal sources and external funding.

Yes. Russell, I would just add to that. As we've said historically, as you think about the profitability of the business, it should be accretive to the overall bank over time. And so we feel like as we move through this transition, we should return to those levels of profitability over the course of this year.

Okay, guys. That's very helpful. And then if I could just switch gears a bit, with regard to WSFS getting out of the customer originations being on pause with upstart expectations for that portfolio to start to decline. Can you just talk a bit about the strategic shift there? And then what, if any, impact you would expect us to have on your net charge-off guidance over time?

Art here. We believe we are well-prepared for the losses we expect in the portfolio. Without significant new originations, the provision under the CECL methodology will decrease. We feel confident in managing the charge-offs, and we anticipate seeing a steady level of charge-offs for another couple of quarters before they begin to decline as the portfolio continues to shrink.

Yes, Russell, to revisit the first part of your question regarding the strategy, the partnership with Upstart was influenced by two main factors. First, it did not address a gap in our consumer credit product lineup. Second, it provided us with a chance to explore digitally originated customers and assess our ability to cross-sell to them. Therefore, the combination of reaching our desired size, evaluating credit performance, and the fact that the cross-sell returns were not as strong as anticipated led us to pause. I want to clarify that we still have the channel available for our customers, but we expect relatively modest originations. Overall, considering the size of that portfolio and our total loan book, it does not significantly affect our earnings.

Okay. Great, Rodger. And then just last one for me, and I'll step back. Again, switching gears. Could you guys just talk a bit about your M&A appetite here on the depository side overall level of discussions or activity and then an ideal profile of any potential partner?

So Russell, really, that has not changed for us. As we've talked about for the last couple of years, after the significant investments we made with the Beneficial and Bryn Mawr franchises, we feel we're very uniquely positioned in a great market for significant organic growth over time. And so we're really not focusing on or contemplating any traditional bank M&A that would revolve around additional deposits. Additionally, though, I would say we continue to invest in the business, and we are seeing opportunities in both the Wealth and the Commercial areas to add talent as well as what you see happening in Cash Connect. So we'll continue to invest in the business if we see the opportunity for returns consistent with our business model. But traditional bank M&A, at this point, is not in our line of sight.

Your next question comes from the line of Frank Schiraldi from Piper Sandler.

I would like to begin with Wealth Management and discuss how the adjustment in deferred revenue has contributed to the decline. Could you explain if this quarter represents a more sustainable run rate? Will that balance out, or how should we view the run rate in light of the deferred revenue commentary?

Yes, Russell, this is Art. That was really a one-time issue. We transitioned some accounts to a different billing platform and discovered that we had approximately $1.3 million overstated in deferred revenue. This overstatement affected this quarter's revenue by that same amount. It's a one-time occurrence. Additionally, we are experiencing some seasonality, particularly in the trust company of Delaware and our institutional trust business, as there is typically a surge in trust and securitization activities at the end of the year. Therefore, when you compare this quarter to the previous one, we are likely to see a decrease. However, if you look at our institutional trust business compared to the same quarter last year, we have actually experienced growth. The pipeline remains strong, and we still feel confident in the growth outlook we have provided for our fee businesses.

Okay. So that $1.3 million is a hit to revenues this quarter and will come back out?

Yes, we'll earn it back as it was deferred revenue.

Could you provide more details on the net interest margin? You have already issued guidance at the beginning of the year and mentioned that you're on track. It appears there was some excess liquidity in the quarter that may have contributed to a lower net interest margin. I'm curious if this is related to an arbitrage opportunity and how that influences your outlook for net interest margin going forward from the first quarter.

Frank, the net interest margin was primarily impacted by an increase in the cost of deposits and funding, which rose by 17 basis points. In March, the cost of funds increased by only 2 basis points. As Rodger noted in his initial comments, most of this increase occurred early in the quarter due to the lag in repricing deposits. We anticipate that our net interest margin will plateau in the second quarter. Additionally, the decrease in accumulated other comprehensive income on the investment securities portfolio also contributed, as a higher balance led to a lower yield, resulting in a decline of about 9 basis points on the mortgage-backed securities. In summary, we are confident that the second quarter will mark a low point, and we expect the net interest margin to begin improving in the latter half of the year, primarily due to the paydown of the mortgage-backed securities portfolio and redeploying that cash flow into loans or potentially investing in Fed funds, which would yield a 300 basis point increase.

Okay. Just to clarify, Art, did you mention that deposit costs were down 2 basis points in March?

The deposit costs only increased 2 basis points in March relative to February. So like I said, that 17 basis point increase in cost of funds for the quarter was for the first half.

Your next question comes from the line of Feddie Strickland from Janney.

Just wanted to ask how much repricing opportunity do you see on fixed rate loans in the near term that could potentially move the needle on loan yield? Or do you think yield stays kind of where it is at this point, just given the floating portion of the portfolio?

Feddie, Steve Clark here. Really, there's no significant repricing opportunity in our fixed rate commercial loan book. I think yield will be fairly consistent throughout the rest of the year, unless the Fed increases rates given our variable rate loan book. So all things being equal, yield should still be in that 7%, low 7% range going forward.

I found the level of asset growth this quarter and earning assets to be surprising. You mentioned having some extra liquidity. Can you explain what contributed to that and what we might expect in terms of asset growth next quarter?

Yes, this is Art. When examining the growth of earning assets, there was likely around $300 million to $400 million in excess liquidity compared to the previous quarter. This was due to our reduction of about $800 million in bank-term funding during the first quarter. We refinanced some existing funds and benefited from lower rates, allowing us to borrow at the face value of our securities. Looking ahead, I anticipate that levels will likely remain flat relative to this quarter. Typically, in the second quarter, we expect to see more substantial cash flows, both incoming and outgoing, due to tax receipts and payments, which will keep cash levels somewhat elevated for the quarter.

That's helpful. And then just one last question, going back to charge-offs. I know the guidance is 50 to 60 basis points this year, and we came in well below that. Is the variance versus guidance just effectively driven by what you're expecting or what we should expect from the consumer book over time to NewLane and Upstart? Is that pretty much the delta between what we saw in the first quarter and what we potentially see in future quarters versus the guidance?

Yes. So, Feddie, I'll just jump in here. So as Art mentioned, we think for both NewLane and for Upstart, we see the level of charge-offs having plateaued and we'll start to drift down here just a little bit, especially with the Upstart portfolio as it probably trades a little bit more quickly. I think the delta really for us on charge-offs will be how the commercial portfolio performed. Obviously, we're pleased with the net recovery this quarter. But we're still coming off of historically low levels, and credit in the C&I book tends to be a little bit lumpy. So you can see a spike or two depending upon one or two credits and the size of those credits. And it's so kind of averaging all of what we have seen as historical charge-off rates that got us to that range that we provided in the outlook. And we continue to assume that some of that will occur during the remainder of the year.

Your next question comes from the line of Manuel Navas from D.A. Davidson.

We began the year strongly with loan growth. How are the pipelines looking? Are they affected at all by the high interest rates? Is there any concern regarding demand due to the rates?

Manuel, Steve Clark again. Pipeline in the commercial bank and the small business group remain fairly strong. So our 90-day weighted average is just a little over $300 million. So activity and opportunities continue to present themselves. I think a significant portion of that is from the disruption that's occurring at some of the bigger players in our market, and that is generating opportunity, as Rodger said earlier, for both customer acquisition and talent acquisition. So the interest rate environment on the C&I side has not impacted our pipeline. And certainly, on the CRE side, we remain very, very selective in terms of new customer acquisition, new sponsor acquisition and continue to focus on supporting our existing customer base.

That's great. In terms of shifting over to deposits a bit, any early take on movements in trust deposits and other flows that you're looking out for?

Manuel, this is Art. Things are currently quite stable. We have a robust pipeline of securitization deals. As I mentioned before, some of these deposits represent cash prefunding trusts that will acquire assets for mortgages. Forecasting this is challenging because it depends on the securitization markets and the types of deals brought to us by different clients. However, the teams are actively working, and there could be promising opportunities, potentially in the second quarter, but definitely in the latter half of the year.

In the past, you've talked about having a little bit of a budget in your deposit beta assumptions to defend deposits more. How has that progressed? And what are your updated thoughts on that ability to defend your deposits even more, if necessary?

Yes. I'll pass it over to Shari, but I want to mention that we are still monitoring the situation. We had a beta of around 47% and projected 50% for interest-bearing accounts. We believe we will be near that target. However, the pressure to utilize excess budget to maintain our deposit pricing seems to have decreased. Shari can provide more insights on the current market.

Sure. I would say that, as Art mentioned, the competitive pressure, although it still exists, it's subsided somewhat. And we are still seeing customers interested in certificates of deposit and the money market. We've been successful attracting new customers to those products. But really pleased and feeling very comfortable. In fact, our CD retention rates are actually running a lot higher than we had expected, really proactive management on the exception pricing front as well.

That's really helpful. Can I ask my last question about the buyback and capital return? You've exceeded the 35% threshold. Do you have any updated comments on that?

No. We continue to stick to the 35% long term. We had some makeup to do from Q4 where we were a little bit under 35%. We made up for it in Q1. But no, generally, we're going to stick to the 35% for the year. So there may be some timing differences between quarters, but no real change.

It's an ongoing event. Art obviously articulated it well. But it is an ongoing evaluation, Manuel. And so as we go through our capital stress testing, and we see opportunities to go above that what we call the routine buybacks, we will evaluate that. It's just not in our current near-term thing.

Your next question comes from the line of Kelly Motta from KBW.

Most of my questions have been asked and answered. However, on Slide 10, it mentions that you've been consistently reviewing all loans over $2.5 million that are maturing in the next 24 months. Given the investor focus on commercial real estate and office space, could you share your findings and any discussions you've had with borrowers whose loans are due or up for repricing, as well as how you're managing those situations?

Kelly, Steve Clark again. So yes, as we've noted, we've had, for several quarters now, an ongoing project or protocol to look 2 years out and roll quarters forward as the year progresses at all loans that are scheduled to mature during this time period. And we just want to be proactive and get in front of our customers well in advance of any maturity dates. And so far, we've been quite successful in working with our customers for loans that have matured during the first quarter of this year and the end of last year with really minor, minor challenges. So that will be ongoing each quarter, and we'll continue to work with all of our customers as it relates to their maturities. There could be and likely will be some discussions with certain borrowers with certain loans as we move forward. But we really view it as really episodic on a loan-by-loan basis versus a broad concern.

And with no further questions in queue, I would like to turn the conference back over to Mr. Bacci.

Thank you for joining the call today. If you have any specific follow-up questions, please feel free to reach out to me directly or Andrew Basile. Rodger and I will be attending conferences and investor meetings throughout the quarter, and we look forward to meeting with many of you. Have a great day.

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