Thank you for standing by. My name is Kayla Baker, I will be your conference Operator today. At this time, I would like to welcome everyone to the First Bank FRBA earnings conference call, second quarter, 2023. 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 would like to ask a question during this time, simply press star, followed by the one on your telephone keypad. If you'd like to withdraw your question again, press the star and one. I would now like to turn the call over to CEO, Patrick Ryan. You may begin.
Thank you, Kayla, and welcome everybody to today's second quarter 2023 First Bank Earnings conference call. I'm joined by Andrew Hibshman, our Chief Financial Officer, Darleen Gillespie, our Chief Retail Banking Officer, and Peter Cahill, our Chief Lending Officer. Before we begin, however, Andrew will read the Safe Harbor Statement.
The following discussion may contain forward-looking statements concerning the financial condition, results of operations, and business of First Bank. We caution that such statements are subject to a number of uncertainties, actual results could differ materially, therefore you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described under Item 1A, Risk Factors in our annual report on Form 10-K for the year ended December 31, 2022, filed with the FDIC. Pat, back to you.
Thank you, Andrew. Overall, the big news obviously is the closing of the Malvern Bank acquisition in mid-July. The financial results for the quarter do not include the combined franchises, they do include some minor level of merger-related costs. The main themes from the first quarter continued into the second quarter, that being deposit pricing pressure, which hurt the margin, also continued strong asset quality metrics. Here's a key summary of some of the key developments during the quarter. We had strong deposit growth, thanks to some sizable new commercial and municipal accounts. We saw continued quality C&I Loan Growth. As I mentioned, our asset quality remained very good, with net recoveries during the quarter and very low levels of delinquency. We continued to ramp up our new C&I business units, with each area meeting or exceeding our budgeted plans year to date.
We have made, as we mentioned, people and technology investments. Those investments are causing some near-term drag on earnings. Nevertheless, we achieved a return on assets of close to 1%, despite these Strategic Investments and Industry Headwinds. Regarding the Malvern merger, we're very excited about the opportunity to meaningfully grow our presence in southeastern Pennsylvania. Plus, this combination gives us unique balance sheet management options and flexibility. Specifically, the combined company should end up leaner, maybe even a little smaller, but more profitable. As always, we'll be reviewing all options available related to the size and makeup of our balance sheet, and we'll follow the path that will drive the best risk-adjusted profitability and shareholder value. Regarding updates on the deposit and funding side, as I mentioned, deposits grew during the quarter.
We were up $158 million, which was a combination of core commercial deposits, as well as holding onto some wholesale funding just to support the balance sheet with extra liquidity during the quarter. We kept liquidity levels higher than usual, given the industry conditions, plus the need for funding the cash portion of the Malvern acquisition. Our Non-interest-bearing balances ticked back up a little in the second quarter, which was nice to see, but we're still down from where we were at the start of the year. On the lending side, we saw $44 million in loan growth in the second quarter, all of that growth coming in C&I and owner-occupied lending. Our disciplined loan pricing and focus on the most attractive segments helped drive continued improvement in our overall loan yield during the quarter.
Overall, we continue our gradual evolution from historically a primarily CRE-focused Community Bank into more of a lower middle-market Commercial Bank. In summary, our core Strategic Commercial Banking Initiatives are bearing fruit, and our acquisition will give us nice strategic opportunities along with significant balance sheet flexibility. We have a unique opportunity to take advantage of the current interest rate environment to sculpt our balance sheet to make us leaner, more profitable, and more efficient as we integrate Malvern and move towards 2024. Our franchise will become more profitable, more valuable, and more attractive as a result of these strategic investments and balance sheet repositioning. At this point, I'd like to turn it over to Andrew to hit on some of the financial results in a little bit more detail. Andrew?
Thanks, Pat. For the three months ended June 30, 2023, we earned $6.8 million in net income or $0.35 per diluted share, which translates to a 0.97% return on average assets. Excluding merger-related expenses, diluted EPS would have been $0.36 per diluted share or 0.99% return on average assets. During the quarter, we had strong deposit growth, Solid Loan growth, continued to improve our liquidity position, maintained strong credit quality metrics as we pushed forward with finalizing the Malvern Bank acquisition. The current interest rate environment and the steps we have taken to increase on-balance sheet liquidity led to a decline in our margin. In addition, the recent investments we've made in people and new locations led to increased Non-interest expenses.
The combination of these factors led to a decline in net income of $190 thousand from the linked first quarter and a decline of $2.0 million compared to the second quarter of 2022. Solid commercial loan growth, primarily in owner-occupied and C&I lending, continued in the quarter. Loans increased $44 million, compared to an increase in loans of $55 million in the first quarter of 2023, which puts us right in line with our original goals for the year. Total deposits were up $158 million during the second quarter of 2023, compared to a decline in deposits of $52 million in the first quarter of 2023.
We also saw somewhat of a bounce back in Non-interest bearing deposits, which were up $13 million during the second quarter of 2023, compared to down $40 million during the first quarter of 2023. Primarily due to the increase in deposit costs, offset somewhat by the increase in the average rate on loans, our tax equivalent net interest margin decreased to 3.28% for the quarter ended Q2 2023, compared to 3.52% in the previous quarter. We continue to expect pressure on the core margin as the inverted yield curve environment persists. We are continuing to hold the line on loan pricing, which is resulting in higher loan yields, and the Malvern acquisition has given us significant liquidity and balance sheet optionality, which will allow us to mitigate the increases to our cost of funds.
The Malvern acquisition will also impact the margin as certain fair value adjustments required at the time of acquisition will accrete or amortize through interest income or interest expense. We are still working through the exact impact of these adjustments. Liquidity levels increased, and we were able to reduce borrowings by $100 million during the second quarter due to increased deposits. We have also continued to enhance our contingent sources of liquidity by adding additional borrowing capacity, by pledging additional commercial loans at the Federal Home Loan Bank and pledging additional securities at the Federal Reserve Bank. As of June 30, 2023, our allowance for credit losses to total loans remains steady at 1.25%.
We maintained the percentage based on a modest level of net charge-offs year to date of $206,000, with net recoveries of $109,000 during the second quarter of 2023, a stable level of problem loans, and our view on future economic activity has not changed materially. Due to the stable level of allowance as a percentage of loans, coupled with the net recoveries, our credit loss expense was $449,000 during the second quarter of 2023, compared to $1.1 million in the first quarter of 2023. In the second quarter of 2023, total Non-interest income remained relatively stable compared to the preceding quarter, excluding losses on investment sales, which were net against Non-interest income in the prior quarter.
Gains on sale of loans increased slightly compared to the preceding quarter, as SBA loan sale activity continues to slowly gain steam, but loan swap activity continues to be slow, which resulted in the reduced loan fees. Annualized second quarter 2023 Non-interest expenses were 1.96% of average assets, or 1.93% excluding merger-related expenses, which compares to a peer average of 2.10%. In total, Non-interest expenses were $13.8 million in the second quarter of 2023, up $319,000 or 2.4% compared to Q1 2023. The increase was primarily due to higher salaries and employee benefits and regulatory fees, offset somewhat by lower merger-related costs. The slight increase in salary and benefits was primarily due to the merit increases that occurred in the back end of the first quarter.
The increases in regulatory fees was due to an increase in FDIC assessment fees. We have work to do to finalize the system conversion for the Malvern acquisition and expect to incur the majority of the final merger-related expenses in the third quarter. We will start seeing some of the benefits of cost savings immediately, but plan to realize the majority of the savings by the end of the fourth quarter. We continue to believe that one of our strengths is our operating efficiency and have refocused our efforts on cost control, as evidenced by our recent closure of our Cranbury branch on June thirtieth. As we work to fully integrate the customers, locations, and employees from the Malvern acquisition, we will see some volatility in our earnings over the next few quarters.
As Pat mentioned, we are well positioned to improve core profitability as we move towards 2024. At this time, I'll turn it over to Darleen Gillespie, our Chief Retail Banking Officer, for her remarks. Darleen?
Thanks, Andrew. Good morning, everyone. After a challenging first quarter of deposit outflows and uncertainty in the market, I'm happy to report on strong deposit growth during the second quarter of 2023. This reflects the continued trust and confidence our value customers have in our Community, Relation-Driven Financial Institution. Our total deposits have increased by $106 million during the first half of 2023. The growth in deposits is proof of how we are steadfast with our strategic initiatives, such as retention and expansion of our existing customer base, acquisition of new commercial and consumer clients, and our deposit campaigns that help to mitigate deposit outflows while focused on building relationships in a competitive rate environment. We began the second quarter with a $44 million increase in total deposits in April.
We saw an increase of $20 million in deposits in May, and deposit balances were up $94 million in June. Much of the growth comes from our commercial and government portfolios. During the second quarter, we onboarded new government clients to the bank through the RFP bidding process. Although we let some high-cost money leave the bank, we still experienced an increase this quarter in our cost of deposits of 50 basis points from first quarter. Clients continue to be rate sensitive, and we continue to evaluate our pricing accordingly. I will notate some of the key factors of our deposit performance. As mentioned, total deposits increased $158 million during the second quarter as a result of our continued focus on retention, expansion, and acquisition deposit initiatives. This gets us back on track for our 2023 deposit growth goal.
We experienced growth in our Non-interest bearing demand deposits in the second quarter, despite the challenging rate environment and losses in the first quarter. This demonstrates the bank's ability to navigate challenges and capitalize on opportunities through our deposit campaigns and targeted marketing strategies. Time deposits decreased slightly as compared to prior quarter. This is intentional by allowing some single service clients and rate shoppers to leave the bank and replacing with relationship-driven business. Our cost of deposit has increased 50 basis points from the first quarter as a result of the competitive landscape. We continue to remain mindful of this when considering future pricing adjustments, as well as the potential effect on our margin. Our deposit mix has remained relatively flat from the first quarter.
We believe the current rate environment will continue to be a challenge, but we are strategically focused on improving our deposit mix by driving in Non-interest bearing core deposits. Our deposit pipeline remains healthy with active campaigns out in the market to drive in new customers and new deposits. We're excited about the potential deposit growth opportunities as we welcome 8 new branch locations into our footprint as a result of the Malvern acquisition. We have changed our retail staffing model by introducing the market manager role within our network, which oversees three to four branches with a feet on the street approach. These individuals are tasked with not only being engaged in the community, but specifically seeking new commercial deposit opportunities while coaching their branch teams to do the same.
As Andrew mentioned, we closed our Cranbury location and consolidated it into our Monroe branch to create some efficiencies and increase profitability of that location. That transition has been going very well, and our clients have not been negatively impacted since the branch was only four miles away. After opening our Fairfield location this past April, which has already exceeded our 2023 deposit growth goal, we look at additional opportunities to expand in the Northern New Jersey and Central New Jersey Markets. Overall, we are very happy with the second quarter successes and look forward to a favorable third quarter and throughout the remainder of the year. At this time, I'll turn it over to Peter Cahill, our Chief Lending Officer, for his remarks. Peter?
Thanks, Darleen. I'll try now to provide some additional information not already covered by the team. After a strong first quarter of 2023, I think we had another good one in Q2. As you just heard, loan growth was $44 million, which puts us just under $100 million in growth for the six months, and as I think Andrew Hibshman mentioned, right on plan. The second quarter kind of mirrored the first quarter. We continued to be selective about new business. We're continuing to be focused on C&I Lending. We've talked about that previously. C&I brings with it more floating interest rates on loans, as well as much higher relationship deposits than you'd see in, for example, investor real estate loans. We've seen progress on increased efforts here, which dates back a few quarters now.
Last year, for example, for all of 2022, C&I loans closed and funded were just under 50% of all new loans brought into First Bank. That includes the fourth quarter of 2022, where the percentage of new loans falling into the C&I bucket rose to 70% of new loans. In Q1 of this year, C&I loans comprised 74% of all new loans closed and funded. This past quarter, C&I loans represented 73% of new loans closed and funded. We're happy the way our results are trending there. New loans closed and funded of all types in Q2 totaled $91 million, up slightly from $86 million in the first quarter. You might guess, loan payoffs were $45 million in Q2, which was an increase from $55 million.
I'm sorry, $35 million in Q1, below the average level of payoffs that we saw last year of almost $50 million per quarter. The other factors obviously impacting net loan growth in all periods are normal term loan amortization and line of credit changes. Regarding line of credit usage, this quarter, it was up slightly from 41% of total commitments of 331 to 43%. The average for the past year, past four quarters, has been 42%. I don't think there's any question that new business generation for us is a little slower than what we experienced in 2022. This is due to our focus on relationship business, the continued impact of rising interest rates and general economic uncertainty. Last year, new loans funded on average for each of the first three quarters totaled $127 million.
In Q4 last year, and for the first two quarters of 2023, new loans funded have averaged about $87 million-$88 million per quarter. One benefit to the rising rates has been a decline in loan payoffs, which averaged $31 million for each of the past three quarters, compared to almost $60 million for each of the first three quarters of 2022. At June 30th, our loan pipeline stood at $171 million, down 21% from the $218 million level at the end of Q1. The total number of individual loans in the pipeline also declined by just about exactly the same percentage. Overall, I'm not dissatisfied with the pipeline, but the economic headwinds we've experienced, we've slowed down things a bit, and we're taking a cautious approach to underwriting new business.
I know I mentioned last quarter that a few years ago, we set a loose target on our pipeline of 50% of loans, kind of the cap for investor real estate. At the end of 2022, we were just below 50%. We were glad to see for Q1 that investor real estate loans were around 30%-31% of the pipeline in terms of total dollars. We've stayed in that range in Q2, where investor real estate loans made up just 35% of the pipeline. We also continue to track on the pipeline anticipated deposits as a percentage of anticipated loan volume. We continue to see positive trends where that ratio of deposits to loans is growing. To summarize new business efforts, we're focusing on finding and growing our business with relationship-oriented borrowers.
We are doing all the things we think we should around setting and monitoring concentration limits and stress testing. We continue to be very well diversified within the existing portfolio itself. On the topic of asset quality, Andrew's comments and the earnings release lay out where we are. We had net recoveries in the quarter. Non-performing loans were up only very slightly. Delinquent loans continue to be low, around 24 basis points at June 30, 2023, down from 35 basis points at the end of Q1. Overall, I'm seeing no areas of great concern. Things from my perspective, continue to look very good here. That recaps the second quarter in lending.
Our objectives for the second half of 2023 will be to continue to organically grow loans and deposits where we can gain relationship business, and at the same time, integrate the Malvern Bank Staff and their Book of Business. The Malvern Integration has just begun, but we think we know the staffs and then the portfolio very well at this point, and we anticipate no major issues. With that, I'll turn things back over to Pat for some final comments. Pat?
Thank you, Peter. At this time, I think what I'd like to do is turn it back over to the Operator to open things up for Q&A.
Great. At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Our first question comes from Nick Cucharale with Hovde. Your line is open.
Good morning, everyone. How are you today?
Doing well, Nick. How are you?
Doing very well, thank you. With respect to the balance sheet flexibility you mentioned in the prepared remarks, I know it's very early stages, you know, considering you just closed the deal last week, but have you made any decisions on the path forward at this point? I'm curious if you've used the accounting treatment to restructure the securities portfolio or pay down their sub-debt, among other options at this time.
Yeah, I think the short answer, Nick, is, you know, everything's on the table. You know, we've sort of taken a look at the balance sheet and kind of prioritized it from, you know, least strategic to most strategic. You know, the obvious path forward would be to focus on, you know, selling off assets that are viewed as less strategic and, you know, gradually work our way down the list. Now, we haven't set any specific targets for exactly how much will ultimately be sold versus retained. Some of it will depend on, you know, what we view as the reasonableness of the market and the bids for things that we might consider selling.
It'll be a fluid process, but I think the good news is we've got a number of different options available, and I think that gives us the ability to, you know, really try to optimize in terms of what we keep, what we don't keep, and what the combined franchise looks like going forward. You know, stay tuned. We hope to be in a position to have a lot of that work finalized by the end of the third quarter, so that when we're back reporting, you know, ±90 days from now, there'll be a lot more visibility in terms of what that looks like.
That's very helpful. On the C&I growth, which was strong again this quarter, are there any particular niches you're targeting with this initiative, or is it broad-based across a whole host of industries?
Well, I think, you know, within C&I, it's broad-based, but as you know, Nick, we've got a couple of, you know, younger business units, not brand new, but things we've been rolling out over the last 12 months-18 months that are doing well. We've got a particular focus now in terms of small micro business lending, you know, kind of loans under $500,000 to the smallest businesses. We're continuing to see nice traction with our private equity sponsor group in terms of opportunities to finance portfolio companies within that segment. Our asset-based lending team is now fully staffed up and running, and we're starting to see some traction there as well.
All of that is in addition to our core market teams, which have been and continue to look for quality C&I opportunities within our, you know, New York to Philadelphia footprint. We got a lot of different levers in terms of business units targeting small and medium-sized business opportunities. That's obviously our bread and butter, our strategic focus. You know, it's nice to see that we're gaining some added traction there.
Great. You noted the systems conversion in the prepared remarks. When is that scheduled to take place?
September. The weekend of September nine, 10, 11, I believe, is the current schedule.
Great. Lastly, with loan growth on track through mid-year, can you remind us of your organic loan growth target for the full year?
Yeah, we typically target in terms of just pure core organic growth, ±200. Obviously, you know, with round numbers, 100 in net growth so far, that puts us right on track. You know, Listen, I think there's plenty of opportunities to get to that 200 number, but I'd also tell you that probably this year, more than most, you know, being additionally selective and making sure it's the right deals with deposits, with our pricing, you know, our goal is doing the right business. If we end up hitting the 200 number, that's fine. If it ends up coming in less than that, we're not overly concerned.
Sounds great. Thank you for taking my questions.
Yeah. Thank you, Nick.
Again, if you would like to ask a question, please press star, then the number one on your telephone keypad. Our next question comes from Manuel Navas with D.A. Davidson. Your line is open.
Hey, good morning. Just to follow up on the loan growth, I understand this year could be a little bit in flux, but, in the commentary, there's some selectivity in the pipeline. Can you just discuss demand, general demand? Is that, that's also, it seems like it's ticked down as well.
Yeah. Listen, there's certainly less activity, but there's not no activity. There's still a fair amount going on. I'd say, businesses and borrowers are being a little more deliberate, but, you know, they certainly haven't come to a grinding halt in any sense. There's still plenty of opportunities. When you think about it in the context of net loan growth, you got to remember the other side of the equation, which is payoffs and pay downs. We're almost certainly gonna do less new business this year, but we won't need to do as much new business to grow loans because payoffs and pay downs have slowed up as well, so.
That's great. As you get larger, do you have a sense for where the, where that $200 million annual target could reach? You know, this year is in flux. I hear that. Any thought on where it could be in future years?
We haven't focused on that yet, right? I mean, we're focused right now on continuing to do good quality business, but also, you know, on this balance sheet, repositioning project. You know, we're still trying to figure out what the size of the balance sheet is gonna be at the end of the year, let alone how much we're gonna grow as a percentage off of that. I think, as we get larger, you know, when we were a small quasi-startup, the loan growth was critical because we needed the revenue to cover the expenses to drive profitability.
I think as we, as we grow and as we mature, you know, there's not gonna be as much of an emphasis on driving growth rates at the levels that we saw in the past, although we're gonna wanna continue to do quality business. You know, really the emphasis is around portfolio optimization. If we can add the right type of customers, I think we've got capacity to continue to grow at that 200 or more number. You know, we're gonna be adding the right business. Quite honestly, Manuel, it's gonna be somewhat driven by what can we fund with core deposits, right?
I mean, depending on the deposit market and what's available there, we may have the ability to grow $300 million, $400 million, but we may choose not to because we don't wanna have to go out and bring in high-priced money to do it. You know, it's a, it's a balancing act, and it's really as much art as science. There's not a specific number we're trying to hit. If we've got lots of good opportunities that we can fund with core deposits, I think we're happy growing more than $200 million. If the funding's an issue and/or the quality of the borrower and relationship doesn't make us feel good, then we may choose to do less than that.
I appreciate that, but I, my follow-up now is on deposits. Really strong growth there. I just wanted to follow up on two comments during the presentation. One, you have the market manager role as you, you have this kind of renewed impetus in market concentration to get more deposits. It seems like you're tracking deposits to loan on a lender-specific ratio more. Can you kind of talk about where those two initiatives overlap and how much of deposits are you getting from your lenders specifically?
Yeah. Listen, the obvious answer is we're, you know, trying to get all hands on deck to grow quality core deposits. We've been working closely with the RMs for years to continue to drive deposit growth along with their loan portfolio. You know, what we've seen in our review is the ratio of deposits to loans for our RMs with portfolios continues to tick up higher, in many cases, close to 40%, 50%, which we think are pretty good levels. You know, that's just one avenue for driving deposit growth. Another area, not the other area, but another area is trying to figure out how do we get more out of the branch network.
I think, as Darlene mentioned, really repositioning, not necessarily adding a lot of staff, but figuring out how we can reallocate staff that we have to get more people out into the market. Listen, while we don't love the fact that people don't come into the branch as much as they used to, we're also taking advantage of that reality by reshuffling positions so that our staff has time to get out in the market more and spend more time, attracting and developing new relationships. I think what Darlene was referring to there was really just a reallocation so that folks had more time out in the market, partly because that's what we need to grow deposits, and partly because they're just not needed as much inside the branch, so.
My last question on deposits. Has pricing across the second quarter and into the third quarter, has the pricing pressure shifted at all? I mean, I'm sure it's high all the time, but, like, is it a little bit less high here in June?
Yeah
A nd July, or is it?
I like that.
Any trend there?
I think a little less high is a good way to describe it. Not quite as frenetic as it was. You know, listen, I think part of it is a lot of banks, ourselves included, just decided, you know, post SVB Signature, that it was worth paying a little more to have extra liquidity. As the market calms down and as, you know, we're seeing stabilization, I think all of us are saying, "Hey, maybe I don't need to carry as much excess liquidity, and therefore, I don't need to be quite as aggressive on the deposit pricing side." I think that's part of it.
You know, part of it is just, you know, folks are starting to feel like we're getting to the end of the rate cycle, and, you know, there's not this constant expectation that rates are gonna move higher, rates are gonna move higher. I think that takes a tiny bit of pressure off of the pricing negotiation. You know, Andrew, you mentioned to me that some of your, your conversations with folks on the wholesale side, you were starting to see a little less pressure there. You wanna jump in on that point?
Yes, it definitely seems like the market's settling down. It's still competitive for some of the wholesale funding, but it definitely feels like the pricing pressure on when the Fed just moved this week, maybe we won't have to move rates on the wholesale side as much as we had in the past. Seems like things are settling down, but like you said, Pat, it's still very competitive. Rates are still a challenge, but it definitely seems to be muted at least a little bit with what we've seen in the first six months of the year.
Thank you, guys. I'll step back and thank you. I really appreciate the comments.
Yeah. Thank you, Manuel.
There are no further questions at this time, so I will turn it back over to Patrick Ryan.
Okay, wonderful. Well, thanks, everybody. Appreciate you taking the time to listen in. Certainly appreciate the questions during the Q&A, and we'll look forward to being back in front of folks at the end of the third quarter with I would guess, lots of updates on what we've been doing from an integration standpoint, as long as well as updates on the core business. Lots to talk about, and we'll look forward to that meeting in about 90 days. Thank you, everyone.
That concludes today's conference call. You may now disconnect.