Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the First Commonwealth Financial Corporation Q3 2022 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star then the number one on your telephone keypad. To withdraw your question, press star one again. Thank you. Ryan Thomas, Vice President of Finance and Investor Relations, you may begin.
Thank you, Chris, and good afternoon, everyone. Thank you for joining us today to discuss First Commonwealth Financial Corporation's third quarter financial results. Participating on today's call will be Mike Price, President and CEO, Jim Reske, Chief Financial Officer, Jane Grebenc, Bank President and Chief Revenue Officer, and Brian Karrip, our Chief Credit Officer. As a reminder, a copy of yesterday's earnings release can be accessed by logging on to fcbanking.com and selecting the Investor Relations link at the top of the page. We've also included a slide presentation on our Investor Relations website with supplemental financial information that will be referenced during today's call. Before we begin, I need to caution listeners that this call will contain forward-looking statements.
Please refer to our forward-looking statements disclaimer on page three of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statement. Today's call will also include non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, our reported results prepared in accordance with GAAP. Reconciliation of these measures can be found in the appendix of today's slide presentation. With that, I will turn the call over to Mike.
Hey, thanks, Ryan, and good afternoon, everyone. Net income of $34 million increased $3.2 million over the second quarter on the heels of significant improvement in net interest income and better fee income, partially offset by pressure on non-interest expense and an uptick in provision expense. Our pre-provision net revenue of $48.9 million was strong and produced a core pre-tax, pre-provision ROA of 2.03%, and our core ROA in the first quarter was 1.43%. Key elements of the quarter follow. Strong loan growth of 3.3% annualized, coupled with the burgeoning net interest margin of 3.76% propelled an $8.7 million increase in net interest income to a record third quarter figure of $82.6 million.
Growth was again broad-based, with commercial lending leading the way, followed closely by indirect lending and mortgage. All of our regions are reporting healthy pipelines in both our consumer and commercial lending businesses. Our strong core depository was especially valuable in maintaining a low cost of funds, further supporting margin expansion as our cost of deposits only increased by one basis point. Between now and year-end, higher rates will result in more muted fourth quarter loan growth and bring the figure to we project mid-single digit guidance. Non-interest income rose $1.4 million to $25.9 million in the third quarter as swap income and commercial lending hit record levels. SBA gain on sale picked up steam as well.
Third quarter non-interest expense rose $3.6 million, and it was a function of investments in talent and technology, broad inflationary pressure on salaries, and a handful of one-time items. However, the core efficiency ratio still fell to 54.06% due to the aforementioned growth of top-line revenue. Third quarter provision expense of $5.9 million was up over the second quarter, even as overall credit quality remained sound. For example, commercial 30+ day delinquency was only two basis points, down from an already low four basis points last quarter. Non-performing loans at $35 million for 48 basis points of total loans were down from last quarter as well. Looking forward, a broad base of both margin and fee businesses coupled with a philosophy of continual improvement should translate into continued growth.
We've built a well-diversified bank that we feel will do well in multiple interest rate and economic scenarios. This is why we've strived for balance in the composition of our lending book, with 47% of outstandings in consumer loans at quarter end and 53% in commercial categories. Intentionally and organically, we've moved towards balance in our loan portfolio starting at least five years ago to the point where we now have roughly 50% in variable rate loans and 50% of our loans in fixed rates. We've also methodically built sources of fee income that peaked at nearly 30% of revenue several quarters ago through meticulous execution in mortgage, SBA, wealth management, and other fee businesses. Coupled with sound credit, we've built the bank to thrive in good and tougher times. We will remain focused on what we can control.
We strive to get better in each of our businesses and regions with better talent and processes every quarter, regardless of the external environment. We are also excited about our 2023 growth prospects with Centric, SBA, Equipment Finance, and continuing growth through our regional business model to name just a few. As we look forward to 2023, the emerging strategic themes will likely be largely unchanged from 2022 which are as follows. First, improve and grow our lending, depository , and fee businesses in each region of our company. Second, increase digital relevance. Third, maintain operating leverage. Fourth, strengthen our culture, leadership, and talent. Fifth, improve brand awareness. For now, I'll just focus on one of those themes, increasing digital relevance. We continue to be pleased with the adoption of our digital banking platforms.
In total, for the quarter, we experienced an 11.5% annualized increase in active mobile users. Importantly, our customers continue to show high engagement with our digital tools with average logins per user per day at 1.07x . That's year to date, which is up 12% year-over-year. With this strong use of the platform, we continue to make investments to bring more features to our customers. The Centric acquisition is proceeding well, in large part due to good dialogue between the leadership teams of both organizations. We still intend to close the transaction on January 1st as planned, subject to pending regulatory approvals. Finally, we are pleased to see that First Commonwealth earned the designation as the number one SBA lender in Western PA and number two in Pennsylvania. With that, I'll turn it over to Jim Reske, our CFO.
Thanks, Mike. As Mike mentioned, the combination of 13.3% annualized loan growth and 38 basis points of margin expansion produced strong financial results for the quarter. As usual, I'll try to provide some helpful color on our earnings trajectory. The margin is benefiting from improved loan yields combined with deposit costs that have remained essentially flat. We had the advantage of coming into this cycle with a cost of deposits low enough to place us in the 90th percentile of our industry, and our cumulative deposit beta in this cycle to date has been effectively zero. Our cost of interest-bearing demand and savings deposits was 7 basis points in the third quarter, which is exactly the same as it was in the third quarter a year ago.
Our total cost of deposits, which includes the non-interest-bearing deposits that form roughly one-third of our deposit base, was five basis points in the third quarter. That's up from four basis points last quarter, but it's actually down from six basis points a year ago. We do expect deposit betas to change, however, as we witnessed deposit competition heat up in our market steadily over the course of the third quarter. We had been using a 25% deposit beta assumption based on our historical experience, but a refresh of that analysis leads us to expect deposit betas of 20% going forward, both for rate increases from here on out and cumulatively through the cycle.
Though assuming a beta in the fourth quarter of 20% and a Fed funds rate of roughly 4.5% by year-end, we would expect the NIM to expand by at least 20 basis points in the fourth quarter. The NIM is quite sensitive to the beta assumption. If, for example, the beta were to come in at just 10% of fourth quarter rate hikes, that would result in about 10 basis points of upside to the NIM projection I just gave you. We'll update 2023 NIM guidance going forward to reflect the Centric acquisition once we receive regulatory approval. Expenses were elevated in the third quarter compared to last quarter for several reasons. Some things represented normal quarterly volatility. For example, hospitalization expense was up by about $500,000 after being well contained all year.
Other items represent the impact of inflationary pressures and are likely here to stay. For example, salaries are up by about $500,000 as we filled open positions and worked to improve employee retention rate. Still other items reflect increased activity and long-term investments in the company. This would include roughly another half million dollars for incentive accruals that were adjusted upward in recognition of higher loan production in the third quarter and improved performance, and the continued build-out of our Equipment Finance business. Finally, there were about $800,000 in one-time expenses that we feel are not part of our normal run rate.
We had one-time technology expenses in the third quarter of about $500,000 related to a conversion of our credit card system, along with costs associated with the cancellation of certain IT contracts and a reconfiguration of our telephone service. There was also about $325,000 in expenses that we don't expect to be ongoing for facilities projects, the largest of which was related to some flood damage at one of our branches. In light of third quarter results, however, we are updating our previous non-interest expense guidance of $56 million-$57 million per quarter to $58 million-$59 million per quarter, but we'll obviously update guidance for 2023 to reflect the Centric acquisition when appropriate. Provision expense was a bit higher than in previous quarters, but the ACL coverage ratio stayed unchanged at 1.31% of total loans.
Provision was driven by our strong loan growth and the normal charge-offs. We did increase reserves due to changes in our economic forecast, but these increases were largely offset by the release of some COVID-related reserves that we still had on the balance sheet. We would emphasize that we still see very few signs of stress in our credit quality metrics. As Mike mentioned, we actually saw improvement in a number of credit metrics year to date, including reductions in non-performing, criticized, and classified loans. Finally, our effective tax rate was 19.82% in the third quarter. With that, I will turn it back over to Mike.
Thanks, Jim. Operator, we'll turn it over to you for questions.
Thank you. As a reminder, if you would like to ask a question, please press star then one on your telephone keypad. Our first question is from Frank Schiraldi with Piper Sandler. Your line is open.
Good afternoon.
Hi, Frank.
I think, Mike, you mentioned uh in speaking um um on loan growth an expectation of mid-single digits, if I heard right. Is that um for the fourth quarter, um the guidance?
It is. We've had some ebb and flow to our loan growth. Like, this year we were at 9%, 11%, and 13%. I think the year before we had a down quarter and then three up quarters. There's just an ebb and flow to some payoffs in the third quarter. Hopefully we'll be back off to the races in the first quarter of 2023.
Okay. You know, previously kind of thought about maybe a little bit of a handoff from consumer to commercial. I guess commercial is a bit stronger. You know, as you look out in 4Q, do you see? Sounded like you talked about strong pipelines in both. Do you think it's, you know, still maybe sort of 50/50 growth in consumer commercial in 4Q?
Yeah. It's been surprisingly so throughout this year. Um y ou know, corporate banking has some nice pipelines and quality investment real estate projects in good markets. We also build up a nice construction book where advances should average about $25 million a month next year. Um and they're in growing markets like Columbus. You know, you have projects coming in there with Honda and Intel. There's a lot of tailwinds in those markets. Even on the C&I side, we see some nice pipelines in the regional books in Cincinnati, Columbus, Cleveland, Pittsburgh, and Central Pennsylvania more excited about Centric and what they're gonna add to the equation. We expect some good swap fees in the fourth quarter. Probably a little bit muted over the third quarter.
As we move to the consumer businesses, they're off a little bit, but not much. Indirect is having a strong quarter. SBA pipelines are getting deeper. Um mortgage has settled down at probably 30% less than peak, but we really still like the business and the operator there has scaled it for that size. And then interestingly on the branch-based side, we've seen the HELOC volume move to or HE loan volume move to HELOC, which you have to wait for the draws. We like the activity. We like the way it sets up for 2023, all things being equal. That's kind of trudging along with uh you know, despite inflation, tight employment, and really constructive business outlook, at least in our markets.
Okay. Great. Then just a question for Jim on the margin. Wanted to make sure I understood or I heard correctly on the um expected beta. Was that a 20% um beta through cycle? And then um just curious if you could talk a little bit about why the change in expectations. Is it just as simple as, you know, what you've seen to date on that side of things?
Yeah, Frank. A good question. I'm glad you asked because we've been saying 25% beta all through this cycle, and we say that every quarter, and then the beta comes in at zero. Looking back, to be honest, we thought we were pretty clever at the beginning of the rate cycle by instituting a delay in our expectations. We said at the beginning that rather than just 25% from the get-go, we thought we would be able to go the first two rate hikes with no beta, zero, and then 25% thereafter. That was three or four quarters ago on our earnings call, so you may recall us saying that. Of course, we've gone 300 basis points of hikes and have had a zero beta through this time.
The beta study we have is based on our historical data. Just look back. The look back was done in October of last year. That was very consistent with our historical experience. At that time it was 25%. That led us to the 25% conclusion. We just refreshed that analysis, and taking into account the low beta this year, the new number is 20% in the aggregate. Now obviously there's a different beta in every deposit category, but the aggregate number is 20%. So we think, going forward, if the Fed does hike in the fourth quarter, we're gonna pass some of that along to our depositors, and that's the current period beta assumption. Then over time, the beta will catch up.
Even if there are no hikes in the first, second, third quarter next year, if the Fed just holds pat, our deposit rates will continue to rise just like everybody else, such that we still think at the end of the cycle, cumulatively, it'll end up totaling around 20%. Hopefully, that gives a little clarity. I appreciate your question.
Yeah. Thanks. Just on the 4Q NIM expansion.
Yeah.
That was based on um betas um moving higher over time, not necessarily a 20% cumulative beta by 4Q. Is that right?
Yes. Thank you again for asking. It's not saying that we'll have reached a cumulative beta of 20% by the end of 4Q. It's only saying in our assumptions that it'll be a 20% current period beta. So if the Fed raise rates by 100 basis points, we would expect passing on 20% of that to depositors in the fourth quarter, only the current period. The rate forecast I gave you actually, that's based on our latest rate forecast that we received that it uh currently expects 275 basis point hikes, so 150 basis points of rate increases in the Fed funds rate by year-end.
Great. Okay. Thanks for all the color.
You bet.
The next question is from Daniel Tamayo with Raymond James. Your line is open.
Thanks. Good afternoon, guys. Um not to continue on this margin discussion, but um that's great color on the fourth quarter. Obviously, the margin is gonna be um kind of above historical levels by that point. Just curious how you're thinking about um the margin going forward past the fourth quarter if you know assuming we get some stability in rates if those start to come down to I guess historical levels, or you think there's something structural about the margin now where you can maintain higher Net Interest Margin. Thanks.
Well, I do think we'll be able to maintain a higher net interest margin for some time. The effort will linger. It'll continue a little bit. We keep repricing the loans upward. We reprice the fixed loans up. Even those as they come due, we reprice those upward. We saw a nice steady progression of that throughout the third quarter. Um so there's the instant repricing if the Fed raises rates here in the fourth quarter. Even if the Fed stops raising rates all through next year, we'll still see some uptick in loan yields um just as we reprice the book upward. I think the question you're getting at kind of uh gets at this notion of a peak NIM and when do we think that NIM will peak.
It's hard to predict because we're in the middle of an acquisition and we can't really talk about some of those numbers right now. Um it does look like the NIM will peak sometime over the course of next year. If the Fed holds rates for a while, a lot of the loans will reprice, and we'll kind of settle into a nice higher NIM and stay there for some time.
I would just add um the five acquisitions that we've done, notwithstanding Centric, have all been accretive to our margin and our profitability, and we expect the same.
Okay. All right. That's very helpful. Thank you. And then maybe we talk a little bit about the fee income. I think we've talked about guidance in the $26 million-$27 million range per quarter. Just wondering what your current thoughts are on that.
You know, probably roughly the same. We have SBA ticking up a little bit. Maybe the swap income ticks down. Even with the strength of Christmas, I think our interchange will probably be roughly the same, maybe up a little. That's kind of the tale of the tape, at least from this vantage point. You're always surprised a little bit. You know, mortgage has been chugging along and doing well, but it's certainly not at the height it was, you know, two or three years ago. We're long on that business. We get a young creditworthy household with a mortgage, and that's also important to the bank.
Understood. Terrific. Lastly, just from a credit perspective, wondering if you're kind of purposely pulling back anywhere as we prepare for, you know, perhaps an economic slowdown next year. If any categories are just a little bit less aggressive in terms of lending. Thanks.
We're not yet. We're reading the tea leaves with um um the economy from quarter to quarter, but we're not yet. We feel like we have good standards, and we can at least lend through the cycle notwithstanding severe shocks or unanticipated consequences in the economy.
All right. Well, thanks for all the color, guys. That's all for me. Appreciate it.
The next question is from Michael Perito with KBW. Your line is open.
Hey, good afternoon. Thanks for taking my questions.
You bet.
I wanted to start, you know, Jim, you mentioned the new kind of expense run rate for the fourth quarter. I know you guys will provide more commentary for next year, specifically in January. Just curious if you guys have any initial thoughts, kind of excluding Centric, when you think about that NIM stepping up towards 4%, the investments you guys are making, some of the digital progress. Um do you guys think you will be able to generate positive operating leverage on the kind of the core business next year, um if rates kind of do what the consensus forecasts say they're gonna do at this point?
That's our history. As we think about deposit betas, understand too if the growth doesn't materialize, the beta will be lower. If the growth is higher, the loan growth is higher, the beta will be higher. You know, our Jim and Jane, our deposit committee, meets every other week, and they monitor that very closely.
What you know what are some of the pressure points, I guess, for lack of a better way of putting it, where like the loan deposit ratio sits at about 90% today. Like, let's say you guys do high single-digit loan growth the next couple quarters, right? I mean, what's the flexibility to you know maybe shrink investments or cash or would you guys look to maintain the liquidity level and just try to be more aggressive adding funding and push the beta a little bit? Can you just maybe spend a little bit more time just on that element of the dynamic in terms of deposit betas?
Yeah. We've only begun to hike rates in the last 30-60 days. We have not hiked any rates.
Deposit rates.
Deposit rates. We just haven't been in, you know, deposit acquisition mode. We haven't had to be. We could sop up a lot of liquidity out there.
Yeah. I'll give some additional color just on the component to your question. We basically have been letting the securities portfolio run off, and it's been a nice source of funding for the bank. Now the runoff slowed down a little bit because we put on some of the securities at lower rates. If you look at the AOCI, obviously a lot of that is underwater. The prepayment speeds have slowed, but it's still producing cash flow. Our plan is to let that continue to produce cash flow and reinvest that into loan growth. Then the excess cash we had earlier in the year, I mean, I think early in the year, at some point this year, it crested and peaked at about half a billion dollars during calendar year 2022.
I think it was early in the second quarter of excess cash. We've put all that into loan growth. The plan is to, as Mike said, now that we're pursuing, we want to pursue deposit. We want to fund our loan growth with deposit growth. That obviously is a higher rate environment, so have to keep up with competition but that is the long-term plan.
Helpful. Then just lastly for me, and I know you can't be too specific, but would just, you know, kind of love to check in on this. You know, this whole AOCI book value tangible capital dynamic has kind of had a, I don't want to say an odd, but an interesting impact on the way the stocks are trading and the way I think people are thinking about M&A. You know, obviously with Centric, you guys are kind of nudging about $1 billion or so over the $10 billion threshold. Just curious, Mike, if you have any kind of just general thoughts about how you're viewing the markets and the opportunities that'll be out there. You know, obviously there's not a huge rush, and we discussed that when you announced the deal.
Just curious if anything that's gone on in the last, you know, 90 days has been noteworthy or changed the way you kind of view the M&A environment?
Nothing in terms of the M&A environment. I'll let Jim speak to AOCI. I mean, we're really constructive on the deal we have right now. They're a branch light franchise with a high net interest margin, commercially oriented bank. It just fits like a glove for us. It's well run with good producers. We just think like the other opportunities that will be very positive for the forward momentum of our company. As Jim mentioned, we can't speak about that for another quarter. Jim, why don't you talk a little bit about the other aspect of this question?
I think I can bifurcate your question in two different uh streams of thought. One is that there is definitely an impact of AOCI as things go on. For example, from the time you negotiate a deal to the time you actually close a deal, there can be such a movement in rates now that your calculation of marks will change, and you have to take that kind of thing into account. I don't think any of that affects and really impacts our long-term thinking on M&A. We want to do deals that are both strategic, that fit in our franchise, fit our community bank philosophy, and that are financially accretive to the bank.
I don't think even the kinds of M&A that we had considered in the past, the geographic regions we've considered in the past, the general M&A long-term strategy for us really hasn't changed as a result of this phenomenon. You have to take it into account, you have to take the rate environment into account, but it doesn't change anything for us long term.
Yeah. What also doesn't change is us appearing in 2024 and 2025 on the other side of Durbin impact and striving to be as profitable, and I've said, if not more profitable than we were, the last several years in terms of ROA, um pre-tax, pre-provision, all of the above. That's the goal. Obviously, M&A gives you nice operating leverage, but we also have businesses that are growing, like SBA, like equipment finance, our core businesses in our regions, our consumer lending businesses. I mean, these were hard, gang. I mean, we were in them de novo three or four years ago, and now they create a broad base of revenue for our company and opportunities for growth and to serve our customers. They also help us through thick and thin when things get tough.
We're not reliant on a category or two of loans.
Hope that helps.
Yeah. No, it does. Good color. Thanks again for taking my question.
Again, as a reminder, if you would like to ask a question, please press star then one on your telephone keypad. Our next question is from Matthew Breese with Stephens. Your line is open.
Good afternoon.
Matt.
Just thinking about kind of the Fed outlook and what happens post-Fed tightening. If we get, you know, a cessation in Fed hikes in early 2023, you know, what is the expectations for the NIM in the aftermath of that? I mean, a lot of asset-sensitive banks are talking about somewhat of a peak and some decline in the margin after that. Curious if that's your expectations.
Yeah, it would be. It would be because there'd be a continuing lingering effect of repricing loan book upward, but also repricing deposit side for to get to that cumulative beta we talked about before. Just to kind of be more clear about that, we would think that we probably would reach peak NIM sometime in the first half next year. It's hard to pinpoint the exact time if it's first quarter, second quarter, or late first quarter or early second quarter, but it's probably sometime in the first half next year.
Okay. Then as we approach that point and given the earlier question about you'll be running at a, you know, above historical average kind of NIM. Do you do anything to preserve it? Do you have any sort of balance sheet swaps or migration of the balance sheet towards a more interest rate neutral position? Should we expect that?
Well, we've done that organically with how we've constructed the balance sheet, 50/50 variable/fixed. We've done that. Then also in the past, we have layered in macro swaps to protect upward and downward movement. We've done it a number of times.
Yes, we'd be open to that.
Okay. Then secondly, you know, just on some of these fixed rate loan resets. I'm curious what the incoming new loan yields are on some of the commercial real estate and multifamily and things like that. On a reset, are you seeing any stress on the borrowers kinda you know bottom lines as you go from you know rates from three, four, five years ago and you know call it the 4% range till today, I'm guessing it's you know north of 6%. Is there any sort of stress on their bottom lines, and have they been able to kind of mitigate that higher interest rate with higher rents and the like?
Well, they have to when they bring us the project because we're all stressing the projects with different interest rate assumptions. If you have better developers, they understand that. That would be the way I would answer that question. Invariably there will be stress for projects, but it depends on the quality of sponsors and developers that you've underwritten and their wherewithal to work through it, should you know things get even tougher.
Yeah. On the rate reset question, I don't have it by category in particular to get to, but I just tell you this is just such a nice progression over the course of the quarter. For the entire quarter, the new loans are coming on at 4.59%, call it 4.59%. Old loans are going off at 4.39%, so it's nice replacement yields. It's a really solid progression month-over-month through the third quarter. For example, the new loan yields in the three months of the quarter were coming out at 4.30%, then 4.60%, and then the last month of the quarter in September, 4.97%. Pushing 5%. In some categories, some commercial categories over 5%. That's just a really nice progression month-over-month.
That's the bank as a whole, that's in the aggregate. It's a nice progression month-to-month in the third quarter. And so we'd expect that to continue even after the Fed for some time anyway, even after the Fed stops raising rates.
Got it. Okay. I appreciate you taking my questions. That's all I had. Thank you.
Thanks, Matt.
We have no further questions at this time. I'll turn it over to Mike Price, President and Chief Executive Officer, for any closing remarks.
You know, sincere thanks for your interest in our company and questions, and it's good to be with you this afternoon.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.