Earnings Transcript for LBAI - Q3 Fiscal Year 2021

Operator: Good morning and welcome to the Lakeland Bancorp, Inc. Third Quarter Earnings Conference Call. My name is Daisy and I'll be coordinating today's call. You will have the opportunity to ask a question at the end of the presentation. [Operator Instructions] 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 ma'am.

Mary Russell: Thank you, Daisy. Good morning, ladies and gentlemen. And thank you for joining us for our third quarter earnings call. Today's presenters are President and CEO, Thomas Shara; and Executive Vice President and Chief Financial Officer, Thomas Splaine. Before beginning their review of our financial results, we ask that you please take note of our standard cautions as to any forward-looking 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 Shara, who will offer his perspective on our third quarter.

Thomas Shara: Thank you, Mary. Good morning, everyone. And welcome to Lakeland Bank’s third quarter earnings conference call. We sincerely hope that you and your families are safe and healthy. Our third quarter results were very solid and trends remained generally positive as our markets in New Jersey and New York continued to perform quite well despite the ongoing pandemic. We continue to steer a Lakeland through these uncertain times and the results which we will discuss on this call have been quite impressive on several fronts so far in 2021. Regarding third quarter earnings, operating earnings remained strong led by net interest income, continued excellent credit quality and continued deposit growth. In spite of strong loan originations, loan portfolio growth remains challenged in the quarter as payoffs continue to exceed our forecast. Ex-PPP loans were essentially flat for both the quarter and year-to-date. Just to reminder that in the quarter, Lakeland made several strategic moves to enhance its long-term performance and shareholder value. In July, we announced the merger with 1st Constitution Bank, which will expand our banking franchise into the attractive growth markets of Mercer, Monmouth, and Middlesex counties, and increase our presence in Bergen, Ocean and Somerset counties. The acquisition also positions Lakeland to leverage 1st Constitution’s mortgage warehouse and mortgage banking business lines. The merger is progressing well and we're expecting to close in early January 2022. In case you missed it 1st Constitution posted very strong results for their third quarter on Friday. last week. In September, we successfully completed $150 million subordinated debt offering at a fixed rate for five years of 2.875%. And in the quarter, we also executed another non-performing loan sale which resulted in the reporting of $700,000 of non-local interest and in addition of $500,000 net recovery for prior charge offs. This is the third quarter in a row where we've strategically sold non-performers with minimal loss content. As a result, our non-performance have been reduced from $43 million at 12.31% last year to $12 million currently. Our non-performing loans to loans equals 21 basis points as of September 30. We believe these actions positioned Lakeland for continued future success. As it relates to the local economy, the economic outlook in our markets continues to improve as COVID-19 remains manageable and our businesses and consumer clients are optimistic for the future. Long-term loan growth is highly correlated to economic growth and we believe economic conditions in our markets will continue to improve and support future loan growth. Another positive is the consumers and their pent-up personal savings position, which will continue to support solid consumer spending in the future. As businesses see demand increasing it is anticipated that credit line usage, which is currently at all-time lows, was likely to increase over time. The fourth quarter has historically been a strong loan growth quarter for Lakeland Bank and our pipeline is very strong and we anticipate strong loan originations next quarter, and expect to see slower prepayments with interest rates moving higher. The recent increase in longer term rates should also provide relief on asset pricing pressure as well. The positive growth continues unabated with increases in all deposit categories, despite our adjustments to deposit pricing throughout the year. We have also experienced PPP loan forgiveness in the quarter of $98 million this additionally compound at our present excess liquidity position, which has resulted in a reduction of our net interest margin this quarter, which Tom will discuss further shortly. It is our intention to deploy these excess liquidity, by funding loan growth and increasing investment securities in the quarter, providing for increasing net interest margin. We have also reduced the positive pricing again, as of 10/1 this month. Our operating expenses increased during the quarter, primarily attributed to a couple of non-recurring items related to the pending merger with 1st Constitution at debt extinguishing costs of our existing subordinated debt, these items totaled $1.9 million pre-tax for the quarter. We've also continued our commitment to technology enhancements and improving customer experience and our competitive positioning. While you've taken several steps to enhance long-term shareholder value this quarter, we remain focused on prudent balance sheet growth, active management of our margin and unwavering commitment to credit quality as we navigate these unpredictable economic conditions. With that, I'd like to turn the call over to our Chief Financial Officer, Tom Splaine, to take you through our detailed financial results. Tom?

Thomas Splaine: Thank you, Tom, and good morning, everyone. Our net income for the quarter was $22.3 million or $0.43 per diluted share compared with $27 million or $0.53 per share for the trailing quarter. Q3 earnings were impacted by a benefit of $2.7 million of negative provisions for credit losses and unfavorably impacted by non-recurring merger related expenses and debt extinguishment cost during the quarter totally $1.9 million. Q2's results reflected the benefit of negative provisions for credit losses, totaling $6 million. Pre-provision net revenue was $27.6 million or a 1.37% annualized rate of return on average assets. Our net interest margin compressed 17 basis points versus the trailing quarter as excess liquidity increased despite an increase in our average investments. As average loans decreased for the quarter and average deposits grew Loan repayments remain elevated and included increased PPP forgiveness. As a result our average cash balance for Q3 increased $327 million and comprises 6.5% of average total assets compared with 2.5% as of Q2. We expect to deploy much of this excess liquidity into loans and securities in the near term to improve earning asset yields and increase interest income. Told deposits increased $216 million in Q3 or 3.2% compared to the trailing quarter. Including non-interest-bearing deposits our total cost of deposits fell to 23 basis points this quarter from 25 basis points in the trailing quarter, and continue to remain among the best in our peer group. Average non-interest-bearing deposits increased $42 million or an annualized 10% rate to $1.72 billion or 25% of our average deposits for the quarter. Our average borrowing levels increased slightly during the quarter by approximately $45 million as a result of the negative carry on our new $150 million subordinated debt offering and the redemption of our existing $75 million subordinated debt offering at the end of Q3. We anticipate the net interest margin to remain under pressure into Q4 and decreased 2 to 3 basis points as we continue to deploy the excess liquidity into loans and securities, while managing funding costs and emphasizing non-interest-bearing deposit growth. Our provision for credit losses was a benefit of $2.7 million for the current quarter, compared with $6 million benefit in the trailing quarter. The current quarter benefit was attributable to improved asset quality, continued favorable macro-economic forecasts, net interest recoveries on previously charged off loans, and a decrease in loans outstanding. Asset quality metrics, non-performing loan levels, early-stage delinquencies and criticized and classified loans ratios all improved versus the trailing quarter. Non-performing assets decreased 48% to 15 basis points of total assets from 29 basis points at June 30th. Excluding PPP loans, the allowance represents 100 basis points of total loans compared with 104 basis points and the trailing quarter. Non-interest income has remained relatively stable versus the trailing quarter at $5.4 million. Operating expenses were negatively impacted by two non-recurring items this quarter, including merger related expenses of $1.1 million and debt extinguishment costs of $831,000. Excluding these non-recurring items, operating expenses increased $1.2 million from the linked quarter due to higher compensation and bonus accrual costs and continued investments into our digital strategy initiative. Our efficiency ratio of 54% for the third quarter of 2021 compares to 52% from the trailing quarter and 54% in the third quarter of 2020. Our effective tax rate increased due to non-taxable merger related costs and was 26.4% for Q3 versus 25.7% for the trailing quarter. And we are currently projecting an effective tax rate of approximately 26% for the year of 2021. That concludes our prepared remarks. Daisy, if you can open up the question period, please.

Operator: Of course. [Operator Instructions] So our first question is from Frank Schiraldi from Piper Sandler. Frank, please go ahead. Your line is open

Frank Schiraldi: Good morning.

Thomas Shara: Good morning, Frank.

Thomas Splaine: Good morning, Frank.

Frank Schiraldi: I wondered if you guys can give a little color in terms of you talked about loan growth expectations and it seems like you are still pretty optimistic given what's in the pipeline. I wondered if you could talk a little bit about once the first constitution deal closes, you guys have talked about in the past the warehousing business being quite an opportunity. Can you just give some more color there, given that you think about rates moving higher? We've probably seen a peak in mortgage activity. But you guys talk about it as being a pretty good tailwind here. So, I wondered if you could just give some more color there.

Thomas Shara: Yes. Sure. Frank, good question. We've been spending a lot of time with the first constitution warehouse team. First constitution $1.8 billion loan, most of their warehouse lines are around $10 million; $10 million to $15 million and obviously in a combined $10 billion bank, the ability to upsize those relationships is pretty significant. And we've already gone out to talk to some of their clients about increasing warehouse lines. In fact, we've already committed to one already where we doubled the line of credit and as a result of doing that, the warehouse companies moving their operating funds to us as well. So those are the kinds of opportunities that we see in the warehouse line, just to upsize existing relationships they've had for a long time. And the other thing that's happening in the mortgage market, frankly see if here in our own production is that the market is moving more to a purchase market from a refinance market. And we expect that the purchase market was continued to be good at least through the first half of 2022.

Frank Schiraldi: Okay. Great. Thanks. And then I wondered if you could just in terms of the expense base, in terms of growth from here; Tom, maybe if you could just give us your thoughts on run rate both before and after the deal closes?

Thomas Splaine: Yes. We were impacted Frank by the two non-recurring items and if you back those out about $1.9 million we think that that projecting back into – to be right around where we think that the expense run rate will be in Q4 barring any significant events. And then as we look into 2022 right now indications are, is that we will be able to close the deal early in the first quarter of 2022, if things keep progressing well. And at that point we'll still have to get through a consolidation and have the back-office systems and do some conversions which are scheduled for February. So cost days will not be realized 100% in the first quarter. And we can give you more guidance on where we think expenses are in 2022 next quarter as it gets closer, but there's still a lot of things up in the air right now as we continue to move forward and get through the rest of this year.

Frank Schiraldi: Okay. All right. Great. Thank you.

Thomas Shara: That's right, Frank.

Operator: Our next question comes from Chris O'Connell from KBW. Chris your line is open. Please go ahead.

Chris O'Connell: Good morning. I apologize if I missed this in the opening comments came out a bit late, but I was hoping you could just flush out a little bit the lone growth pipeline and house the origination's fared this quarter compared to last quarter? And maybe also just where the line utilization was at this quarter compared to last quarter? And then maybe pre-COVID as well?

Thomas Splaine: Yeah. Sure, Chris. So, originations were good for the quarter. The challenge continues to be prepayment speeds. We generally get last look at these deals and some of the competitors are doing deals, mostly insurance companies for the most part and the GSCs 10-year interest only is what we're seeing a lot. And in some cases, we're seeing rates in the twos for five and seven years, which we just don't want to chase at this point. But originations are about 90% of last year's origination so far this year. So, they're fine. The pipeline is about on top of where it was this time last year, and last year, just a reminder, we with the same volumes we grew 11% organically. So, it's just really the prepayment speeds that are coming at us. Historically the fourth quarter is always been a strong one for us based on where the pipeline is today, I would expect that to continue. We do think with rates moving up a bit, prepayments will slow. And to your question on line utilization; utilization for the quarter was around 32% that's down from 36% last quarter and historically line utilization to run around 50%. So that just shows the amount of liquidity that's in the system right now that eventually will work its way back out and we'll create some organic loan growth, but right now the utilization rate is around 32%.

Chris O'Connell: Got it. That's helpful. Thanks. And then one quick one if you had the PPP, the interest income I think it was $3.1 million this quarter. If you have what it was last quarter that'd be great? And then also as we're looking at the amount of cash put on this quarter, it sounds like slight pressure to the core margin for next quarter, as we look out two to three quarters of PPP out of the run rate here. Where do you think the core margin can kind of shake out post PPP, after this excess cash kind of gets deployed?

Thomas Splaine: Sure, Chris. Right now, PPP income like you said for this quarter was $3.1 million, last quarter it was $3.7 million. And where we stand right now is our PPP balances – outstanding balances are down to $109 million outstanding, and $3.4 million of un-recognize fees yet to be incurred. So, we anticipate additional forgiveness as we get through Q4 but it's unlikely that we will get all PPP loans through the pipeline by the end of the year due to customer applications. Looking forward of where NIM we think is going to shake out in 2022, that's a wonderful question. There's a lot of moving parts as we head into 2022, we do plan to utilize the excess liquidity and put that to work as we get through here, but the other complicating factor that makes the answering the question very difficult right now, Chris is the acquisition of first constitution and the fair value marks and things like that that will all be hitting us in the first quarter as well as the date two provision on for earnings. So, it's not just net interest margin, it's earnings for Q1. And we'll be giving better insight into that as we get through Q4 and looking into 2022 right now. So, I know that's not the best answer, but that's the one we have for right now.

Chris O'Connell: Got it. Got it. That's helpful. Thank you. And that's all I have for now. Thanks.

Thomas Shara: Thanks, Chris.

Operator: Our next question comes from William Wallace from Raymond James. William, your line is open. Please go ahead.

William Wallace: Hi, thanks. I wanted to circle back on the loan growth commentary. If you – let's just kind of, think bigger picture, if you let's layer in the first constitution merger and your comments around building the kind of existing balances with existing customers in the warehouse business, what type of growth – what type of portfolio grower is Lakeland proforma with just trying to kind of offset how the potential pressures in the mortgage business might work against you. So just kind of thinking holistically, what kind of growth you think you can do overall next year?

Thomas Splaine: Well, I think while historically we've done a really good job growing existing relationships from the acquired bank. As we sit here today, probably five of our top ten clients have come from small bank acquisitions. So, we have an ability to upsize relationships that are constrained within a smaller bank. And we've been out talking to a lot of the 1st Constitution customers about not having to do participations and getting deals that they have done in other places that they have outgrown 1st Constitution. So, I think, for 2022, mid-single-digit growth seems very, very realistic as an initial goal, including 1st Constitution growth.

William Wallace: Okay. And then with the, I believe you worded it as the digital transformation, I can’t remember how you worded it in the release, and understanding that there is going to be a lot of moving parts with cost saves, et cetera, around 1st Constitution, what kind of inflationary pressures might you anticipate on whatever that core expense base settles in that due to investments in technology, wage inflation, et cetera?

Thomas Splaine: Natural inflation into next year. We've stated that we are going to get 44% cost savings through the 1st Constitution deal in 2022. And then as everyone knows, it's getting more and more difficult to hire people right now and prices are going up. So, I would anticipate natural inflation into next year in 2022 to be somewhere in the neighborhood of mid-single digits, maybe the 5%, 6% range, just off the top. So that's just kind of my indication of where we're heading right now. And like you said, there is a lot of moving parts when it comes to an acquisition and getting cost savings out in a timely manner, once we get through the system conversion costs and things like that.

William Wallace: And then would investments related to your, kind of the digital side of the business, would that be on top of 5% to 6% or would that be included in that 5% to 6% potential kind of base inflation?

Thomas Splaine: Yes, I think that would not be in addition to the 5% or 6%. I think you put that in there and the investments that we're making in there are saving us from going out and hiring additional manpower and things like that, and the efficiencies that you get from the automation of the digital strategy in dealing with your customer just kind of helps control the expense run rate on a go forward basis.

William Wallace: Okay. That's helpful. Thank you. And then just quick housekeeping question, do you have the average PPP balances in the third quarter?

Thomas Splaine: We were at 2.07% last quarter outstanding at the end of the quarter and at the end of this quarter at 1.09%. So simple average just throws you about 1.50%-ish, 1.55%.

William Wallace: Okay. All right. Thank you.

Thomas Shara: Thanks.

Operator: Our next question comes from Erik Zwick from Boenning & Scattergood. Eric, your line is open, please go ahead.

Erik Zwick: Thank you. Good morning, guys.

Thomas Shara: Hey Erik.

Thomas Splaine: Good morning, Erik.

Erik Zwick: Just curious, you've talked in several of the answers and as well as in your prepared remarks about deploying the excess capital into loans and investments securities, and talked about the opportunity and in the pipeline, just curious, how long do you expect that the process would take? And I think you mentioned if we look back, was it nine or twelve months ago, their cash balances were more in kind of the 2%-ish level, is that the target to get back to, and how long does that take?

Thomas Splaine: Yes, there is a lot of factors that go into that one, Eric. Like Tom indicated in his comments our production this year is very good. Loan generation has been good. We run at 90% of last year's level and we grew 11%. So, it's really the prepayment speeds that's the wild card right now, and that has been affecting us. So, we're working really hard to kind of stay in the same place. So, deploying the excess capital, if pre-payment speeds, slow down a little bit, and maybe with the long-term rates starting to tick up higher, that begins. That would be a very good contributing factor to us deploying some more excess capital out there. The loan pipelines are strong and we are booking loans. So, we're very encouraged by that. And like this quarter, we put another $140 million into the securities portfolio, which helps, but it doesn't give you the yield that you would get in your loan portfolio. So, there will be some more PPP runoff in Q4 with the forgiveness. And we're looking to already deploy that cash balance coming at us and getting that out in Q4 as well. So, we're going to continue to manage and deploy the excess cash as fast as we can. But we're trying to be prudent and not try to take too much risk of investing it out too long at this point. So, we haven't done anything silly when it comes to offering really long-term loans are getting too far over our – in front of ourselves when it comes to looking at putting stuff in the investment portfolio.

Erik Zwick: Got it. And then thinking about the non-performing loans that you sold in the quarter, curious, were those sold to another bank or a non-bank entity? And curious, is there opportunity to sell anything additional in that NPL portfolio at this point?

Thomas Shara: Well, we're running out of stuff to sell Erik, which is a good thing. But it's all institutional investors. I will tell you that the demand is ferocious. Probably getting 20 plus investors each time we do one of these things, but they are not bank investors, but they are folks that are hungry for yield. And we've been kind of surprised that the realization rate we've been able to get on these things, the last sale was in the 90s quite frankly. But really, we're down to $12 million. We have one loan over a $1 million in non-performing, so there's really not anything left to sell. And we don't see any new formations more importantly. So, we have one credit of size that that is under contract. So there really is no product left to sell.

Erik Zwick: Got it. So, continue to manage what you've got left and then not seeing any outsized risk there. So that's good. Okay. And then kind of sticking on that credit front you mentioned the reserves ex-PPP now about 1% of total loans. Is that a good level today? And I guess I'm thinking more if loan growth kind of ramps up as you are expecting it, how should we think about provisioning going forward?

Thomas Splaine: Okay, we don't give a lot of guidance on the allowance for loan loss and provisions just because of the nature of the account. What I can tell you as you and Tom just discussed, our problem loans are at a very low-level early-stage delinquencies, non-accrual, non-performing are all down to very low levels. As we look forward, macro-economic conditions continue to improve. So being a CECL modeler with the allowance for loan loss, it's indicating net reserve levels should be lower than they were in 2021. So that's kind of the general indication of what we're looking at right now from a very, very high level. But we're not going to give any general guidance on provision expense going forward.

Erik Zwick: Understood, thanks for taking my questions today.

Thomas Splaine: Thanks Eric.

Thomas Shara: Thanks Eric.

Operator: [Operator Instructions] We have no further questions, so I'll hand back over to the team for closing.

Thomas Shara: Thank you, Daisy. And thanks for all of you for participating in today's call. If you do have any further questions, feel free to reach out to Tom River [ph] anytime. But thank you for being with us and please stay safe. Take care, everybody.

Operator: Thank you all for joining. You may now disconnect your lines and have a lovely day.