Earnings Call Transcript - WSFS Q1 2020

Operator, Operator

Good morning and welcome to the Bryn Mawr Bank Corporation First Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. At this time, I would like to turn the conference over to Mr. Mike Harrington, Chief Financial Officer. Mr. Harrington, please go ahead.

Mike Harrington, CFO

Thank you, Jamie. Thanks everyone for joining us today. I hope you had a chance to review our most recent earnings release and presentation. Both of these documents are available on our website at bmt.com in the Investor Relations section. We will be referring to the presentation during the course of this conference call. On the call with me today are Frank Leto, President and Chief Executive Officer, and Liam Brickley, Chief Credit Officer. Before we begin, please be advised that during the course of this conference call, management may make forward-looking statements which are not based on historical facts. Please refer to the disclaimer labeled forward-looking statements and Safe Harbor in our earnings release for more information regarding what constitutes a forward-looking statement. All forward-looking statements discussed during this call are based on management's current beliefs and assumptions and speak only as to the date and time they are made. The Corporation does not undertake to update forward-looking statements. For a more complete discussion of the assumptions, risks, and uncertainties related to our business, you are encouraged to review our filings with the Securities and Exchange Commission located on our website. I would now like to turn the call over to Frank.

Frank Leto, President and CEO

Thanks, Mike. And I'd like to thank all of you for joining our conference call today. Let's begin by addressing our response to the COVID-19 pandemic. In January, when news began to surface of the virus, the topic became a regular item of discussion internally. As potential impacts of the virus began to emerge, we declared the virus an incident and convened our incident assessment team. That team assessed the situation within a few days and elevated the issue to our crisis management team. The crisis management team, which is comprised of executives and members of our senior management across the organization and chaired by our Chief Risk Officer, Patrick Killeen, immediately convened and initiated our business contingency plan, a component of which includes actions related to pandemics. While none of us could have predicted this exact scenario, we've routinely planned and prepared for situations such as this. The crisis management team was tasked with further assessing the situation and providing recommendations to executive management in addition to following the playbook outlined in our pandemic plan. Among the many actions, two priorities included ensuring the safety of our employees and customers as well as testing and stressing our remote capabilities to handle additional users on our remote private network. As of today, nearly all of our back office support and many of our client-facing employees in lending, wealth, and insurance groups are working from home. This comprises approximately 70% of our total workforce. I want to emphasize that technology investments we've made and spoken about the past several years have allowed us to complete this transition seamlessly and to a degree I never imagined. Other actions we've taken to date include closing all branch lobbies and reducing our branch hours of operation to further protect our clients and employees and adding a virtual format capability to our Annual Meeting which convened last week. As things began to normalize in April, the crisis management team continued to meet frequently to monitor and react to specific situations. While the risks in the current marketplace are vast and ever changing, we believe our largest risks are in the operational, financial health, credit, and reputation areas. From an operational risk standpoint, business disruption, loss of personnel, third-party reliability, cybersecurity, and the inability to meet our client and community needs are key focal points. The crisis management team works alongside the executive management group to quickly and effectively respond to the hurdles we face. We have reallocated resources across the organization where necessary to meet increasing demand of our clients and communities. Managing financial risk starts well before the crisis. We have sound practices in place including frequent stress testing, implementing strategies to protect our margin, and evaluating our liquidity position on a daily basis. Our job now is to leverage our financial strength and skills to successfully navigate this unprecedented environment. We have to be keen on economic conditions including interest-rate sensitivity, meeting our funding obligations, and continuing to invest in opportunities to support the business. While Liam Brickley, our Chief Credit Officer, will discuss our credit profile momentarily, I will add that we have been very proactive with clients, engaging their response to the market. We are aggressively monitoring high-risk segments of our loan portfolio and acting where needed. Our 131-year reputation is one which we take great pride in. Bryn Mawr Trust has helped and continues to help our clients and communities to build a legacy in which we all share. Banks are at the forefront of this pandemic and we are working very hard to help those in need. Today, we're working extensively to create managed solutions for our clients and communities. One area of focus over the last few weeks has been the SBA's Paycheck Protection Program. As of the close of Friday, we received thousands of online requests and over 1,600 applications were submitted. To date, over 700 applications have been approved with SBA authorization for a total dollar amount over $220 million to be funded through the bank. Although the program's funding has been exhausted, we're proud of how our team pulled together to design and implement a process needed to handle this immense influx of activity and we continue to process the applications we received in case the program receives additional funding. More information on all of the relief programs can be found on our website or in our investor presentation released yesterday. While each day brings new challenges and opportunities, we are confident in our organization's ability to come out the other side stronger than ever. I'd like to now turn over to Mike to discuss our first quarter results.

Mike Harrington, CFO

Thank you, Frank. For the first quarter of 2020, we posted a net loss of $11.2 million, negative $0.56 per diluted share. The main driver of the loss for the quarter was our implementation of CECL and the recording of the associated provision for credit losses, which is reflective of the current economic conditions brought on by the COVID-19 pandemic. We're experiencing economic conditions unlike any we have ever seen, and the future path of economic activity is highly uncertain. For CECL modeling purposes, historical data may not be relevant in calculating credit losses. For example, Pennsylvania unemployment, a key driver of losses in our allowance model, is expected to exceed historical highs shortly, and the return to normal levels is subject to a great degree of variability. Management, in the spirit of the accounting guidance prescribed under CECL, made efforts to estimate the allowance by leveraging historical loss data and its correlation to economic data such as unemployment, in combination with our stress testing modeling and qualitative factors to arrive at an assessment as of March 31, 2020. We believe our allowance as stated represents a reasonable estimate of future credit losses as of the reporting date, acknowledging that the estimate will be subject to change as the path of economic activity becomes clear. Setting aside the provision expense discussion, our business activity was strong during the first quarter. We saw our net interest income increase by 1% from the fourth quarter as loan growth increased 2.1% from the prior quarter, and strategies we used to defend the margin helped mitigate the effect of lower interest rates. Our fee income continues to be a consistent source of earnings for the bank. As fee-based wealth assets have grown over the years, they moderated the impact of the market sell-off late in the quarter. As anticipated, our non-interest expenses were flat quarter-over-quarter, despite the recording of a $3 million reserve for unfunded loan commitments related to the change in the credit risk environment associated with the pandemic. Our tax-equivalent net interest margin increased from 3.36% to 3.38% quarter-over-quarter. This is a direct result of the strategies we applied to manage the margin including the thoughtful reduction of costs paid on over $500 million in deposits and modifying pricing on loans to reflect the inherent risk of lending in this environment. We had also positioned our borrowing portfolio more short-term within the overnight market. We evaluate our liquidity position on a daily basis, and we view our options accessible to us frequently. The Bank has significant liquidity available at the Federal Home Loan Bank, and to a lesser degree at the Federal Reserve. We also have multiple options for other wholesale deposit channels, and the introduction of the Paycheck Protection Program, the Fed has made available an additional avenue for liquidity to support funding these loans. We expect to avail ourselves of this funding. Our investment portfolio is also a source of liquidity and it's very liquid and high quality. Capital at both the bank and the corporation remains well above our internal targets and levels needed to be deemed well capitalized. We manage our capital levels by contemplating various economic scenarios; stress testing is a fundamental tool we utilize to understand the scope of our capital and liquidity positions under the most severe circumstances. This modeling helps inform the amount of capital we target in normal times. These models will be put to the test, as we are obviously living a stress scenario. In light of the developments surrounding COVID-19, we bought back shares in March. At that point, we had repurchased 207,000 shares during the first quarter of 2020. As the environment evolves, we will reevaluate capital and liquidity positions and decide on capital actions. Regarding our shareholder dividend, you may have seen we approved the $0.26 per share dividend yesterday. I should note on slide 8, asset quality is fairly stable in the quarter with the exception of leases where we elected to charge off all 60-plus day items in liquidation in anticipation of credits experiencing distress in the current environment. Also depicted is the increasing provision cost related to adoption of CECL. The slide depicts more detail with regards to the implementation of CECL and the changes in the allowance at and alongside the January 1 CECL adoption, which represented a modest increase in the allowance of only 14%. Subsequent to January 1, the future state of the economy can be much more tenuous. The emergence of those conditions is reflected in the allowance calculation as of quarter end, also with the increase in reserve for unfunded commitments as I noted earlier. Before I turn it over to Liam, I wanted to note that we have withdrawn all guidance as it relates to our business activity for 2020 given the uncertainty of the current environment. I'll pass it off to our Chief Credit Officer, Liam Brickley, for a discussion of the bank's loan portfolio.

Liam Brickley, Chief Credit Officer

Thanks, Mike. Credit has always been a key focus at Bryn Mawr regardless of the economic environment. The Bank has always had a reputation for being responsive, consistent and conservative as it relates to credit. Our team is currently spending considerable time, literally every day of the week, working with new and existing clients to help them during this uncertain period. As outlined on slide 10, our portfolio is diversified across both borrower and property types. We continue to actively review all areas of the credit portfolio with a focus on those segments that are more vulnerable to current market conditions. Specifically, we are actively working with clients in our commercial business and our commercial real estate non-owner occupied segment. We also have an outreach program for our consumer segment. Further, the bank has a lease portfolio that accounts for roughly 5% of total loans. While this segment is susceptible to downturns in the economy, it is diversified by borrower, industry and geography, with borrowers in all 50 states and Washington D.C. We do anticipate losses in the space given economic conditions, which is partially reflected in the provision for the quarter. We are working with clients across the retail, multifamily, flex, office and hospitality spaces in our commercial real estate business. We have many long-term relationships with sponsors who supported their projects through prior economic cycles. It's worth noting that we are primarily a recourse lender. As indicated on slide 11, entering the crisis, the CRE portfolio was granular with reasonable loan-to-value ratios across all property types. The bank has modest and granular exposure to vulnerable industries, including restaurants, manufacturing and energy, and we do not anticipate significant losses in those areas. We have not seen a significant increase in utilization under our lines of credit. From December 31 through March 31, our commercial line-of-credit usage increased by approximately 2% or $16 million. In response to the pandemic, we've developed several relief programs to assist our clients through these hard times. The programs are consistent with the guidance issued by the Federal Reserve and the Financial Accounting Standards Board. Participants in the federal programs come from our C&I, our small business and our commercial real estate portfolios. Commercial deferral decisions are made one client at a time based on current conditions with the client and the impact of the virus on their business model. For commercial and small businesses, our program offers deferral of all payments or modification to an interest-only structure for a period of three months, with a one-time bank option which allows us to extend these deferrals for an additional three months if conditions prove that to be necessary. To date, we have over 240 commercial participants, with a total loan balance of approximately $500 million taking advantage of these deferral programs. For our consumer clients, we offer a six-month full payment holiday consistent with various guidance statements by the Fed and Fannie Mae. To date, we have 140 consumer clients with total loan balance of $25 million utilizing these short-term payment holidays. We are also actively engaged in the SBA Paycheck Protection Program as Frank detailed earlier. As Mike mentioned, we are living in an environment that none of us have seen in the past. However, our conservative nature over the years leading up to this pandemic has allowed us to be well positioned to mitigate future losses. We remain vigilant and confident in our management team and their experience in navigating these uncertain economic environments. With that, I'll turn it back to Frank.

Frank Leto, President and CEO

Thanks, Liam, and thanks, Mike, and thank you again. With that, I think we'll open up the call to questions. I'll turn it back to the operator.

Operator, Operator

And our first question today comes from Michael Perito from KBW. Please go ahead with your question.

Michael Perito, Analyst

Hey, good morning, guys. Thanks for hosting the call this quarter. I want to start on the credit and provision discussion. I realize it's a little difficult, but the dance we're trying to work with over here is to figure out relative credit exposures. The new slides are helpful, but I was wondering if maybe Mike or Liam could break out a little bit more about some of the economic assumptions that drove the large provision in the quarter. You mentioned in prepared remarks, Mike, that you thought it was a reasonable assumption of how you see it today. It would be helpful to expand on some of those more specific assumptions so we can compare them to our models and see how they could change going forward.

Mike Harrington, CFO

Sure. Why don't I start and then Liam can add anything he'd like. The primary driver in our CECL model as it was built is Pennsylvania unemployment, which I mentioned in my prepared remarks. Right now, Mike, we're assuming that the unemployment rate hits its maximum at around 9%, which is approximately the high reached in the last financial crisis. We assume it trends up to about 9% fairly quickly from current levels, stays elevated for a quarter, and then starts to revert back to a long-term historical mean, which for ease of conversation we referenced around 6%. So, over the next six quarters we're assuming unemployment is about 9% and then trending down to 6%, and then it stays at 6% thereafter for modeling purposes. The model was fundamentally built off unemployment because that was the highest correlated macroeconomic factor to charge-offs. That trajectory of unemployment generates the charge-off figures that drive the provision and allowance figures shown. One other thing we baked into the model is we recognize that payment holidays are in place, so it's not likely we'll see a lot of charge-offs in the immediate next few quarters because of these payment holidays. Some of that activity will happen later, and we factor that in from a cash-flow perspective. Other than that, that's really at the heart of what we've factored into the model right now. Liam, do you have anything you want to add?

Liam Brickley, Chief Credit Officer

The only other thing I would point out is in the development of our CECL modeling through the last 15 years, the firm has had fairly minimal losses in the C&I space. We used peer benchmarking data in building the model, frankly, because we had inadequate internal data to build a fully replicable model. So that is another driver in some of the downside assumptions here.

Frank Leto, President and CEO

That's helpful, Liam. The leases also have some of that exposure reflected in the modeling.

Michael Perito, Analyst

Yes, that makes sense and that's helpful. A follow-up: if the unemployment rate plays out as you've punched into the CECL model, how does the reserve then stabilize near term and then move down later depending on charge-offs? Obviously, there is a wide range of possible outcomes, but if we just assume the assumptions you made today are correct, is that how you would expect it to react over the next year or so?

Frank Leto, President and CEO

I'll answer. If what we projected here turns into reality then charge-offs would work their way through the portfolio and, given the amount of provision we recorded, the allowance would be positioned accordingly on a go-forward basis. But there's so much variability related to that, and that's why any forward statement is challenging right now — it's just impossible to know. We wrestled with this in arriving at where we did. Also, we compared this result in allowance to the stress testing we do. We do a lot of stress testing outside of this process and compare those results to what we're seeing here as a cross-check using a separate model and third-party data — just another view of the environment. We also did qualitative overlays on some categories and metrics, particularly in the retail sector, to account for uncertainty related to credit profiles in certain sectors on a go-forward basis.

Mike Harrington, CFO

Yes.

Frank Leto, President and CEO

We added qualitative adjustments to a few sectors you see on slide nine to account for that added uncertainty.

Michael Perito, Analyst

Okay. One last question on the credit topic. Have you seen any significant changes in commercial or residential real estate values in your markets given everything going on? Or has that not really materialized yet?

Frank Leto, President and CEO

It's too early to make an assessment. Trading activity was very brisk up through the end of February and then effectively stopped. The long-term implications on values and pricing will play out, but we have no empirical data to point to price softness right now.

Michael Perito, Analyst

And then switching gears to margin: it was pretty resilient this quarter, but there was a dramatic move lower in short-term rates in the first quarter. Do you have any near-term thoughts on how that dynamic might play out as liability repricing opportunities dwindle and there could be asset pressures?

Mike Harrington, CFO

On the asset side, one dynamic will be the PPP loans being added to our balance sheet. The actual yield on those will depend on the average life of those loans and how quickly they repay. One thing that surprised us related to your question was deposit funding — we thought it might fall further than it has. LIBOR hasn't moved down in lockstep and actually widened out relative to Fed funds, so we haven't seen wholesale markets reprice as much as expected, and that has held deposit pricing a bit higher than we thought. If that normalizes, we might have some potential to lower deposit costs, but right now we're being thoughtful because we want to retain liquidity in the institution. The whole marketplace is supporting fairly high deposit costs relative to the decrease in the Fed funds rate.

Michael Perito, Analyst

Okay, that's helpful. Thanks for hosting the call this quarter, and I hope you and your families stay safe.

Frank Leto, President and CEO

Likewise, thanks Mike.

Mike Harrington, CFO

Thanks Mike.

Operator, Operator

And our next question comes from Erik Zwick from Boenning & Scattergood. Please go with your question.

Erik Zwick, Analyst

Good morning, guys. Mike, to follow up on your commentary about the CECL model being based off Pennsylvania unemployment and mentioning that over time it trends down to that 6% level as a long-term average, I'm curious if that 6% was also what you were using as of January 1 of this year given that that's your view of the long-term average, or was the starting point at that time more where it had been running near the 4.5% range?

Frank Leto, President and CEO

Right, that's a good question, Erik. The starting point was the current rate as of that point in time. The model holds the current rate out for a number of quarters, and then the model begins to revert to the long-term average — that's how it was structured. So when we made our adjustment on January 1, the employment path started at the current rate at that time.

Mike Harrington, CFO

Yes, we were starting at the actual and trending to the long-term average.

Erik Zwick, Analyst

Okay, that's helpful. Switching gears and looking at wealth management revenue and the run rate going forward: approximately 40% of that wealth management AUM fees are based on account market value. Are those fees calculated based on a period in balance or an average for the quarter?

Frank Leto, President and CEO

The majority are calculated based on quarter-end balances. Although we do some intra-quarter calculations, the bulk of the fees are a function of quarter-end market values.

Mike Harrington, CFO

Regarding the PPP participation: for those loans that meet the qualifications for being forgiven, our expectation is any fees will be treated similar to FAS 91 fee treatment. That fee will accrete as the loan is outstanding. When the loan is forgiven or repaid, the fee accretion will be recorded as interest income in the margin. We're currently estimating about $6.5 million in fees related to PPP that we expect to collect once we present the bill to the SBA.

Erik Zwick, Analyst

Great. Thank you so much for taking my questions.

Frank Leto, President and CEO

Thanks, Erik.

Operator, Operator

And our next question comes from Joe from a financial group. Please go ahead with your question.

Joe, Analyst

Morning, everyone. Just building on one of the prior questions to confirm, Mike: was the prior high in the Pennsylvania unemployment rate during the Great Recession what drove your forecast and not any sort of official projections for Pennsylvania unemployment for this specific situation? Is that right?

Mike Harrington, CFO

Correct. Yes, and I think that number is approximately 8.8%.

Joe, Analyst

Okay. Are there any projections at this point for Pennsylvania unemployment from local forecasters or other sources you respect that you've seen?

Mike Harrington, CFO

We did not rely on any specific state-level official forecasts. We looked at generally available forecasts like Bloomberg consensus and some private firm forecasts to see if our assumptions were in the right range, but we didn't have an official Pennsylvania forecast from a government agency that we used directly.

Joe, Analyst

Some banks have given reserve projections if the macro situation worsens. Do you have assumptions for expected reserve builds if unemployment were to go to, say, 15% or 20%?

Mike Harrington, CFO

We're not prepared to provide that level of forward-looking reserve projections today. We ran many versions of the model and worked through multiple scenarios, but when you get into unemployment numbers in excess of historical records, the model loses some of its predictive value because there's no reference point. We also considered likely impacts of government programs and tried to account for that in our assumptions rather than simply defaulting to an extreme unemployment number.

Joe, Analyst

Roughly what percentage of the provision allocation was driven by the unemployment projection you used? Is it something like two-thirds?

Mike Harrington, CFO

I would say roughly two-thirds of the increase was directly correlated with the unemployment assumption. Liam, feel free to weigh in.

Liam Brickley, Chief Credit Officer

Yes, I think roughly two-thirds of the bump-up was directly correlated with the unemployment number, and it may actually be higher than that.

Joe, Analyst

So if a reliable forecaster projected 20% unemployment, would you expect to need a materially larger reserve? Does the model become unreliable at certain levels?

Mike Harrington, CFO

Yes, the model becomes less reliable at those extreme levels. There are many wildcards — we don't know the full impact of government programs being rolled out. One of the reasons we landed where we did was to factor in the support from stimulus programs as best we could and not simply default to an extreme unemployment scenario without considering those overlays.

Joe, Analyst

Regarding the wealth business: it seems from your comments that some of the hit you took was market-driven in the first quarter. Is that fair to say?

Mike Harrington, CFO

Yes, the wealth business itself performed well in Q1 with net client asset growth, but it was impacted by the general market sell-off which affected AUM-based fees. The underlying business activity was strong and we're pleased with that. We also might see some timing shifts related to tax-preparation season, but we expect some stabilization as markets normalize.

Joe, Analyst

And the near-term outlook for the dividend — could that be reevaluated if conditions deteriorate further?

Mike Harrington, CFO

We will evaluate capital and dividend decisions each quarter. Right now, we feel good about our capital position. The holding company has substantial cash, roughly $90 million, and capital remains well positioned. If conditions deteriorate significantly from here, we'll reassess and make decisions accordingly.

Frank Leto, President and CEO

I agree with Mike. We'll continue to monitor the situation and make decisions as appropriate.

Operator, Operator

Our next question comes from Christopher Marinac from Janney Montgomery. Please go ahead with your question.

Christopher Marinac, Analyst

Hey, thanks. Good morning. Given the charge-offs you took on leasing and C&I, what does that portend in terms of where the classified and other risk grades go when we see those? And then, should you have fewer charge-offs next quarter, how should we think about that?

Liam Brickley, Chief Credit Officer

We are not anticipating a high volume of charge-offs in Q2, largely because many clients experiencing distress are taking advantage of the payment holiday programs which can mask underlying weakness. That's particularly true in the leasing portfolio. We don't foresee a rapid change in charge-off activity in Q2. In terms of credit classifications, we entered the crisis in relatively good shape. We evaluate larger clients consistently, looking at both cash flows and underlying collateral values, and we will make real-time risk rating adjustments as facts present themselves. Right now, credit class numbers are consistent with recent quarters and we have seen no significant migration to date. Adjustments will be made based on facts as they come in.

Christopher Marinac, Analyst

Do downgrades drive further provision expense, or was some of that already factored into the March 31 allowance you built?

Liam Brickley, Chief Credit Officer

It's fair to say that the March 31 adjustment takes into account anticipated downgrades in the next quarter or two.

Mike Harrington, CFO

This provision was somewhat higher because we were proactive, particularly with the lease portfolio. Those leases were already delinquent or at risk, and we wanted to get ahead of expected charge-offs rather than delay recognition.

Christopher Marinac, Analyst

Do you have a sense of deposit retention as you go through this? I know you had some deposits that were expected to leave prior to the crisis.

Mike Harrington, CFO

We did have one large deposit expected to roll out and that explains much of the variance on the quarter. Otherwise, the deposit base is extremely stable. We've been careful with pricing but remain focused on liquidity and ensuring we stay in a strong liquidity position.

Christopher Marinac, Analyst

Great. Thanks for taking my questions.

Operator, Operator

And our next question is a follow-up from Michael Perito from KBW. Please go ahead with your question.

Michael Perito, Analyst

One quick follow-up on operating expenses going forward. Frank, you mentioned that some of the technology investments have paid off and expenses were fairly flat quarter-over-quarter. Can you give an update on the outlook for expenses, especially given the rapidly changing revenue environment?

Frank Leto, President and CEO

Mike hit the nail on the head. The focus for 2020 was leveling out that expense line after the prior expense build related to hires and technology investments, which have paid off. It doesn't change dramatically, though we may need to shift focus, and it will take time to see how much impact all of this will have on operating expenses in areas like facilities. So we need to let it play out.

Mike Harrington, CFO

I'll add that operating expenses would have been down a few million dollars, but embedded in the other expense lines in the quarter was the reserve we took for unfunded commitments of about $3 million. That reserve is the primary driver of the flat expense line quarter-over-quarter. Outside of that, the investments we've made have positioned us well and we don't currently see anything that will meaningfully accelerate expense growth absent new COVID-19 related items that might arise.

Michael Perito, Analyst

Is there any sense for how elevated that unfunded commitment reserve was relative to normal? Would you say that was a couple of million that most likely will not recur?

Mike Harrington, CFO

Yes. As of December 31, that reserve was $360,000. Under CECL we moved that to $1.2 million. So the build in the quarter was meaningful relative to prior quarters and likely will not recur at the same magnitude unless the credit environment worsens materially.

Michael Perito, Analyst

Okay, great. Thank you for the additional color.

Frank Leto, President and CEO

No problem.

Operator, Operator

At this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

Frank Leto, President and CEO

This is Frank again. I just wanted to thank everybody for taking the time in this uncertain environment to listen to our conference call today. We hope everybody will be healthy and safe going forward. We look forward to talking to you all in the coming months. Thanks.

Operator, Operator

Ladies and gentlemen, that does conclude today's conference call. Thank you for joining. You may now disconnect your lines.