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spk08: Hello, everyone, and welcome to the Financial Institutions Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Bruno, and I will be operating your call today. During the presentation, you can register to ask a question by pressing star 1 on your telephone keypad. I will now hand over to your host, Pamela Kennard, Investor Relations Analyst. Pamela, please go ahead.
spk01: Thank you for joining us for today's call. Providing prepared comments will be President and CEO Marty Birmingham and CFO Jack Plant. Chief Community Banking Officer Justin Bigum and Director of Financial Planning and Analysis Mike Grover will join us for Q&A. Today's prepared comments and Q&A will include forward-looking statements. Actual results may differ materially from forward-looking statements due to a variety of risks, uncertainties, and other factors. We refer you to yesterday's earnings release and investor presentation, as well as historical SEC filings, all available on our investor relations website for our safe harbor description and a detailed discussion of the risk factors relating to forward-looking statements. We'll also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures. Reconciliations of these measures to GAAP financial measures were provided in the earnings release filed as an exhibit to Form 8-K. Please note that this call includes information that may only be added as of today's date, January 31st, 2023. I'll now turn the call over to President and CEO Marty Birmingham.
spk03: Thank you, Pam. Good morning, everyone, and thank you for joining us today. Fourth quarter net income available to common shareholders was $11.7 million, or $0.76 per diluted share, down as compared to the link and prior year quarters. The decline was primarily the result of higher provision for credit losses and lower PPP-related revenue, described in detail in our earnings release. Adjusting for revenue related to PPP loans, restructuring charges, and impact of the third quarter 2022 surrender and redeployment of company-owned life insurance, pre-tax, pre-provision income for the quarter was $20.8 million, $261,000 higher than the linked quarter in 865,000 higher than the prior year period. I believe these are strong results in a challenging operating environment. Organic loan growth was once again a highlight this quarter, with 4.7% increase in total loans from September 30th. All major loan categories contributed to this growth, with increases of 4.8% in commercial business, 7.4% in commercial mortgage, 2.1% in residential real estate, and 2.6% in consumer indirect. As our loan portfolio has grown over the past several years, I have reinforced our commitment to credit discipline and the management of risk. We have continued to invest in credit and risk personnel and develop what we believe is an effective and efficient risk and control environment. A current example is a transition of Randy Phillips to a newly created position of Deputy Chief Credit Officer from his current role of Chief Risk Officer. With 32 years of local commercial credit experience, Randy has the skills and experience to help lead and support the continued evolution of our credit delivery function. The Chief Risk Officer role will be assumed on February 6th by a risk professional who has 34 years of progressive experience in compliance, consumer credit, audit, and operations while working for international, national, and regional banking institutions. He most recently served as Chief Compliance Officer in a $50 billion bank. In 2023, we expect that our loan portfolio performance will be consistent with historic credit outcomes, despite market concerns regarding the economic environment, a potential recession, and the quality of credit. Positive year-end total loan portfolio metrics included non-performing loans to total loans of 25 basis points. Allowance for credit losses on loans to total loans of 112 basis points. And allowance for credit losses on loans to non-performing loans of 445%. In addition, there were zero delinquencies in our large commercial loan portfolio as of December 31st. The ratio of annualized net charge-offs to average loans was 34 basis points in the current quarter, 22 basis points in the third quarter of 2022, and 51 basis points in the fourth quarter of 2021. During the fourth quarter, we did have a $1.2 million charge off of a credit with a previously established specific reserve, which was related to a small commercial loan associated with office space. Our overall loan portfolio is performing quite well, inclusive of this asset class. As I stated in the earnings press release, commercial loan growth was back end weighted in 2022, largely driven by the success of our Mid-Atlantic team. After joining us in February, they worked quickly to develop a pipeline of high-quality opportunities in the Baltimore and Washington, D.C. market. Commercial loans outstanding in the Mid-Atlantic market increased by approximately $75 million in the fourth quarter and totaled $148 million at year-end. Our commercial loan pipeline in the Mid-Atlantic market is holding steady at about $200 million, while the total commercial loan pipeline is about $750 million. I'm very pleased with the progress made to date in this market with new credit and deposit customer relationships established and cross-sale conversations related to insurance and wealth underway. Despite the ongoing pressures of inflation, higher interest rates, and tight housing inventory, our residential loan portfolio grew 2.1% from September 30th. This increase can be primarily attributed to our loan program that provides easier access to homeownership for borrowers with less than 80% of the area median income. We are also seeing positive outcomes from recently added talent and operational efficiencies implemented to enhance our underwriting and application processes. The consumer indirect loan portfolio was $1 billion at year end, up 2.6% or $26 million from the link quarter due to continued strong demand. We are proactively moderating consumer indirect production through pricing and remain laser-focused on credit quality and stringent underwriting standards. Net charge-offs were 57 basis points in the current quarter, down from the linked quarter, and in line with historical trends. I'd like to remind everyone that our indirect business is a prime lending operation with an average portfolio FICO score above 700. This business has delivered consistent results through several economic cycles with annual charge-offs ranging from a low of 14 basis points to a high of 87 basis points between 2008 and 2022. Annual indirect charge-offs were 45 basis points in 2022. A long history of demonstrated outperformance of this portfolio coupled with the exceptional quality of our commercial loan book and unwavering credit standards across all of our lending platforms provide me with the utmost comfort as we enter the 2023 operating environment. This concludes my introductory comments. It's now my pleasure to turn the call over to Jack for additional details on results and our guidance for 2023. Jack?
spk06: Thank you, Marty. Good morning, everyone. Loan growth contributed to an $81,000 increase in net interest income from the linked quarter. The impact of Triple P loans is winding down is only $1 million of these loans remained as of December 31st. During the fourth and third quarters of 2022, $1.6 million and $6 million of Triple P loans were forgiven, respectively, with a related fee accretion of $78,000 in the fourth quarter as compared to $312,000 in the third quarter. NIM, on a fully taxable equivalent basis, was 323 basis points in the fourth quarter of 2022, down five basis points from the linked quarter due to repricing in the seasonality of our public deposit portfolio, coupled with a shift in mix from lower-cost transaction deposit accounts to higher-cost time deposits. Relative to the magnitude of FOMC rate increases that occurred in 2022, our total deposit portfolio has experienced a cycle-to-date beta of 22%, including the cost of time deposits. Excluding the cost of time deposits, the non-maturity deposit portfolio had a beta of 7%. The investment securities portfolio was down slightly from the linked quarter as a result of the use of portfolio cash flow to fund loan originations in the quarter. As I stated in the earnings press release, for 2023, we have modeled cash flows of approximately $1 billion from the investment and loan portfolios for reinvestment in new loan originations at market rates, benefiting NIM. Our cost of funds was 109 basis points in the current quarter, up from 58 basis points in the linked quarter due to the impact of higher rates on public and reciprocal deposits and wholesale borrowings, combined with a shift in overall mix from lower cost transaction deposit accounts to higher cost time deposits. Non-interest income which includes revenue from our insurance and wealth management businesses, was $10.9 million in the fourth quarter, down $1.7 million from the linked quarter. The primary driver of this decline was the third quarter 2022 non-recurring $2 million enhancement associated with the surrender and redeployment of company-owned life insurance. Non-interest expense of $33.5 million was $686,000 higher than the linked quarter, primarily as a result of $440,000 of non-recurring severance expense related to a restructuring that eliminated approximately 20 positions across the organization, and $350,000 of non-recurring restructuring charges related to the 2020 closure of five branches. Income tax expense was $2.4 million in the quarter, representing an effective tax rate of 16.4%. compared to $4.7 million and an effective tax rate of 25.4% in the third quarter of 2022. Approximately $1.5 million of third quarter expense was associated with the previously mentioned company-owned life insurance surrender and redeployment strategy. The full year negative impact to accumulated other comprehensive loss was $124 million, driven by the unrealized loss position of our available for sale securities portfolio. As illustrated in our investor presentation, this unrealized loss position negatively impacted year-end TCE by 216 basis points and tangible common book value per share by $8.10. Excluding the AOCI impact, our TCE ratio and tangible common book value per share would have been 7.65% and $28.63, respectively. We continue to expect these metrics to return to more normalized levels over time, given the high quality of our investment portfolio. I would now like to spend the next few minutes providing our outlook for 2023 in key areas. We expect mid to high single digit growth in our total loan portfolio. Growth will be driven by the commercial loan categories and include our expansion into the mid-Atlantic region in the recent opening of a Syracuse LPO. We plan for mid-single-digit growth in non-public deposits. We are focused on attracting new consumer and commercial deposit accounts and expect the positive impact of these new accounts to be partially offset by a lower average balance per account as an outcome of the economic environment. Banking as a Service, or BAS, initiatives are expected to generate approximately $150 million of deposits in 2023, a significant contributor to our non-public deposit growth goals. We are projecting reciprocal and public deposits to be relatively flat, with typical seasonal fluctuations on a quarterly basis. We expect full-year NIM of 330 to 335 basis points. using a forward rate curve that reflects economists' predictions for 25 basis point rate increases in February and March, with Fed activity remaining muted thereafter. Net interest margin is expected to be relatively flat in the first quarter, with expansion in the remaining quarters as we reposition our balance sheet by utilizing cash flow from the loan and investment portfolios, coupled with core deposit growth to fund anticipated loan originations. As a reminder, our NIM fluctuates from quarter to quarter due to the seasonality of public deposits and its impact on both our earning asset and funding mix. In quarters where our average public deposit balances are higher due to seasonal inflows, the second and fourth quarters, our earning asset yields are lower given the short-term duration of that deposit and limited opportunity to invest the funds. We are projecting relatively flat non-interest income, excluding non-recurring items such as the impact of the 2022 company-owned life insurance surrender and redeployment transaction, and other non-interest income categories that are difficult to predict, such as limited partnership income, gains on investment securities, and gain on sale of indirect loans. We are targeting an increase in the mid-single-digit range for non-interest expense. Our spend in 2023 reflects inflationary impacts experienced in 2022, partially offset by savings from the staffing restructuring completed in the fourth quarter. 2023 non-interest expense also includes ongoing investments in strategic initiatives, including our customer relationship management solution, digital banking, and BAS. We expect these investments to begin producing incremental revenue in 2023 contributing to positive operating leverage, an ROA above 1%, and an efficiency ratio below 60%. We expect the 2023 effective tax rate to fall within a range of 19 to 20%, including the impact of the amortization of tax credit investments placed in service in recent years. We will continue to evaluate tax credit opportunities, and our effective tax rate would be positively impacted by taking advantage of further investment opportunities. We expect net charge-offs to be within our annual historical range of approximately 35 to 40 basis points. Our overall focus includes executing on key strategic initiatives that will improve profitability and operating leverage over time. We believe that achieving results in line with the guidance provided will drive these outcomes. That concludes my prepared remarks. I'll now turn the call back to Marty.
spk03: Thank you, Jack. We are proud of our many accomplishments in 2022. In addition to delivering strong financial and operating results in a challenging environment, we achieved the following. In February, Five Star Bank launched a commercial lending platform in Baltimore and Washington, D.C., by taking advantage of experience and available talent to hire a team of four commercial banking officers. As previously mentioned, this team is experiencing great success in establishing relationships with strong sponsors and closing loans. During the second quarter, we took advantage of the opportunity to sell a $31 million portfolio of indirect loans and recognize a gain of $586,000, demonstrating our ability to capture gains within this portfolio by leveraging capital market relationships to remix loan exposures. In September, we celebrated the grand opening of Five Star Bank Center, the new home of our Western New York Regional Administrative Office and SDN Insurance Agency. This was an investment in both the Buffalo region and our future in this important market. The investment underscores our commitment to Western New York and our valued local associates, setting the stage for continued growth in the Buffalo market. Our BAS pipeline expanded throughout the year and, as noted in our investor presentation, we have several partnerships in various stages of onboarding. We also remain steadfast in our mission to support our customers and our communities. For the fifth consecutive year, our five-star bank community report highlights the ways in which we are fulfilling our purpose and promoting sustainable business practices that deliver long-term value to the communities we serve as well as our shareholders. I encourage you to read the Five Star Bank 2022 Community Report available on the Five Star Bank website and our investor relations website to better understand the many ways we keep people at the heart of everything we do. Our positive momentum continues in 2023. Just last week, we announced our expansion into the Syracuse market with a new commercial loan production office in the city's historic Franklin Square. This new office provides entrance into Onondaga County expanding Five Star Bank's upstate New York footprint to 15 counties throughout western New York, the southern tier, and the Finger Lakes region. The Syracuse office will be home to a three-person commercial and industrial team and a commercial real estate banker. In accordance with our strategic plan, we've expanded beyond our historic rural upstate New York footprint to serve metros like Buffalo, Rochester, and now Syracuse. This most recent expansion supports our focus on driving credit discipline loan growth and growing deposits by bringing our style of community banking with local leadership and local decision-making to businesses of all sizes throughout central New York. In closing, I would like to thank my fellow teammates for their ongoing dedication and commitment. Their efforts are instrumental to our achievements and ongoing success. Operator, please open the call for questions.
spk08: Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your telephone keypad. If you'd like to cancel the question, please press star followed by two. Please do also remember to unmute your microphone. Our first question is from Alex Twerdal from Piper Sandler. Alex, Your line is now open. Please go ahead.
spk02: Hey, good morning, guys.
spk09: Good morning, Alex. First off, Jack, I was hoping you could give us a little bit more on the billing of cash flow from the securities and loans. I guess first off, how much of that would you need just to keep the loan portfolio flat? I'm just trying to figure out how much might be excess after the loan growth guidance that you gave us.
spk06: So if we're bifurcating that guidance between the two portfolios, we're currently modeling $180 million in cash flow from the securities portfolio, and then about $900 million in cash flow off the loan portfolio.
spk04: Okay.
spk09: And is that going to be – should we expect those cash flows to be pretty consistent throughout the year, or are there any big chunks in there that we should be aware of?
spk06: Phil Kleisler- model to be a little consistent fairly consistent there is lumpiness in the commercial portfolio, but from a timing standpoint, we would expect that. Phil Kleisler- be relatively flat over the year.
spk09: Okay. And then when we think about the reinvestment of that into new loans, can you give us a little bit of sense for what kind of rates you're getting, what kind of yields you're getting on new production, and if that is different across the different portfolios as well as the different geographies that you're in?
spk06: I can comment on the total portfolio. You know, just as recently as December, we were seeing new origination rates in the commercial portfolio come on around 7%. and a little bit better in the indirect portfolio.
spk09: Okay. And the last question that I had is on the $150 million of deposits from the banking as a service relationships, would those typically be time deposits or transactional deposits or, you know, what kind of, I guess, what kind of rate would you need to pay on the types of deposits that those relationships would generate?
spk06: Those are generally non-maturity deposits. And the rate that we would have there is favorable to what we're seeing in the time deposit space. So I'm not going to comment purely on what we're paying, but it does benefit margin.
spk09: Great. Thanks for taking my questions.
spk08: Thank you, Alex. Thank you, Alex. Our next question is from Damon Del Monte. from KBW. Damon, your line's now open. Please go ahead.
spk02: Good morning, guys. Thanks for taking my questions today. With respect to the deposit betas, I think, Marty, you made the comment that cycle to date, you see about 22% deposit beta. What is the full cycle expectation from you guys on your end?
spk03: I think Jack made that comment. It's 22% all in. Oh, sorry, Jack.
spk06: Go ahead, Jack. Hey, Damon. Yeah, so cycle-to-date through the end of the year, we were at 22% for total deposits. As we look at our expectation for rate increases in 2023 and then go back and consider that full cycle, which would essentially be two years, right, we're looking at 25% to 30% cycle-to-date betas.
spk02: Okay, so you feel like you got the majority of it pushed through already if you're already at 22%, right? Yeah, from what we observed in the fourth quarter. Got it. Okay. And then with respect to the growth you guys have been getting in the Mid-Atlantic, could you just give a little bit more color on the size and the type of industries that these loans are for? I know they're predominantly office space, but what kind of businesses are these supporting?
spk03: So it's really kind of been across the board. We've seen some very nice healthcare-related opportunities related to tenants related to the federal government and others in between.
spk02: Got it. Okay. And what about, like, the average size of these credits?
spk03: It was $7 to $12 million. Some have been larger, but on the whole, it's been fairly granular.
spk02: All right. Great. And then lastly, you know, the guidance calls for 35 to 40 basis points of net charge off. So when we think about loan growth, when we think about that level of charge offs, you know, the reserve was around, I think, 112 this last quarter. Is your goal to hold that? Is your goal to grow that a little bit, kind of just given growing uncertainty, trying to kind of triangulate to figure out how we should think about actual provision each quarter?
spk06: Yeah, Damon, I think you're spot on there. The coverage ratio of 112 basis points is consistent with where we were from our day one CECL modeling. And there are moving parts of the CECL model related to unemployment forecast, which is our quantitative driver. But that coverage ratio makes me comfortable when I look at the credit quality of our portfolio. So holding that against loan growth and modeling 35 to 40 basis points of charge off should get you to the number you need from a provisioning standpoint.
spk02: Perfect. Great. That's all that I had. Thank you very much.
spk07: Thanks, Damon.
spk08: As a reminder, ladies and gentlemen, to ask any further questions, please press star followed by one on your telephone keypad now. Our next question is from Eric Zwick from Hooft Group. Eric, your line is now open. Please go ahead.
spk05: Good morning, guys. Good morning, Eric. First, just wanted to start and make sure I've got something right. Jack, in terms of the outlook for non-interest income, that could be relatively flat 23 versus kind of that adjusted 22 number. Sorry if I missed this. Can you just refresh me on what that kind of adjusted 22 base number should be?
spk06: Yeah, we stripped out $2 million of gains that we had from, or additional income we had from a bank-owned life insurance enhancement realized in the third quarter when we surrendered and redeployed part of that portfolio. So we consider that to be non-recurring.
spk05: Okay, just that $2 million?
spk06: Yes.
spk05: Great, thank you. And then in terms of You talked a little bit about the cash flow coming off of the securities portfolio. That book has shrunk over the last year or so in terms of percentage of total assets down to about 20%. Now, what would be the optimal size relative to total assets for the securities portfolio in your mind?
spk06: Yeah, if we get down to the 18% range, I think that'd be comfortable.
spk05: Got it. And then in terms of the 350,000 of restructuring charges related to the branch closures. I think you mentioned there, you know, right down to the real estate assets to fair market values based on current market conditions. Curious if those fair value marks are, you know, kind of something specific related to those branches or if there's anything larger you're seeing in terms of, you know, real estate values in your markets or any kind of, you know, broader view or a reader we could take from, from those marks.
spk06: Those were five branches that were located in our rural banking footprint. Two of those are under sale agreements at this stage of the game. And the other three were written down to recent broker opinion of value as of year end. So it's just reflective of market conditions for older abandoned bank space in that area.
spk03: I think it's specific to these buildings, these facilities versus a larger issue in the marketplace. These are kind of single-use type of facilities, some are older, and they are in markets where demand is pretty modest. Correct.
spk05: That's helpful. That's what I suspected, but just wanted to make sure. And then last one, just thinking about the Banking as a Service initiative, just curious if you can kind of update us on, you know, from a bigger picture perspective, where you are in the entire process and what goals or milestones are
spk03: uh you know you hope to reach in 23 you mentioned the uh the deposits uh that you expect about 150 million deposits but just curious what else uh you're kind of targeting and looking for this year well the way we're we're thinking about that first and foremost is to make sure that we have uh and curate a series of opportunities that end up being a reasonable risk and really in alignment working with companies that are in alignment with our own approach to our risk appetite statement. As we indicated in our investor deck, we've got five opportunities that we're in various stages of. One is live and two are in integration onboarding and two are in testing right now. So we are emphasizing commercial business versus consumer because we think that that's a more a sustainable opportunity over the longer term. And, you know, we can, from a budgeting standpoint, it's injects guidance that, you know, in the next 12 months, what we're investing is and what will the benefits and the costs will end up offsetting each other and be neutral to our budget. But over time, we see large opportunity, substantive opportunity in terms of driving non-interest revenues contributing to our deposit portfolio and a modest amount of utilization of the balance sheet relative to lending.
spk04: Great. That was very helpful. That's it for me. Thanks for taking my questions today.
spk07: Thanks, Eric.
spk08: Our next question is, again, from Alex from Piper Sandler. Alex, your line is now open. Please go ahead.
spk09: Hey, I just wanted to follow up quickly on the announcement you guys made earlier this week on Syracuse. And, you know, I was hoping, Marty, maybe you could talk a little bit more about the overall strategy in that market. I know there's been a major investment announced by Micron, and I'm just curious if this is, you know, kind of the start of an overall longer-term strategy to kind of be a little bit more active in that market or how you're thinking about it.
spk03: So thanks for circling back, Alex. We've been active really in that market servicing it at the end of our geographic footprint, which is halfway between Rochester and Syracuse out of our Auburn market. But we've had significant participation through seasoned relationship management. Our regional president is a long-term commercial banking professional that's really helped us drive some very nice opportunities, full commercial relationships. And so, based on that experience, we've been working together to build out a loan production office, including, importantly, our human capital that would help us lead that initiative. The Micron, you know, announcement really is indicative of what we've been talking to investors about for a number of years in that, you know, on a regional basis, New York State has been encouraging regions to work together to develop strategic economic development plans that are grounded in the assets, the technology, the human capital that is in the regions, the industries that are there, and to pursue it and to leverage the collaborative opportunity for investment that comes through the public sector, private sector, and other sources. So the Micron deal obviously was turbocharged through the Senate Majority Leader and others And we see that as very significant upside relative to that region. But I would just point out that as you go down the thruway, there are very bright opportunities in every kind of so-called major city on Buffalo, Rochester, Syracuse, Utica, and Albany as a result of that collaborative regional economic development process.
spk09: Great. That's really helpful. Thanks for taking my follow-up.
spk07: Thanks.
spk08: We currently have no further questions. I will now hand back to our speaker, Mr. Birmingham. Mr. Birmingham, please go ahead.
spk03: Thanks so much for your assistance operating this morning. Thanks to all who participated. We look forward to continuing to build on our communication with you at the conclusion of our first quarter results. Thank you.
spk08: Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Have a good day.
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