Lakeland Bancorp, Inc.

Good morning and welcome to the Lakeland Bancorp Inc. Second Quarter Earnings Conference Call. My name is Tamiya and I'll be coordinating today's call. You will have the opportunity to ask a question at the end of the presentation. If you would like to register a question, please press star followed by one on your telephone keypad. Please note this event is being recorded. I would now like to turn the conference over to Mary Russell, Assistant Controller and Director of Financial Reporting. Please go ahead, Mary.

Thank you, Tamiya. Good morning, ladies and gentlemen, and thank you for joining us for our second quarter earnings call. Today's presenters are President and CEO Thomas Schara and Executive Vice President and Chief Financial Officer Thomas Blaine. Before beginning the review of our financial results, we ask that you please take note of our standard caution as to any further booking statements which may be made during the course of today's call. Our full disclaimer is contained in this morning's earnings release. which has been posted to the investor relations page on our website, lakelandbank.com. Now it is my pleasure to introduce Thomas Shariff, who will offer his perspective on our second quarter.

Thank you, Mary. Good morning, everyone, and welcome to our second quarter earnings call. I will start off the call with a high-level summary of the quarter, followed by Tom Splane, our CFO, who will walk you through our earnings in detail. We're delighted by our financial results for the quarter, which represents a clean quarter after an merger-related items for the first Constitution acquisition earlier this year. For the quarter, our ROA, ROE, and ROTCE were 115, 1071, and 1445, respectively. We posted record net income of $29 million, driven by net interest income of $80 million, representing a 14% increase from the prior quarter. The increase in net interest income is attributable to our meaningful margin expansion plus our organic loan generation during the quarter, which totaled $270 million, representing a 16% annualized growth rate, while we're able to keep deposit paid as low during the quarter. The loan growth was across all categories in commercial and consumer portfolios except for construction and PPP loans. Construction loans decreased 33 million as several loans converted to permanent loans during the quarter, and PPP was reduced by 26 million and now stands at only 10 million at the end of the quarter. I'm happy to report that our commercial closings for the second quarter were a record and eclipsed the first quarter totals, which were also a record. The pipeline going into the second half of the year is still very strong. Our healthcare lending team and Hudson Valley lending teams had a tremendous quarter, and we expect them to have a strong balance of the year as well. Recently, we're also starting to develop new relationships as a result of the recent large bank M&A markets, this will be beneficial in subsequent quarters. Overall, we expect continued loan growth to remain strong for the balance of the year, with organic growth for the year expected to be in the high single digits for fall of 2022. On the residential mortgage side, originations remain subdued as refinance activity has ended and customers become acclimated to the current rate environment. We continue to retain some high-quality, well-priced jumbos and arms on the balance sheet while the market stabilizes. The average FICO score in this portfolio year-to-date has been 754. On the deposit side, deposits decreased organically 3% for the quarter, with some planned reductions in municipal deposits and a continued decrease in time deposits. We have not experienced any runoff in the deposit base from First Constitution. Non-interest income-bearing deposits increased $30 million during the quarter and now total 27% of total deposits, while core deposits now make up 91% of total deposits. On the credit side, asset quality remained very solid. For the quarter, we had a small net recovery of $141,000. Non-performing assets to assets at the end of the quarter were 21 basis points. The allowance remained relatively stable at $69 million. or 93 basis points of loans versus $58 million and 97 basis points at your end. Overall, the central and northern New Jersey economy remains strong, despite implications with higher inflation. Our commercial customers continue to report strong results and a fairly positive outlook, although there are some concerns around inflation, supply chain challenges, and in some cases a lack of staffing, which is slowing sales a bit. Overall, the local economy remains very strong. The unemployment rate in the state is now 3.9%, and the state has fully recovered all the jobs lost during the pandemic. Our outlook for credit and the economy remains very, very strong. That concludes my prepared remarks. I'm now going to turn over the balance of the presentation to Tom. Once he's concluded with his comments, we're happy to answer your questions. Tom, take it away.

Thank you, Tom. Good morning, everyone. As Tom mentioned, Lakeland's Second quarter net income was a record of $29.1 million or 44 cents per diluted share compared to the first quarter of 2022 of $15.9 million or 25 cents per diluted share. And the second quarter of 2021, which was our previous record net income of $27.4 million or 53 cents per diluted share. To crystallize their record net income for this quarter, Our previous high record income in Q2 of 2021 was aided by a negative provision for credit losses of $6 million compared to the current quarter provision for credit losses of $3.6 million, which equates to a $9.9 million unfavorable impact to pre-tax earnings. On the income statement, Q2 financial results were favorably impacted by the organic loan growth of $270 million, deployment of excess cash into higher yielding assets, and the increase in interest rates, all combining to increase yields on our interest earning assets by 36 basis points for the quarter. As a result, net interest margin for Q2 increased 36 basis points to 3.38%. compared to the linked quarter of 3.02% and the prior year quarter of 3.27%. In comparison to the prior quarter, our pre-provisioned net revenue, excluding merger-related charges in Q1, increased $10.5 million, or 33%, to $43.2 million in Q2. The yield on our loans increased 30 basis points from the linked quarter to 4.22%. While loan prepayment speeds remain elevated and combined with interest recoveries on non-accrual loans and PPP fees had a positive net impact of eight basis points to net interest margin compared to the prior quarter. Deposit rates remain fairly steady with interest rate increasing only on products related to the Fed funds rate. The strength of our banking franchise is the composition of our core deposit portfolio as evidenced by the total cost of deposits increasing three basis points to 22 basis points compared to the lean quarter. Our Q2 provision for loan losses was an expense of $3.6 million and was comprised of $1.6 million in provision for credit losses on loans, $1.5 million provision for credit losses on investments, and $500,000 provision for credit losses on unfunded loan commitments. Our current quarter provision for credit losses on loans for the loan growth in the portfolio for the quarter, while the provision for credit losses on investments was a result of a decrease in the market value of corporate securities based on interest rates and not related to any credit downgrades on the securities. Regarding asset quality, as Tom mentioned, non-performing assets increased two basis points, 21 basis points of total assets for the quarter, and the credit remains stellar. Q2 net charge-off for recovery of $141,000 and would represent the fourth consecutive quarter of net recoveries, excluding the accounting for the acquired first constitution purchase credit deteriorated loans in Q1. At June 30th, the allowance for loan losses on loans represents 93 basis points of total loans compared to 94 basis points in the trailing quarter. Q2 non-interest income increased slightly in Q2 to $7.1 million as improvements in swap fees and wealth management fees were partially offset by continued softness in the gain on sale of residential mortgages and SBA loans. Q2 non-interest expense of $45.1 million decreased $4.9 million in the link quarter, which reflected the merger-related expenses from the first Constitution acquisition in Q1. For the second quarter, lower expenses for compensation and benefits and occupancy expenses were partially offset by higher data processing and other operating expenses. Our efficiency ratio dropped to 51% compared to 58% in the link quarter. Our Q2 effective tax rate was 24.7% compared to 23.9% in Q1. On the balance sheet, in comparison to the prior quarter, total assets increased $98.9 million or 1%. with loans increasing $270.4 million, or 3.8%, while the cash balances decreased $176.2 million to historical liquidity levels. Deposit balances decreased $247 million, or 2.8%, due mainly to municipal depositors reducing excess funds and the continued runoff of interest-sensitive time deposit accounts. Borrowings increased $329.4 million to fund the loan growth. At June 30th, our loan-to-deposit ratio was 87%, up from 82% at March 31st. For capital management, our capital levels remained strong and were relatively static compared with the prior quarter, with tangible capital ratio decreased less than 1%, to 8.01% at June 30th compared to 8.07% at March 31st, as asset growth, cash dividends, and other comprehensive income changes offset earnings retention for the quarter. Based on the high degree of uncertainty regarding economic conditions during the quarter and a potential impact of interest rate changes causing additional mark-to-market adjustments in our available-for-sale investment securities portfolio, as well as significant growth in the loan portfolio, we did not repurchase any common stock in Q2 under our existing authorized share repurchase program. We believe it was prudent to maintain our tangible capital ratio at 8% in light of the economic uncertainty, as well as the anticipated strong loan growth, and we will continue to evaluate our capital ratios moving forward. Regarding our outlook for the remainder of 2022, we believe that we are well positioned for rising interest rates. Our projected interest rate risk position is neutral and we become more asset sensitive in future periods. The significant increase in net interest margin experienced in Q2 is unlikely to be repeated as excess liquidity is removed from the financial system and deposit pricing reacts to the Federal Reserve's recent increases in the Fed funds rate. Deposit betas are likely to transition higher in Q3 as deposit competition increases. As Tom discussed earlier, we expect the loan portfolio to grow organically in the high single digits for 2022 and asset quality to remain very high. Non-interest expenses for 22, excluding the merger-related costs in Q1, are expected to be in the low $180 million range, inclusive of the higher run rate in Q1. Salary and benefits expenses are likely to trend slightly higher due to current hiring conditions and our development of our current digital initiatives. Income tax expense for 2022 is expected to be approximately 24.5%. That concludes our prepared remarks, and we'll be happy to address any questions. And with that, Tamia, can you open the question period for us?

Absolutely. We will now begin the question and answer session. If you would like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason at all you would like to remove that question, please press star followed by 2. Again, to ask a question, press star 1. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We'll pause here briefly as questions are registered. The first question comes from Frank Chiraldi with Piper Sandler. Your line is open.

Good morning. Good morning, Frank. Just a couple of questions. A couple of questions. First, you noted liquidity kind of back to historic levels, and I know deposit balances can be a bit volatile given some of the buckets, but sense of where you expect or where you target the loan-to-deposit ratio in coming quarters?

Yeah, I think, Frank, we're meandering back to our more normalized levels. For us, historically, we tend to have our loan-to-deposit ratio in the low to mid-90s, so between 92% and 95%.

Excuse me, Mark. So, Mark, are you there?

So, Mark, are you there?

Okay. And in terms of pressures on the deposit base or in terms of pricing, I know it's early in the quarter, but are you starting to see those pressures build or is that at this point still just such an assumption as liquidity leaves the system?

For right now, we're starting to see competitors starting to move rates right now as early as yesterday based upon the Fed moves. And we are contemplating that as we head forward. We've kept our deposit betas through the prior quarter. interest rate changes at a very low level. And I think now we're going to start seeing them start to migrate closer back to model betas as we move forward. So we won't have as much NIM expansion based on deposit betas going forward.

Gotcha. And then just lastly, I wonder just on loan growth, do you get a sense that, you know, the outside growth we're seeing not only from you guys, but, but in the industry here, it's just sort of a pull forward, uh, from, from later in the year, just getting, getting fed action, you know, um, just trying to lock in pricing, maybe not sure, uh, if you can comment on that or just kind of what you were hearing on that front from your, uh, from your customers.

You know, the feedback we're getting from our customers is very positive, but you know, maybe, You know, in the North Jersey marketplace, it's a little different than other parts of the country. But people are very optimistic. We're seeing sales grow. We're actually starting to get some requests for larger lines of credit, which we haven't seen in years. So it seems like the central North Jersey economy is faring pretty well. And we've surveyed customers in virtually every asset class. And they're all saying the same things, that things are quite good, they're optimistic about back after the year. And like I said in my opening comments, our pipeline is continuing to stay full, even though we're accelerating closing. So it feels pretty good, Frank. I think the long go should continue. Okay, great. Thank you for all the calling. Yeah, no problem.

Thank you. The next question comes from Christopher O'Connell with KBW. Please proceed.

Morning. It's open to start off on the expense comments. I think previously you were thinking, you know, a little bit closer to the high 170s range for the year, now low 180s. Just curious as to, you know, what's driving that and is there, you know, is it a result of, you know, an improved loan growth outlook or is there, you know, higher revenues tied to that or is it, yeah, it'd be great.

Yeah, I mean, if you were to back out the merchant related expenses that we had for our first constitution in Q1, What we're looking at now is the $45 million of operating expenses in Q2 is a pretty good run rate for us as we head forward for the rest of the year. We are getting the cost saves as targeted from First Constitution, so we're still on track for that. It's just that some of our other expenses are creeping upward, mainly on salaries and benefits due to the hiring constraints that are out there right now. that are putting a little upward pressure on our expenses. But overall, you know, that's kind of the way expenses are forecasted as we get through the rest of this year.

Got it. So is there still some cost that is yet to be achieved that's just being offset by the higher salaries?

Yeah, that's the way it's shaking right now.

Okay, great. And on, you know, the comments around, you know, mortgage banking, you know, the gain on sale going into the back half of the year, just, you know, any other color there or how we should frame kind of that line going forward?

Yeah, Chris, I think it's going to remain under pressure. I mean, you know, the refinance activity is gone and, you know, inventory is in this part of the country is pretty restricted. So I think, you know, we'll continue to be opportunistic, put some things in portfolio. Like I said earlier, we're putting some jumbos on, some arms on, and those rates are in the high fours, low fives right now. So it seems like a better place to put loans than to sell. But we're hoping things pick up in the back end of the year, but they're not going to be anywhere near where we projected at the beginning of the year. And we're also offsetting some of that loss with swaps. We're starting to see much more swap activity in the second half of the year.

Okay, got it. So, like, all in on a core basis is, you know, the same $7 million to $8 million a good range, or are the swaps kind of offsetting some of the lower mortgage banking?

Yeah, that's a good assumption there, Chris.

Okay. And then the comments around, you know, the buyback and keeping capital ratios kind of at 8% plus on TCE. You know, I know you guys have previously indicated, you know, wanting to start utilizing the buyback. You know, if there's not a ton of AOCI hits coming in future quarters, is it even with, you know, maybe a little bit uh, you know, more questionable economic environment, do you think you can, you know, start to repurchase again?

Yeah, I, I think you're looking at it the same way we were looking at it there, Chris. Um, we were, you know, with the economic uncertainty, we were a little hesitant. Um, we did really want to start up on the, uh, share repurchase plan and, um, basically, uh, You know, we just weren't – we weren't there, and we saw a lot of loan growth coming at us that we knew was going to put downward pressure on our capital level. So we'll take the loan growth. Share repurchases are good for us when we don't have something better to do with our capital. And as long as we have a really healthy loan pipeline and we're growing the bank, that's the most important thing right now. So – As we look in the second half of this year, if the economic uncertainty settles down as well as loan growth gets a little bit softer as we head forward, right now it's looking very good. Yes, we'll definitely look at share repurchases as a tool to manage our capital level.

Okay, great. That is all I have for now. Thank you. Thanks, Chris.

Thank you. Our next question comes from Manuel Navas with DA Davidson. Your line is open.

Good morning. Hey, so I might have missed this. What are you booking new loans at and has that shifted a little bit into here in July?

Yeah, we'll put on rates probably in the mid to high fours right now, Manuel, and moving up. And that was prior to the Fed move yesterday. So we're seeing much, much better pricing, and we're seeing that across the board.

Okay, that's helpful. Is there a thought process of – I understand that deposit beta is creeping up – But think in big picture, how high could the NIM get by the year end or early next year?

That's a great question. If we had to look behind the curtain at the Fed, maybe we'd have a better indication. But I think that right now, you know, the NIM expansion that we had this quarter was based upon – the adjustable rate of our portfolio. Plus we did have the tailwind for us of, um, some non accrual interest recapture. So that, that benefited the quarter. So as we look forward, you know, these increases, um, it's all going to come down to a deposit pressure with competition. And, um, so for us, as we head forward, I think that, uh, You know, for us being in the 330 range going forward, it's going to be where we're kind of targeting right now based upon where we're at and where we see things going as we move forward.

Do you think that there comes a point where data is catching up that you could see NIM kind of bounce around rather than keep expanding?

I guess that's always a possibility, but I think that there's still a lot of liquidity out in the system. So I think the positive pressure is probably at this point of the cycle, not as intense as it was when we were, you know, at the last time we were in an up-rate environment.

Okay. That's really helpful. Thank you.

Thank you. Thanks.

Thank you. There are no further questions in the queue, so as a reminder, it is star 1 in the telephone keypad if you would like to ask a question. We have a follow-up question from Christopher O'Connell with KBW. Please proceed.

Hey, just wanted to circle back on those last comments there on the margin. I thought if I heard correctly, the impact of, you know, PPP non-accrual prepays was eight basis points this quarter, right?

Yeah, compared to Q1, increase over Q1.

So backing that out, we're kind of, we're already really in the 330 range of the min, so... just trying to get a, you know, a sense of, of, you know, the new expansion comments, you know, versus, you know, the three 30 range and already kind of being there.

Right. So if you, if you were to back off some of that positive impact that we had this quarter, um, cause PPP is virtually going away and, um, with the non accruals, you know, the, the one time non accrual recapture, NIM comes back, more of a core NIM basis comes down somewhat. And then we get some expansion based upon the recent increases in rates offset by deposit data. So for us, I think we're looking at keeping the NIM in the range of low to mid 330s, and we'll be conservative on our projections. And we'll take it from here as we move forward. So we do still see some NIM expansions.

Got it. So some new expansion, but just not as off the core basis once back at those items.

Right. Yeah. There was some positive impacts in Q2 that will not repeat themselves.

Okay. That's all I had. Thank you.

Thank you. Thanks.

Thank you. There are no further questions in the queue, so I will now pass it back to Tom Chera.

Okay, thanks everybody. Thanks for joining us this morning. If you have any additional questions, feel free to give time where I fall. Enjoy the rest of the summer and thanks again for participating this morning. Take care.

This concludes the Lakeland Bancorp Inc. Q2 2022 earnings conference call. Thank you for your participation. You may now disconnect your line.