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First Bank (FRBA 1.24%)
Q4Â 2019 Earnings Call
Jan 30, 2020, 9:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, and welcome to the First Bank Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions]
I would now like to turn the conference call over to Mr. Patrick Ryan, President and CEO. Mr. Ryan, the floor is yours, sir.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Thank you. I'd like to welcome everyone to First Bank's Fourth Quarter 2019 Earnings Conference Call. I'm joined today by our Chief Financial Officer, Steve Carman; our Chief Lending Officer, Peter Cahill; and our Chief Deposits Officer, Emilio Cooper.
Before we begin, however, Steve, will you please read the safe harbor statement.
Stephen F. Carman -- Executive VP, Treasurer and Chief Finencial Officer
The following discussion may contain forward-looking statements concerning the financial condition, results of operations and business of First Bank. We caution that such statements are subject to a number of uncertainties, and actual results could differ materially, and therefore, you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described under Item 1A, Risk Factors, in our annual report on Form 10-K for the year ended December 31, 2018, filed with the FDIC. Pat, back to you.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Thank you, Steve. I'd like to start with some high-level comments before turning over to the team to provide a little more detail. I think overall, from a strategic perspective, it was a strong finish in Q4 to a challenging year. I think in the fourth quarter, we produced some very good results even despite a onetime nonrecurring expense related to the valuation of our New Jersey deferred tax assets. Our primary goals for the quarter were to lower our deposit costs, improve our net interest margin and successfully integrate the Grand Bank team. I think we delivered on all fronts. Our cost of interest-bearing deposits declined 14 basis points from 1.82% to 1.68% on a linked-quarter basis.
Our net interest margin correspondingly increased 19 basis points quarter-to-quarter from 3.15% in Q3 to 3.34% in Q4. And our systems integration of Grand Bank occurred on December 9, things went very well, and we're excited about having the Grand Bank folks as part of the First Bank team. Furthermore, we had a very good quarter related to our ancillary income sources in the fourth quarter. I'll highlight a couple. Our prepayment penalty income was $361,000 in the quarter, which is a fair bit above our quarterly average for the year of $215,000 in prepayment income per quarter. We also saw a significant uptick in our loan swap fee income in the quarter, we realized income of $349,000, which is up significantly from earlier quarters.
We had gains on sale of SBA loans, which are part of our normal business, but also can be a little bit lumpy from quarter-to-quarter. We had $172,000 in income during the fourth quarter and that was a nice rebound after a couple of quiet quarters in Q2 and Q3. We also realized some gains on recovery of acquired loans of $190,000 in the quarter, that's roughly in line with what we've been generating on average over the past few quarters. Because of changes in the tax rules in New Jersey, we had to bring down the value of our New Jersey deferred tax asset by approximately $730,000 during the quarter. That was a dollar-for-dollar reduction to net income.
Fortunately, we believe the impact from the changes in the New Jersey tax law are behind us, and we continue to believe that the appropriate effective tax rate going forward is between 24% and 25%. Given some of the movements on the ancillary income side, it's a little difficult to peg a normalized profit run rate going forward, but certainly, we feel very good about the trends in our core business. As we look at our cost of funds moving forward, we think there's continued opportunity to move our funding costs lower, both through improving our mix, reducing the cost of our CDs. And we also have an opportunity for some significant savings based on our subordinated debt, which is hitting its 5-year anniversary in late April, and we believe there'll be opportunities to refinance that debt at better rates in the near future.
We will have, we believe some continued downward pressure on yield. So we're hopeful that our savings The funding side will offset any yield pressure and that we can see a stable net interest margin going forward. We believe we're in a good position from an expense management standpoint, we believe we can continue to keep a tight lid on expenses going forward. And while we believe that ancillary income sources will move around from quarter to quarter, we believe the trends they're all positive. The expense numbers in Q4 also require a little bit of explanation. Certainly, it was a very good quarter from an expense standpoint, and we feel good about the underlying trends. That said, the Q4 numbers were artificially low because of lower FDIC assessments and some adjustments to accruals we made around incentive comp and marketing.
We believe that on a go-forward run rate basis, our quarterly noninterest expense run rate is probably closer to $9.7 million. On the credit quality front, we did have a movement higher in our NPA ratios, which we certainly were not happy to see, although we also had some very good news in the form of executed sales contract on our primary collateral related to our largest C&I nonperformer, and we believe that loan should be paid off and gone during the first quarter of this year. Regarding the overall balance sheet, in the fourth quarter, we did see some declines in loans and deposits. Some of this was a timing issue, but some of it was also related to strategic choices we made. The level of paydowns, obviously, to some degree, were outside of our control. But we did in certain instances choose not to match lower rates or terms by competition and rather take in the prepayment penalty income.
We were also very focused on lowering our deposit costs and we did not want to put undue stress on our funding sources as we were focused on driving costs lower. Thankfully, it turns out the retention rates we had, as we repriced CDs and other deposits during the quarter were very good. And Emilio, we'll get into a little more detail on that later. Looking forward to 2020, again, I feel good about the core operating trends. Our deposit costs are coming down, and our noninterest-bearing pipeline looks very good. Our loan yields will continue to trickle down but I believe at a manageable pace. Expense management plans are working and healthy but moderated growth goals will allow for continued expense management going forward.
We're hopeful and expecting that credit trends will show an improvement during the upcoming year, and our tax rate will stabilize at a much lower level than what we realized in 2019. In summary, we're pleased with the positive progress we made in Q4, and we're cautiously optimistic about the prospects for 2020.
At this time, I'd like Steve to discuss some additional details regarding our fourth quarter and full year performance.
Stephen F. Carman -- Executive VP, Treasurer and Chief Finencial Officer
Thanks, Pat. Net income for 2019 was $15.2 million or $0.79 per diluted share compared to $17.6 million or $0.95 per diluted share for 2018. Net interest income growth of 6.2% and an increase in noninterest income was offset by higher noninterest expense and tax expense. As Pat mentioned, we finished 2019 on a strong note with net income for the fourth quarter of $5.2 million or $0.25 per diluted share. Included in our quarterly results was a revaluation of First Bank's deferred tax asset, a onetime charge, based on a clarification in December 2019, from the State of New Jersey regarding the tax legislation passed in July of 2018. The revaluation of our deferred tax asset resulted in additional tax expense of approximately $730,000. Excluding this adjustment, net income for the fourth quarter would have been about $5.8 million or $0.28 per diluted share.
Net income for the fourth quarter 2018 was $4.1 million or $0.22 per diluted share. Pretax income for the fourth quarter of 2019 included loan prepayment income of about $361,000, loan rate swap fee income of $349,000 and gains on sale of SBA loans of $172,000. And improving net interest margin also contributed to our positive results for the three months ended December 31, 2019. During 2019, we've discussed our efforts to stabilize our net interest margin during a period of lower interest rates, a relatively flat to at times inverted yield curve. Our cash equivalent net interest margin for the fourth quarter of 2019 was 3.34% compared to 3.15% for the linked third quarter.
For illustrative purposes, excluding the impact of loan prepayment penalty income, a regular component of our business, our core margins for the fourth quarter of 2019 improved due to lower deposit costs, which declined 14 basis points during the quarter and the positive impact from the Grand Bank acquisition. Our goal in 2020 is to maintain a stable net interest margin. As we have discussed on previous earnings calls, our strategic focus remains adding noninterest-bearing deposits and lower cost commercial deposits, which Emilio will discuss in his remarks shortly. Regarding interest-bearing deposits, decrease in higher cost CDs has been a priority. The cost of time deposits is down almost 15 basis points in the second half of 2019. Approximately $572 million of our $711 million CD portfolio will reprice lower during 2020. In the first nine months of 2020, $519 million in CDs will reprice at an approximate average rate of 35 to 40 basis points lower based on current rates being offered. Clearly, there are other factors that will impact our margin in 2020, such as rates on loans, the level of loan prepayment penalty income, purchased accounting associated with our acquisitions, et cetera.
That said, lowering our cost of deposits will be very important in maintaining a stable net interest margin. During 2019 and into 2020, we will continue to emphasize and take actions to manage the level of noninterest expense growth, excluding any merger-related costs. Our efficiency ratio for the fourth quarter of 2019 was 53.21% compared to 58.22% for the linked third quarter. Absent the impact of loan prepayment income and loan rate swap fees in the fourth quarter, we do expect our efficiency ratio in 2020 to remain below 60%. A note on taxes. Higher tax expense in 2019 reflects the impact of clarifications to New Jersey State tax law passed in 2018, such as the aforementioned revaluation of our deferred tax asset in the fourth quarter.
Absent the revaluation impact, our effective tax rate for 2019 would have been 25.55%. We expect that our effective tax rate will improve somewhat in 2020 as the New Jersey surcharge is reduced in 2020, and we plan to employ additional State tax planning strategies. Lastly, in the fourth quarter, we announced the stock buyback programs. There was no activity in the fourth quarter. However, in the first quarter that program has commenced with the transaction in January.
At this time, I'd like to turn it over to Peter Cahill for his update on lending. Peter?
Peter J. Cahill -- Executive Vice President and Chief Lending Officer
Thank you, Steve. Loan growth for the year was $261 million or just under 18%. This, of course, includes loans originated or acquired via the Grand Bank acquisition, which totaled $146 million and represented around $56 million of the 2019 total growth in loans. In the fourth quarter, loans declined by about $20 million, virtually all of which took place right at the end of the year in December and was due mainly to prepayments of investor real estate loans. There's a good news to be had on the payoffs is that we generated a decent amount of prepayment income from them, which Pat and Steve both mentioned. Organic loan growth for the year, which excludes former Grand Bank business, totaled $115 million. With the loan prepayments, we had a disappointing finish to the year after averaging monthly organic loan growth of around $15 million through the third quarter. Prepayments are a trait of the investor real estate business that makes up a big part of our portfolio because investors at some point take profits.
The timing there worked against us this past quarter. At the end of the day, organic loan growth reflected 8% growth over the balance of loans outstanding at 12/31/18, and relative to many of our peers is not too bad. Overall, looking forward into 2020, our new business pipeline continues to look good. At the end of the year, adjusted for probability, it stood around $178 million, which is right in line with month end averages during 2019. Maintaining a good loan pipeline is critical to ensuring good growth. We know we had loan prepayments of almost $130 million in 2019, and we estimate our monthly loan amortization to be around $6 million a month or $72 million annually. This means to grow our loans organically by $115 million in 2019, we had to generate well over $300 million in new loans. We continue to work hard on finding new C&I relationships, and we continue to see good opportunities for investor real estate business. And we, of course, are very focused on generating deposits.
Our portfolio C&I loans was one area that did increase during that very flat fourth quarter. During the fourth quarter, we made some adjustments organizationally within lending. We took a few of our top real estate lenders and formed an investor real estate team. Investor real estate will always be a major focus of ours. We want to make sure we have the right people focus there. We also want to make sure the remaining staff, the majority of our relationship managers, are focused on C&I relationships and the deposits that come with them. Also as a result of the Grand Bank acquisition, we acquired a small team that's been making SBA loans in the Central New Jersey market. Historically, we seem to do a fee each year. And we think that with that new team, we can conservatively grow that business a bit and respond better to borrowing needs in our market.
Lastly, I've spoken in the past about relationship management -- manager turnover, and our efforts to get fully staffed during times of growth. In the second half of the year, we reallocated some resources. And at this point, from a relationship manager headcount perspective, all openings are filled. As we move forward into 2020, our plan will be to support more modest growth via additional support staff, such as portfolio managers, underwriters or loan administrators to support the regional sales teams. I should also comment on asset quality. We did reference some further deterioration in some of the asset quality metrics in the fourth quarter. This was outlined in the earnings release that touched upon earlier by Pat. Almost all of this was caused fromtwocommercial relationships, both are C&I relationships and both, we believe, are adequately collateralized by real estate. As our earnings release stated, the real estate security in the large loan is under contract for sale.
And that closing should take place later this quarter. As we have in the past, we continue to monitor the loan portfolio closely, including a formal, very detailed asset quality meeting that's held at the end of every quarter. We continue to be within the portfolio limits set by our Board of Directors and the portfolio remains well diversified. Our underwriting standards have not changed. And as we move into 2020, we will be focused on improved profitability and a somewhat slower planned growth. So in summary, in lending, we think we had a pretty good year in 2019. We grew at a decent rate. Our first quarter core system conversion, which did put a bit of a strain on the lending efforts, is well behind us, and we onboarded the Grand Bank staff and their book of business. Looking forward, we've got the lending area well organized, the signs are good for continued growth, and we believe that we have our hands on asset quality, and we expect improvement there in the coming quarter.
That's is my fourth quarter lending report, I'll turn it over now to Emilio Cooper to discuss deposit initiatives.
Emilio Cooper -- Executive Vice President and Chief Deposit Officer
Thanks, Peter. Overall, deposit results for Q4 were positive and helped us deliver a strong finish for the year. Our primary objective in Q4 was a successful integration of Grand Bank customers, reduction of deposit costs and improvement in our mix. We did well in all three areas. For the quarter, average deposit balances were up by $151 million versus Q3. That was primarily driven by the Grand Bank acquisition. Total deposits increased by 18% for the year, driven by good organic deposit growth and the Grand Bank acquisition. Noninterest-bearing average balances grew by over $55 million for the full year. Noninterest-bearing balances met our targeted mix levels built into our strategic plan and now represent over 17% of total deposit balances. We feel very good about this movement, and this will remain a key area of focus for us in 2020 and beyond. As Pat and Steve alluded to in their comments, we are being very disciplined in our deposit pricing. As a result, we were able to reduce the cost of our interest-bearing deposits by 14 basis points in the quarter while maintaining strong CD balance retention, in line with our strategic objectives.
As an example, in December, we retained over 80% of our CD balances while lowering the average rate by over 60 basis points on CDs that matured in December. This is a trend we expect to continue throughout the majority of the year in 2020. There were many key accomplishments in the deposit business for First Bank in 2019 that included the following. Keep in mind, these accomplishments were delivered against the backdrop of 2019 being a year where we converted our core operating system and integrated a newly acquired bank. Organic deposit growth was $76 million for the year, representing a 6% increase versus 2018. Total growth, including Grand was 18%. Noninterest-bearing deposits grew organically by over $15 million, which represents a 26% improvement in growth versus 2018 and overall noninterest-bearing growth of 7%. We've built a solid foundation in 2019, which supported this growth and continue to improve our ability to execute each successive month. We increased the mix of noninterest-bearing balances up to 17% versus 15.7% at the end of 2018.
We successfully launched two new products with an enhanced marketing approach that facilitated the growth in consumer deposits by $72 million versus a loss of $13 million in 2018. We upgraded our core deposit system, which has enhanced our capabilities and positions us with increased flexibility to partner with modern solutions providers to be cutting-edge informative functionality of our product offering versus the competition. We launched a new commercial analysis account, which is leaned to increased fee capture for cash management and deposit account service charges and will drive improved noninterest income over time.
As we look ahead to 2020, there are many initiatives under way that will continue to lead to improved profitability and growth in our business. Some of the initiatives we are most excited about include: banker business development training that will begin in Q1 and continued throughout the year as we ingrain a new approach to creating compelling reasons for C&I customers to switch to First Bank; the launch of our online account opening platform and digital marketing campaigns, which will increase the reach of our brand beyond the geographic footprint of our physical locations; the optimization of our staff mix to increase the number of proactive business development team members in the marketplace; improved reporting to track individual sales goals versus monthly production; and the continued lowering of core deposit costs and flexibility in deposit portfolio through shift in our deposit mix.
These represent just a few of the initiatives we have under way that we know will lead to continued value creation in our business. We are pleased with the continued growth we see happening in the deposit business. Last quarter, I communicated that we were working toward a much faster start in 2020 than what we experienced in 2019, and we are off to a solid start. That wraps my Q4 update. Back to you, Pat.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Thank you, Emilio. That concludes our prepared comments. At this point, I'd like to turn it back to the operator to start the Q&A session.
Questions and Answers:
Operator
[Operator Instructions] And our first question will come from Nick Cucharale of Piper Sandler. Please go ahead.
Nick Cucharale -- Piper Sandler -- Analyst
Good morning, gentlemen.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Good morning, gentlemen.
Nick Cucharale -- Piper Sandler -- Analyst
So I wanted to start with the expenses. With the systems conversion on December 9, can you update us on the progress of cost savings from Grand Bank and the likelihood of future extractions in coming periods?
Patrick L. Ryan -- President, Chief Executive Officer and Director
Yes. So there were certain people that were not retained immediately at close. And so some of those savings did materialize in the quarter, but we also had some other folks that we kept through year-end to help with the system conversion and the transition. And so there are some additional savings opportunities on the personnel side that will materialize moving forward. So I would say we probably got half of what we're looking for right away. And the rest, we expect we'll start to see a benefit as we move forward in 2020.
Nick Cucharale -- Piper Sandler -- Analyst
Okay. And then I appreciate the commentary on the choice to moderate growth relative to prior years. Can you help us quantify your expectations? Or is it quite fluid given the operating environment and your success on the funding side.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Well, listen, it's certainly fluid in the sense that we have the capital, and we have the ability to grow. If the success on the deposit side exceeds expectations, I think, we're prepared to grow a little bit faster. But I think the key difference, Nick, in the past, when we were in start-up phase for the bank, we had to bring in good loan business as it became available and figure out how to fund it. And now I think we're trying to rebalance and scale a little bit and make sure that the quality of new loan business we're bringing on is getting funded by reasonably cost quality deposits. So I think we're probably looking at growth in the mid, maybe up toward the high single digits, as we move forward, rather than historically, I think, organically, the growth has probably been more in the 10% to 15% range.
Nick Cucharale -- Piper Sandler -- Analyst
That's great color. And then just lastly, on asset quality. Was this quarter's increase in nonperformers due to the acquired book? Or are they legacy First Bank relationships?
Patrick L. Ryan -- President, Chief Executive Officer and Director
No, it was primarily -- there were a couple of things related to Grand. But it was primarily related to the C&I loans that we mentioned on the call, the one that we think is basically resolved, we hope through a sale and expect to get that, we believe, taken care of in Q1. The other one was a situation that emerged, and we were able to renegotiate and restructure that loan to put us in a position where we think we're well secured. But because it was a restructured loan, it's probably going to be in the numbers for a while until we get full resolution there.
Nick Cucharale -- Piper Sandler -- Analyst
Thanks for taking my questions. Got it.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Thank you, Nick.
Operator
[Operator Instructions] Next, we have Howard Henick with Scurlydog Capital. Please go ahead.
Howard Henick -- Scurlydog Capital -- Analyst
Hey guys, I'm just a little confused on thetwoloans we're talking about and the comments that basically they're going to get sold and taken care of. I'm not sure exactly what that means. I know there's been reserves taken against those loans. So are you expecting to take a loss equal to your reserves, so there will be no kind of net difference? Or are you expecting a full recovery and therefore, actually, recovery in the reserves and make a profit? Not that it's really a profit, but you know what I'm saying.
Patrick L. Ryan -- President, Chief Executive Officer and Director
Yes, the loan that we had talked about last quarter had a specific reserve initially set up. But based on the contract purchase price. That specific reserve was removed as it was no longer necessary given the expected proceeds we believe we'll get through the sale. So the major change there, obviously, is the contract for sale and the value at which the property is being sold relative to our initial estimates. So I think that's all good news there. On the new loan, that's a situation that emerged. And as we mentioned, we believe we're adequately collateralized there, but that's going to take some time to sort it out.
Howard Henick -- Scurlydog Capital -- Analyst
And how large is the new loan? I know you say thetwoloans are like $8 million in total, but I don't know what the difference is.
Patrick L. Ryan -- President, Chief Executive Officer and Director
No, that the -- the loan that the -- where the property is under contract for sale that was when we announced it in the third quarter, I think it was an $8.5 million principal balance. We've gotten some payments down on that total credit facility. So at year-end, it was at $8.2 million versus $8.5 million. The other loan is under $6 million, I think $5.8 million.
Howard Henick -- Scurlydog Capital -- Analyst
And that's a C&I loan, but you believe adequately collateralized, correct?
Patrick L. Ryan -- President, Chief Executive Officer and Director
Correct.
Howard Henick -- Scurlydog Capital -- Analyst
Okay, thank you.
Operator
Well at this time, it appears that we have no further questions. We'll then conclude our question-and-answer session. I would now like to turn the conference call back over to the management team for any closing remarks. Gentlemen?
Patrick L. Ryan -- President, Chief Executive Officer and Director
Okay. Thank you. Well, we appreciate everybody's time, and we look forward to regrouping with everybody at the end of the first quarter. Thank you very much.
Operator
[Operator Closing Remarks]
Duration: 30 minutes
Call participants:
Patrick L. Ryan -- President, Chief Executive Officer and Director
Stephen F. Carman -- Executive VP, Treasurer and Chief Finencial Officer
Peter J. Cahill -- Executive Vice President and Chief Lending Officer
Emilio Cooper -- Executive Vice President and Chief Deposit Officer
Nick Cucharale -- Piper Sandler -- Analyst
Howard Henick -- Scurlydog Capital -- Analyst
