Earnings Call Transcript - WSFS Q4 2023

Operator, Operator

Hello, and welcome to the WSFS Financial Corporation Fourth Quarter Earnings Call. All lines have been muted to avoid background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to your host for today, Mr. Art Bacci, Interim Chief Financial Officer. You may begin.

Art Bacci, Interim Chief Financial Officer

Thank you. Good afternoon, and thank you again for joining our fourth quarter 2023 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 are Rodger Levenson, Chairman, President, and CEO; Steve Clark, Chief Commercial Banking Officer; and Shari Kruzinski, Chief Consumer Banking Officer. Before I turn the call over to Roger for his remarks on the quarter, I would like to read out 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 these 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 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 Roger.

Rodger Levenson, Chairman, President, and CEO

Thank you, Art, and everyone else, for joining us on the call today. WSFS performed very well in the fourth quarter, as we continued to demonstrate the strength and diversity of our business model. These results capped a successful 2023 with full year core earnings per share of $4.55, core return on tangible common equity of 22.48%, and a core return on assets of 1.38%. Each of these metrics exceeded 2022 levels. Highlights for the quarter and full year included: Customer deposit growth of 3% linked quarter or 13% annualized. Growth occurred across our Wealth and Trust, Commercial and Consumer businesses. Deposit mix remained strong with 31% of average deposits in non-interest demand accounts. Loan growth of 1% linked quarter or 3% annualized. Full year customer deposit and loan growth of 2% and 7%, respectively, with the year-end loan-to-deposit ratio of 77%. Core net interest margin of 3.99% for the quarter, with interest-bearing deposit beta at 44%. Core fee revenue growth of 6% linked quarter. Growth was driven by Wealth and Trust, Cash Connect, and Capital Markets businesses. Full year core fee revenue growth of 10% and core fee revenue ratio of 30.4% in the fourth quarter. The core efficiency ratio was 54.5% for the quarter, which included several favorable one-time adjustments of approximately $4 million for estimated incentive and employee benefit accruals. Excluding these adjustments, the core efficiency ratio would have been 56.2%. Asset quality remained stable. Net charge-offs and problem loans were essentially flat to Q3, and NPAs ticked up 8 basis points. The balance sheet remains strong with ACL coverage of 1.35% and all capital ratios significantly above well-capitalized levels. In summary, our franchise growth was facilitated by the continued optimization of our investments and highly unique competitive market position. We enter 2024 with strong momentum and look forward to continuing to execute on our 2022 to 2024 strategic plan. I will now turn it back to Art for commentary on our 2024 outlook and to facilitate Q&A.

Art Bacci, Interim Chief Financial Officer

Thank you, Rodger. I will now cover our outlook for 2024. Looking forward to 2024, we expect a full year core return on assets of around 1.20%. Our outlook assumes no interest rate cuts in 2024. This assumption is a different approach from our prior periods, whereby we tied our interest rate outlook to the forward curve. Our analysis demonstrates the forward curve has been a poor indicator of actual interest rate changes. Additionally, recent economic data along with comments from the Federal Reserve and European Central Bank officials have combined to temper market expectations for lower interest rates. We have also assessed our outlook assuming three interest rate cuts totaling 75 basis points, all in the second half of 2024. The impact potentially reduces our net interest margin by approximately 15 basis points in 2024. Further information on our interest rate sensitivity is provided on Slide 10 of the supplement. WSFS' diverse business model provides management with multiple strategies to achieve our previously communicated goal of top-quartile performance. Our favorable market position, a loan-to-deposit ratio of 77%, and consistent cash flows from our securities portfolio enable us to opportunistically fund relationship-based loans in our markets. Our multiple sources of core deposits provide us with favorable deposit cost and funding mix, further contributing to our top-tier net interest margin. Fee income contributes almost one-third of our total revenue. Our fee-based businesses continue to be increasingly integrated with our overall business model and all have significant growth opportunities, because of joint relationships with our commercial and consumer customers, industry consolidation, and potential non-bank M&A activity. I will also point out that gradual declining interest rates potentially enhance our financial results and capital positions than better equity and fixed income market performance, increased mortgage and asset securitization transactions, and higher market valuations of our investment portfolio and tangible book value as demonstrated during the fourth quarter. Net charge-offs are expected to be between 50 basis points and 60 basis points of average loans for the year, primarily driven by Upstart and NewLane, as well as continued normalization of credit trends. Overall, our portfolio credit metrics were stable this quarter, and our ACL coverage ratio is 1.35% of total loans and leases. Excluding the held to maturity securities and including acquisition credit marks, the ACL ratio stands at 1.64% of loans and leases. Further information on our ACL ratio is included on Slide 13 of the supplement. Finally, our strong capital position and earnings enable us to absorb unfavorable developments in the economy, to continue to invest in our franchise, capitalize on market opportunities, and to take steps to further enhance shareholder returns. Thank you, and we will now open the line for questions.

Operator, Operator

Thank you. Your first question comes from Michael Perito of KBW. Your line is open.

Michael Perito, Analyst

Hey guys, good afternoon. Happy New Year. Thanks for taking my questions.

Rodger Levenson, Chairman, President, and CEO

Happy to do it.

Michael Perito, Analyst

There's a lot of useful information about margins and rates in the presentation, and I appreciate that. To clarify, looking at Slide 10 regarding the $9.6 million NII impact from the '25 cut, if I understand correctly, it seems like each cut, assuming everything else stays the same, would reduce the NIM from the 3.80% to 3.90% range by 5 basis points, bringing it down to roughly 3.75% to 3.85%. Would you generally agree with that directionally? This also takes into account the benefits of the off-balance sheet hedging strategy. Is that accurate, or would you adjust anything?

Art Bacci, Interim Chief Financial Officer

Mike, I think that's directionally correct. And I would just reiterate, that's an annualized number. So, if rates are going to get reduced in the second half of the year, we clearly wouldn't feel that full impact in 2024.

Michael Perito, Analyst

Correct. Yes. Okay. Is the 3.80% related to the additional hedges, the $250 million approved for extra floors? Would that potentially lessen that range somewhat, or is that already factored in?

Art Bacci, Interim Chief Financial Officer

No, that's included in that, because any hedges we would implement would need to result in significantly lower rates. Currently, the $750 million we've executed is at about a 4% SOFR rate. Therefore, there would need to be a significant decline in the SOFR for the hedges to become effective.

Michael Perito, Analyst

Got it. That's great. Thank you. Now, looking at the fees, this has been a very strong quarter. A few comments in the presentation caught my attention, and I would love to delve deeper into them. There’s significant growth potential on the Wealth side, and a mention of Cash Connect and peer consolidation stood out. You also have high expectations for double-digit growth in fees for 2024, which is impressive. Can you provide more details on where these growth opportunities are coming from and what supports this assumption?

Art Bacci, Interim Chief Financial Officer

Sure. This is Art again, Mike. In the fourth quarter, specifically late in the third quarter and into the fourth quarter, one of the major players in the Cash Connect sector left the market, and we have managed to acquire their clients. We've observed ongoing inflows in our pipeline during the first and second quarters of 2024 as a result of this, leading to a strong belief that Cash Connect will experience double-digit growth in 2024 compared to 2023. Additionally, in our Wealth segment, the combination of our businesses is generating very robust pipelines heading into 2024. Our Institutional Trust business has a solid pipeline, including nearly $100 million in potential deposits. Furthermore, the integration of our Wealth Management business with our regular banking operations and the referrals we are receiving from both commercial and consumer banking create excellent opportunities to continue expanding our assets under management.

Michael Perito, Analyst

That's helpful, Art. Thanks. I just have two more quick questions. It appears that the consumer charge-offs for unsecured loans have been stable and remain within the range that you have communicated. Could you provide any broader commentary on that? The data points have been mixed; for instance, Discover, which has a prime unsecured portfolio, experienced an increase in charge-offs and delinquencies, while others have remained more stable. We will receive a few more data points next week. Do you have any updated thoughts regarding the unsecured consumer credit environment, especially in relation to your portfolio as we look towards 2024?

Art Bacci, Interim Chief Financial Officer

This is Art again. If you exclude Upstart, we've observed that charge-offs have been quite stable and low in the unsecured category. Upstart has been the only area where we've noticed increased charge-offs, which we believe are related to some earlier cohorts that we've booked. We expect this to work its way through the system, and we hope to see a decline in the first or second quarter. Additionally, we are not significantly expanding our Upstart portfolio and have reached our concentration limits on unsecured lending. Currently, we are just replacing some of the run-off, and we will continue to assess the charge-off situation, which may influence future decisions.

Michael Perito, Analyst

Got it. Lastly, the guidance is very useful in outlining your plans for the year. However, there seems to be a lack of information regarding buybacks. I understand your model and approach remain consistent, but any updated insights or discussions from the Board about the buyback would be beneficial as we look ahead.

Rodger Levenson, Chairman, President, and CEO

Hey, Mike, it's Rodger. Nothing's changed with our capital return philosophy. And it's been our historic practice from a forward-looking outlook or for our plan to only put in there the routine buybacks that we use to supplement the dividend. We continue to periodically evaluate potentially higher buyback levels, but as you know, that's dependent upon the forward look of the economy as well as assessment of our balance sheet and where the share price is, because we have a model that targets at least a 16% IRR. So, we'll continue to evaluate that as those factors play out, but nothing different from our ongoing philosophy.

Michael Perito, Analyst

Very good. Listen, thanks, guys. I appreciate it. Have a great weekend. Talk to you soon.

Art Bacci, Interim Chief Financial Officer

You too.

Operator, Operator

Your next question comes from the line of Feddie Strickland with Janney Montgomery Scott. Your line is open.

Feddie Strickland, Analyst

Hey, good afternoon, everyone. Just wanted to start back on the sensitivity analysis for a second. Could there be some level of upside there, just given the fact that that assumes a static balance sheet and you're clearly going to grow loans kind of within your guide? Just trying to think through in a little more detail about what happens with the margin, if we as analysts do assume some level of rate cuts.

Art Bacci, Interim Chief Financial Officer

I believe there is potential for growth. Our current position has remained stable. Our asset sensitivity has helped us in times when rates increased, and we have consistently achieved a top-quintile net interest margin through various rate cycles. We have several options to consider. One possibility is that if rates begin to rise, some of our betas could perform better than expected. However, many banks still have high loan-to-deposit ratios and liquidity issues, leading them to keep rates higher than we might prefer. We can defend our market position and compete against those banks. Additionally, a declining rate environment could stimulate more mortgage and asset-backed securitizations, as well as refinancing of corporate debt, which would benefit our Institutional Trust business and enhance deposit growth, particularly in non-interest-bearing deposits. These factors could significantly favor us as we move into 2024.

Feddie Strickland, Analyst

Understood. That makes a lot of sense. And I guess along those same lines, can you remind us of where you feel like DDAs could end up over the next couple of quarters? I think I peg them at about 31% of average deposits today. Does that glide down into the high-20%s or what are your assumptions on the level of noninterest-bearing deposits over time?

Art Bacci, Interim Chief Financial Officer

I believe that the 30% rate targets reflect normalization for us. On average, it has remained fairly consistent, although there may be some volatility from quarter to quarter due to the Trust deposits. However, when looking at the average, it has been around 30%, which aligns with pre-pandemic levels. We are quite confident that 30% is a solid target. Additionally, if rates decrease and market securitization activity increases, that could actually lead to an uptick.

Feddie Strickland, Analyst

Got it. And then just one last question for me on expenses. I know your guide mentions continued investment in the franchise. Are there any initiatives in particular that could move expenses up more earlier versus later in the year? Any detail you can give on any either technology initiatives or hiring or anything along those lines? What's driving some of those expenses?

Rodger Levenson, Chairman, President, and CEO

Feddie, this is Roger. I want to highlight that we are continuing to invest in our franchise. We have several ongoing technology investments that have been in progress for several years. We are also looking to hire, with some segments already planning for additional staff, primarily in relation to potential revenue growth. We see further opportunities to add personnel if it aligns with our goals, along with the small RIA investment we made in 2023. Overall, we are focused on investing and growing the business during this period, as we believe it's a prime time to capture market share while others are pulling back. This approach is evident across all of our NIE categories.

Feddie Strickland, Analyst

Understood. So, supportive more of long-term growth rather than any particular initiative or new product line or anything like that?

Rodger Levenson, Chairman, President, and CEO

That's an accurate assessment.

Feddie Strickland, Analyst

Got it. Thanks so much. I'll step back in the queue.

Operator, Operator

Your next question comes from the line of Russell Gunther with Stephens. Your line is open.

Russell Gunther, Analyst

Hey, good afternoon, guys.

Rodger Levenson, Chairman, President, and CEO

Good afternoon.

Russell Gunther, Analyst

Art, I appreciate the discussion about the margin. Hey, Roger. Art, thank you for the talk on the net interest margin. Considering the three rate cuts, what are your assumptions regarding the deposit beta as rates go down? It seems from your earlier comments that you're taking a conservative approach, but I'm interested in what you have factored into the sensitivity for the three cuts.

Art Bacci, Interim Chief Financial Officer

Well, obviously, if rates start to go down, we would recalibrate our beta. We kind of initially think early on the beta would be fairly low again, because of the competitive environment. We do have opportunities. We have product, money market, products that are tied to an index. So, if the index declines, obviously our rates will go down. We've done some exception pricing, primarily with some sort of public money and commercial money that could be repriced down. But on the consumer side, there continues to be a fair amount of competition in the market. And so, we believe that's probably going to be a slower decline. Now, if that were to change, clearly we could lower our rates. But that's our assumption, is the competitive market will require us to continue to provide some premium on deposits to protect our franchise.

Russell Gunther, Analyst

Okay. I appreciate that, Art. And then, if you could just as a follow up, remind us the amount of indexed deposits you have?

Art Bacci, Interim Chief Financial Officer

The amount of indexed deposits is that what you said, Russell?

Russell Gunther, Analyst

If you have it.

Art Bacci, Interim Chief Financial Officer

Yeah, we may have to get back to you.

Russell Gunther, Analyst

No problem.

Art Bacci, Interim Chief Financial Officer

Primarily in the money market account. Let us get back to you, Russell, on that.

Russell Gunther, Analyst

I appreciate that. No problem. And then just last one for me, guys. The '24 outlook, again, with the stable rates, any risk to the fee guide if you were to sensitize to three cuts? I mean, it sounds like the Cash Connect is really a market share gain opportunity, but just thinking through that double-digit target in the three cut scenario as well, how do you see that playing out?

Art Bacci, Interim Chief Financial Officer

I think potentially through rate cuts certainly would increase the value of fixed-income AUM and potentially have an upside in the market, which would increase our AUM. And we're building in like a 3% market-based AUM growth. So that could potentially increase if the markets were to go up. As I mentioned previously, some rate decreases could enhance the securitization market and lead to further corporate debt refinancing, which would benefit our Institutional Trust business.

Russell Gunther, Analyst

Okay. That's very helpful. Thank you guys for taking my question.

Operator, Operator

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

Frank Schiraldi, Analyst

Hey, guys.

Rodger Levenson, Chairman, President, and CEO

Hi, Frank.

Frank Schiraldi, Analyst

Regarding the Cash Connect business, given the increase in activity in the fourth quarter and potentially into this year, it seems there is a solid foundation for growth with the double-digit year-over-year increase. However, I’m curious if there is enough opportunity for growth relative to fourth quarter levels in 2024. What are your thoughts on growth prospects for Cash Connect from this point forward?

Art Bacci, Interim Chief Financial Officer

I think given the volume that's in the pipeline from the providers of ATM services that are moving from that other competitor, there's potential for some low double-digit growth from the fourth quarter.

Rodger Levenson, Chairman, President, and CEO

I think, Frank, with the Cash Connect, there's also some pricing power for us due to the consolidation, which could help us gain some business.

Frank Schiraldi, Analyst

Okay. Yeah, I was going to ask about returns in that business. The ROA looked like got a pretty good boost. I don't know if that's sustainable, and if you even could see further ROA pick up in 2024, where that business could again be accretive to the bottom-line, ROA?

Rodger Levenson, Chairman, President, and CEO

Yes, as you mentioned, Cash Connect has historically contributed positively to our overall return on assets, and we are returning to those levels. We previously invested significantly in products and technology, and now we are seeing the benefits of that investment along with opportunities in the traditional bailment business. We're achieving some scale and gaining pricing power, which indicates that we have the potential for it to continue positively impacting our overall corporate return on assets in the near future.

Art Bacci, Interim Chief Financial Officer

Yeah. Frank, we pretty much saw a bottoming of the ROA in the first quarter this year. And between the first and fourth quarter, the ROA has increased 250%. So, with additional volume being added in the first half of next year, we would expect that ROA to continue to move up.

Frank Schiraldi, Analyst

Okay. Great. And then, Art, just on the AUM linked quarter, the growth noted, obviously, a lot of that was market-driven. But just wondering if you have net flows you've seen in AUM from a customer standpoint over the last couple of quarters?

Art Bacci, Interim Chief Financial Officer

We experienced a slight increase in outflows during the fourth quarter. Prior to that, we were essentially break-even through the first three quarters, which was a significant improvement compared to previous years as we were still working on integrating Bryn Mawr Trust and facing client changes along with some advisor departures. In the fourth quarter, we noticed a bit more client departures, which we believe is partly due to customers utilizing more of their assets to maintain their lifestyles in the face of rising inflation and interest rates, leading them to purchase homes with cash instead of relying on financing.

Frank Schiraldi, Analyst

Okay. And lastly, sorry if I missed it, but the increase in NPA is clearly from a low base, but what primarily drove that?

Steve Clark, Chief Commercial Banking Officer

Hey, Frank, this is Steve Clark speaking. That was really two specific loans, one in the multifamily sector. This particular multifamily was master leased to a co-living operator, who declared bankruptcy. So that sponsor is working to reposition that property into more of a traditional multifamily. The other was in our legacy healthcare book, the elder care. Frank, the facility just did not recover from COVID. So, they were the two specific loans, one in multifamily, one in legacy elder care.

Frank Schiraldi, Analyst

Okay. And then, are either of those additions still current or these are 90 days past due in NPAs?

Steve Clark, Chief Commercial Banking Officer

No, they're both NPAs.

Frank Schiraldi, Analyst

Okay. All right. I appreciate it. Thank you.

Art Bacci, Interim Chief Financial Officer

Thanks, Frank.

Operator, Operator

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

Manuel Navas, Analyst

Good afternoon. Does the fee guidance include any acquisitions? And would any acquisitions on the fee side be additive?

Art Bacci, Interim Chief Financial Officer

Yeah, Manuel, this is Art. Any M&A would be additive. We have not baked in anything into our guidance for M&A.

Manuel Navas, Analyst

And what's your appetite on the fee side?

Art Bacci, Interim Chief Financial Officer

We continue to look at opportunities, namely across our fee businesses, and we did do the transaction in 2023 and we have a couple of other things we're looking at, but we're just looking at it, nothing definitive, right now.

Manuel Navas, Analyst

Okay. And there was a little bit of elevated paydown activity in the commercial. Do you have any view on how that continues? And can you just talk about loan growth across the year?

Steve Clark, Chief Commercial Banking Officer

Yeah, Manuel, Steve Clark again. So last year, year-over-year, we grew loans across all segments, about 7%. We believe mid-single digit for 2024 is attainable, again across all segments, C&I, CRE, consumer with our Spring EQ partnership, and residential mortgage as we made a strategic decision to hold more on the balance sheet. The focus certainly is still C&I, both in the commercial bank and our small business bank. Elevated payoffs in that C&I segment in the fourth quarter really revolve around three transactions. Totaled almost $80 million in the hospitality space, two of our sponsors sold their assets and the third refinanced, and that resulted in some unplanned significant reductions in C&I. The rest of the reduction was line activity at year-end with companies clearing out their line of credit balances in preparation for year-end.

Manuel Navas, Analyst

Thank you. I appreciate that.

Operator, Operator

Your next question is a follow-up from Feddie Strickland with Janney Montgomery Scott. Your line is open.

Feddie Strickland, Analyst

Thank you. I just have a quick follow-up. I wanted to ask about the growth of the balance sheet and earning assets in relation to loans. If I’m correct, it seems to have been relatively low and even declined a bit over the last few quarters. Should we expect the balance sheet to remain mostly flat, or will it start to grow with some of the loan growth?

Art Bacci, Interim Chief Financial Officer

Feddie, this is Art. I would say that the balance sheet will likely remain generally flat. Remember, we have about $500 million in cash flow each year coming from the mortgage-backed securities and investment portfolio, which would support about a 3.5% growth in the loan portfolio. Therefore, the loans would need to increase significantly for us to begin growing the balance sheet.

Feddie Strickland, Analyst

Got it. Thanks, Art. That's it from me.

Operator, Operator

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

Art Bacci, Interim Chief Financial Officer

Thank you for joining the call today. If you have any specific follow-up questions, please feel free to reach out to Andrew or myself. Also, 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 nice weekend.

Operator, Operator

This concludes today's conference call. We thank you for joining. You may now disconnect your lines.