LBAI - Lakeland Bancorp Inc. (LBAI) Q3 2022 Earnings Call Transcript
Lakeland Bancorp, Inc. (LBAI)
Q3 2022 Earnings Conference Call
October 27, 2022, 10:00 AM ET
Company Participants
Mary Russell - Assistant Controller and Director, Financial Reporting
Thomas Shara - President and CEO
Thomas Splaine - Executive Vice President and CFO
Conference Call Participants
Chris O'Connell - KBW
Presentation
Operator
Good morning. And welcome to the Lakeland Bancorp, Incorporated Third Quarter Earnings Conference Call. My name is Megan, and I will be coordinating today’s call. You will have the opportunity to ask a question after 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, Megan. 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 the review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements, which may be made during the purpose 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, and good morning, everyone, and welcome to our third quarter earnings call. I will start the call off with a high-level summary for the quarter, followed by Tom Splaine, our CFO, who will walk you through our earnings in detail.
First off, I’d like to acknowledge our recently announced merger with Provident Financial Services and inform everyone that we will have more information to share with you shortly when we file our joint proxy prospectus with the Securities and Exchange Commission, and our regulatory application in connection with the merger.
Our financial results for the quarter were solid, as we continue to successfully organically grow both loan and deposit portfolios, which were both up over 2% compared to the prior quarter as well as continuing to maintain pristine asset quality.
For the third quarter, we posted net income of $28.7 million or $0.44 a share, which is in line with the prior quarter net income and represents an ROA of 1.10%, ROE of 10.33% and an ROTCE of 13.87%.
Excluding merger-related expenses of $3.5 million this quarter, pre-tax, our net income for Q3 would have been $31.3 million or $0.48 -- $0.46 a share, resulting in ROA, ROE and ROTCE of 1.21%, 11.36% and 15.25%, respectively.
Third quarter net interest income was consistent with prior quarter as improvements in interest income related to higher rates in our organic loan growth quarter-on-quarter, which totaled $160 million, representing a 9% annualized growth rate was offset by a similar increase in interest expense on deposit pricing to fund expected balance sheet growth and advantageous prices. The loan growth for the quarter was across the majority of loan categories, including commercial and the consumer portfolios.
Commercial closings for the quarter was strong, but below second quarter, which was a record quarter. The pipeline going into the fourth quarter is very strong and we expect solid loan growth in the fourth quarter, which has traditionally been our strongest. We anticipate organic loan growth will meet prior guidance of high-single digits for the full year.
On the deposit side, total deposits decreased $176 million or 2% for the quarter, as we undertook an initiative to lock in longer term certificate of deposits early in the third quarter in anticipation of continued interest rate increases and market interest rates during the remainder of the year. Non-interest-bearing deposits decreased slightly during the quarter totaled 26% of total deposits, while core deposits now make up 88% of total deposits.
On the credit side, asset quality remained excellent. Non-performing loans at 9/30 were only $18 million versus $22 million at 6/30. For the quarter, we released a small net recovery. Non-performing assets to assets decreased this quarter to 17 basis points, while the allowance remained relatively stable at $69 million or 91 basis points of loans versus 93 basis points at 6/30. Reserve coverage for non-performing assets at quarter end totaled 375%.
As it relates to the economy on our footprint, our commercial customers are generally weathering rapidly increasing inflation and thus far have maintained their margins and profitability.
With rates rising as quickly as they have over the last few quarters, we are staying in close contact with our customers to ensure they are able to withstand higher operating costs along with higher interest rates. As you can see from our non-performing and delinquency trends, so far we are not seeing any cracks.
That concludes my prepared remarks. Now I’d like to turn it over the balance of the presentation to Tom, once he’s concluded with his comments, we are happy to answer your questions. Tom, take it away.
Thomas Splaine
Thank you, Tom, and good morning, everyone. Lakeland’s Q3 net income was $28.8 million or $0.44 per diluted share, compared to the second quarter of 2022 of $29 million or $0.44 per diluted share and the third quarter of 2021 of $22 million and $0.43 per diluted share. The current quarter includes $3.5 million in pre-tax merger-related expenses, which if excluded will increase net income to $31.3 million or $0.48 per diluted share.
Q3 financial results were favorably impacted by organic loan growth of $160 million, deployment of investment portfolio cash flows into higher yielding assets and the increase in interest rates, all combining to increase yields on our interest earning assets by 29 basis points for the quarter.
Offsetting these items, we increased deposit rates due to the competitive environment and we embarked upon a deposit acquisition strategy in early Q3 to secure longer term certificates of deposit in anticipation of the ongoing increases in market interest rates during the remainder of 2022 and into 2023. These items increased our yield on interest-bearing liabilities 54 basis points.
As a result, reported net interest margin for Q3 decreased 10 basis points to 3.28%, compared to the linked quarter of 3.38% and an increase from prior year quarter of 2.98%. Comparing Q3 net interest margin versus the prior quarter, in Q2 we experienced interest recoveries on non-accrual loans and higher loan prepayment fees, which had a combined positive impact of 10 basis points on Q3 net interest margin -- on Q2 net interest margin. Excluding these items, results a flat net interest margin of 3.28% quarter-over-quarter, even factoring in the higher deposit pricing during Q3.
Compared to the prior quarter, the yield on loans increased 21 basis points to 4.43%, while the yield on investment securities increased 27 basis points to 2.12%.
Deposit rates increased due to the competitive pressures and the CD initiative, and for the products that are indexed to the Fed funds rate. The cost of deposits increased to 62 basis points, compared to 22 basis points for the prior quarter.
Our Q3 provision for credit losses was an expense of $1.3 million was primarily related to credit losses on investments as a result of the decrease in the market value of corporate securities based upon interest rates and not based upon any credit downgrades of the securities.
Regarding asset quality, as Tom mentioned, non-performing assets decreased 4 basis points during the quarter to 17 basis points and credit remains strong.
Our Q3 net charge-offs were a recovery of $32,000 and would represent the fifth consecutive quarter of net recoveries, excluding the accounting for the 1st Constitution acquisition for purchase credit deteriorated loans back in Q1 of this year. As of September 30th, the allowance for credit losses on loans represented 91 basis points of total loans, compared with 93 basis points in the trailing quarter.
Q3 non-interest income remained steady at $7.2 million, as improvements in loan swap fees and the benefit on bank-owned life insurance were offset by continued softness in the gain on sale of residential mortgage loans and SBA loans.
Q3 non-interest expenses of $47.8 million included $3.5 million in merger-related expenses, absent which these expenses would have decreased $750,000 from the linked quarter. Our efficiency ratio decreased to 49.8%, compared to the prior quarter of 50.7%. Our Q3 effective tax rate increased slightly to 25% as compared to the trailing quarter.
On the balance sheet, in comparison to the prior quarter, total assets increased $141 million or 1.4%, with the loan portfolio increasing $160.2 million or 2.2%, while investment securities decreased $77 million, as cash flows were used to fund the loan growth.
Deposit balances increased $176 million or 2.1% for the quarter, primarily due to our longer-term certificate of deposit strategy discussed earlier, while borrowings decreased $74 million.
Our September 30th loan-to-deposit ratio was 87% consistent with the prior quarter and gives us ample liquidity to fund future loan growth.
For capital management, our capital levels remained strong and tangible capital ratio decreased to 7.83%, compared to 8.01% at June 30th, as asset growth, cash dividends and other comprehensive income changes offset earnings retention for the quarter.
Due to the potential impact of interest rate changes causing additional mark-to-market adjustments on our available-for-sale investment securities portfolio, as well as the continued strong loan growth in our loan portfolio, we did not repurchase any common stock in Q3 under our existing authorized share repurchase program. All of our capital ratio percentages are consistent with the prior quarter and we remain well capitalized.
Regarding our outlook for the remainder of 2022, we believe that we are well positioned for rising interest rates. Our projected net -- our projected interest rate risk position is neutral and we have become more asset-sensitive in future periods.
Deposit pricing increases and the certificate of deposit strategy we implemented in Q3 was designed to prefund our expected balance sheet growth with significantly lower cost of funding than is currently available via Federal Home Loan Bank borrowings and broker deposit markets. We do not anticipate increasing deposit pricing in Q4, which will decrease the deposit beta cycle to-date.
As a result, we anticipate Q4 net interest margin will expand into the mid-3.30s range. As Tom discussed earlier, we expect loan portfolio to organically grow in the high-single digits in 2022 and that asset quality will remain high.
Non-interest expenses for 2022, excluding merger-related costs are forecasted in the low $180 million range and income tax expense for 2022 is forecasted to be approximately 25% for the year.
That concludes our prepared remarks and we would be happy to address any questions. With that, Megan, can you open up the question period for us, please?
Question-and-Answer Session
Operator
Absolutely. [Operator Instructions] Our first question comes from Chris O'Connell with KBW. Your line is now open.
Chris O'Connell
Good morning.
Thomas Shara
Good morning, Chris.
Chris O'Connell
I was hoping you talk a little bit about -- a little bit more about the deposit strategy, maybe where the CDs are coming on at and how much of that is going to flow into the fourth quarter here just on an average balance basis and where you see the deposit costs going in terms of -- I know you said that they will be flat in terms of no new raises, but how much of the raises in the third quarter will kind of flow into them?
Thomas Shara
Right. Yeah. Chris, on the strategy, we forecasted interest rates continue to rise based upon the Federal Reserve’s bank’s intention and we just want to get out in front of it. We secured approximately $300 million in one-year to two-year CDs at an average rate in the 2 40 to 2 50 range.
Comparable borrowings right now from the home loan bank are in the neighborhood of 5%. So we think that we secured some nice funding in advance, which had some downward pressure on NIM in Q3 what should benefit us as we go forward now. So I think that answers your question, but let me know if I didn’t do it fully.
Chris O'Connell
Yeah. Absolutely. That helps. And then as far as the prefunding goes, I mean, cash balances didn’t move that much. So I guess when thinking about the future loan growth and these deposits going forward. So is it going to be kind of new deposit growth or future borrowings or kind of run-off of the securities portfolio that’s going to be fall into loans on a go-forward basis?
Thomas Shara
Yeah. That’s right, Chris. When you look at the overall balance sheet, we -- you have about $75 million in cash flow coming out of the investment securities portfolio, as well as all the cash flow, the yield -- lower yielding loans coming off the loan portfolio and that’s being turned back into more loans going forward. So that’s what we see right now.
And then we have ample -- we can do some more deposit taking if we want on a go-forward basis depending on where we are at with additional loan growth above our projections. But I think we are in a good place from a liquidity standpoint that we can take care of what we need to do.
We fully leverage the cash position, as you mentioned, in the beginning of the year and so we are not sitting on excess liquidity right now, but we have plenty of capacity to borrow and move if we need to.
Chris O'Connell
Got it. So over the next couple of quarters or so as you guys take on loan growth, is it fair to say that the securities portfolio might drift down a bit?
Thomas Shara
Yeah. That’s the intention. If, historically, we operated with the securities to total assets approximately around that 15% -- 12% to 15% range. Right now, they are still around 20% of total assets and we like to deploy those cash flows into higher yielding loans and increased profitability on a go-forward basis.
Chris O'Connell
Got it. And then on the loan portfolio growth, you guys are getting good growth this quarter. It sounds like the pipeline going in the back end of the year is pretty strong, maybe just a little bit of color around where you are seeing demand and kind of where you are being cautious at this point in the cycle, And yeah, that would be great?
Thomas Splaine
Chris, we are seeing growth -- heavy growth in the healthcare space, which we said last quarter, they are continuing to make some pretty good traction there. The Hudson Valley market continues to grow nicely. The Toms River Ocean County market is growing nicely. So it’s coming pretty much across the Board, but healthcare is clearly leading the way.
We continue to avoid suburban office, but that’s the years that we have been doing that. Multifamily still remains strong, retail still remains strong and industrial warehouse space is just continuing to be on fire. So those are the areas we are focusing our activities, but being very cautious on hospitality and suburban office.
Chris O'Connell
Got it. And where is the pipeline compared to last quarter?
Thomas Splaine
It is up about 10% from last quarter.
Chris O'Connell
Okay. Great. And then last one for me, on the buyback…
Thomas Shara
Yeah.
Chris O'Connell
… being paused here, is it safe to say that, that will continue to stay paused with the deal funding?
Thomas Shara
Yeah. Chris, basically, based upon the balance sheet and what we are doing right now, I think, we are going to keep it paused, as well as because of the merger acquisition with Provident Financial. So we are going to be on the sidelines for Q4.
Chris O'Connell
Great. Thanks for taking my questions.
Thomas Shara
Thanks, Chris.
Thomas Splaine
Thanks, Chris.
Operator
Thank you, Mr. O’Connell. There are currently no questions registered. [Operator Instructions] There are no additional questions waiting at this time. So I will pass the conference back over to Tom Shara for any additional remarks.
Thomas Shara
Thank you, Megan. Thanks everybody for joining us today. If you do have any questions for Tom and I, we are available pretty much all day today. So please give us a call. Thanks very much and have a great day everybody.
Thomas Splaine
Thank you.
Mary Russell
Thank you.
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Lakeland Bancorp, Inc. (LBAI) Q3 2022 Earnings Call Transcript