Premier Financial Corp. (PFC) Q2 2022 Earnings Call Transcript

Premier Financial Corp. (PFC -0.62%)
Q2 2022 Earnings Call
Jul 27, 2022, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Premier Financial Corporation second Quarter 2022 earnings conference call. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to Paul Nungester with Premier Financial Corporation. Please go ahead.

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Thank you. Good morning, everyone, and thank you for joining us for today's second quarter 2022 earnings conference call. This call is also being webcast, and the audio replay will be available at the Premier Financial Corp. website at premierfincorp.com.

Following our prepared comments on the company's strategy and performance, we will be available to take your questions. Before we begin, I'd like to remind you that during the conference call today, including during the question-and-answer period, you may hear forward-looking statements related to future financial results and business operations for Premier Financial Corp. Actual results may differ materially from current management forecasts and projections as a result of factors over which the company has no control. Information on these risk factors and additional information on forward-looking statements are included in the news release and in the company's reports on file with the Securities and Exchange Commission.

And now, I'll turn the call over to Gary for his comments.

Gary Small -- President and Director

Thank you, Paul, and good morning to all. Thank you for joining us today. We've got a lot to cover, and I'll get right to the highlights. It was just an outstanding loan growth quarter in Q2.

We had growth across a broad base with each business line, commercial, consumer and residential experiencing growth of at least eight and a half percent in real terms for the quarter on a point-to-point basis in all the markets in which we operate contributed to that growth. So it was broad and it was deep. We built a really great revenue generation team, and we're in a very good position to capture the new business, and we certainly saw our share of it in the quarter. C&I, CRE and multifamily business each experienced good activity on the commercial front.

So again, very balanced. Paul will outline the strong moves made in the net interest income and margin front for the quarter, but I want to highlight that we have excellent momentum heading into Q3. And you'll expect to see meaningful average loan balance movement from Q3 to Q2 over Q2 with the kind of accelerated growth we have, the average is really matter here. Our mortgage application activity for the quarter was very good versus the industry.

However, as we all have seen, margin compression is mooting the financial contribution for the year, and that's going to be a continuing story, Matt will cover. Excellent quarter in the auto financing business. It's the strongest production quarter in our history. And as we look at July, it seems to continue -- to be continuing in the third quarter as well.

Loss provision for the quarter was higher than normal, obviously, and it was 100% driven by the loan growth activity of the quarter. We grew $500 million from the end of March until the end of June. And with CECL you provide for that day 1, and that's really driving the number. We did have a large single credit that we're all familiar with from last year's conversations that drove a net charge-off for the quarter.

It did not affect provision for the quarter as we have set aside a specific reserve for this credit at the end of '21. I'll be coming back with some guidance comments at the -- toward the end of the call. And now, I'll turn it over to Paul for performance discussion.

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Thank you, Gary. I'll review our second quarter results and start by highlighting our strong growth for the quarter. Total loans, including those held for sale, increased by $494 million during the quarter or 35.7% annualized growth or 8.8% year-over-year growth. We saw strong growth in all categories, including commercial, residential and consumer.

And we also had a good quarter in deposit growth, which increased $199 million or 12.6% annualized. Both noninterest-bearing and interest-bearing deposits each had strong double-digit growth. This growth in concert with the rising rate environment drove improved net interest income and core margin expansion. Net interest income increased 2.1% on a linked-quarter basis and 4.3% from the prior year, while core margin, excluding PPP and acquisition and market accretion increased 12 basis points from both first quarter '22 and second quarter '21.

This was primarily due to loan growth as well as higher loan yields, which rose 14 basis points from 1Q to 3.94%, excluding PPP and acquisition market accretion. Partially offsetting this was an increase in average cost of funds, which rose 6 basis points on a linked-quarter basis to 0.24%. This was primarily due to increased utilization of higher cost FHLB funds as well as a small increase in average cost of deposits, which rose only 3 basis points on a linked-quarter basis to 0.17%. Looking forward, we have tremendous velocity coming from our loans, which ended the quarter about $300 million higher than our 2Q average balances.

That, in combination with rising rates, helping yields while we manage our deposit betas will drive continued growth in net interest income and margin. Non-interest income of $14.4 million for 2Q was down $2.5 million from the prior quarter, primarily due to mortgage banking and security losses. Mortgage banking income decreased $2.3 million on a linked-quarter basis due to a $1.4 million decrease in gains primarily from lower saleable mix and compressed margins and a $0.9 million lower MSR valuation gain. Security losses were $1.2 million in 2Q, solely from decreased valuations on our equity securities compared to $0.6 million of similar losses in 1Q.

Partially offsetting these decreases was an 11% linked quarter increase of $0.7 million in service fees from higher consumer activity for interchange and NSF/ATM fees. Insurance commissions were down $0.3 million from last quarter due to contingent commissions, which occurred in the first quarter. Expenses of $39 million were down 5% on a linked-quarter basis, primarily due to lower compensation and benefits. These decreased $3.2 million, partly from higher deferred costs related to the strong quarterly loan production as well as lower healthcare costs.

Lower expenses helped improve our efficiency ratio, which declined to 52.2% for 2Q from 54.6% in 1Q. The net effect of lower expenses and higher net interest income, offset partially by lower non-interest income by the 3% linked quarter increase in pre-tax pre-provision income, $34.4 million and a 1.78% return on average assets. The allowance was essentially flat in 2Q with a $5.2 million provision expense for loan growth, offset by a $5.3 million charge-off. The charge-off was due to the previously disclosed student loan servicer credit, and we are fully reserved for that such that it did not have an impact on provision expense and we would have had net recoveries but for that.

To be clear, 2Q expense was related specifically to our big quarter of loan growth, while the charge-off was already reserved for. Our asset quality stats improved again during the quarter, with decreases in both non-performing assets and classified loans. And at June 30, our allowance coverage of non-performing loans was 193%. Finishing the balance sheet as capital with a quarterly decrease primarily due to a $42 million negative valuation adjustment on the available-for-sale securities portfolio plus a few buybacks.

During the quarter, we completed 91,000 of share buybacks for a total of $2.6 million. At June 30, our tangible equity ratio was 7.3%. However, excluding AOCI, tangible equity would be 9% at June 30 compared to 9.4% at March 31. That completes my financial review, and I will now turn the call over to Matt for a discussion of lending and credit.

Matt?

Matt Garrity -- Executive Vice President, Chief Lending Officer, and Head of Residential Lending

Thanks, Paul. We're excited to report total loan growth net of PPP in excess of $494 million or 8.93% for the second quarter. Growth came from all segments of our lending businesses with strong commercial growth of 8.6%, excluding PPP, mortgage loan growth of 9.45% and consumer loan growth of 13.53%. Our commercial business had an outstanding quarter of loan growth, with second quarter growth of approximately $315 million.

For the first half of 2022, commercial loan growth was very strong at 11.6% year to date or approximately $412 million. We're proud of our team's efforts this year, which has resulted in solid growth across all of our markets. The factors that drove such a strong performance for the second quarter were largely two categories. First, second quarter loan production increased by approximately 75% from a very good first quarter.

We had a strong pipeline going into the second quarter, and our team did an excellent job of capitalizing on the opportunity. To some extent, we believe the volatility of the interest rate environment pulled forward some activity into the second quarter that otherwise might have dragged out into the third or fourth quarters. The second factor, although to a lesser extent, with some delay in expected payoffs. We may see this trend continue throughout the balance of the year as our borrowers who utilize the permanent market considered deferring those transactions until the rate environment becomes more favorable.

C&I production for the second quarter was good, up approximately 12% over the prior quarter. C&I production was approximately 33% of total originations in the first half of 2022, and we're pleased with the progress we're making here. Line utilization for the second quarter improved, up a few percentage points, but still under 40%. As we look ahead to the second half of 2022, we're pleased to report that we have delivered on the commercial loan growth for the full year that we said we would.

While we don't expect the same pace of loan growth in the second half of 2022 that we did in the first, our pipeline levels remain strong and our expectations for the third quarter are similar to what we achieved in the first. This would move our full year loan growth for 2022 into the low to mid-teens above our original guidance. In comparing the second quarter of 2022 to the first quarter, our residential mortgage business experienced solid seasonal growth in terms of originations while mortgage banking income remains under pressure, consistent with the industry. Originations increased 41% in the second quarter when compared to the first quarter and originations are down 10% when comparing the second quarter of 2022 to the second quarter of 2021, as we have largely filled the gap left by declining refinance business with increased purchase activity.

Our total originations for the first six months of 2022 were within 91% of our original expectations. As we discussed on last quarter's call, as expected, we continue to face challenges with mortgage banking income, both in terms of margin and saleable mix. We saw better execution in putting a larger percentage of our production into the portfolio in the second quarter, which impacted gain on sale revenue. As a result, gain on sale revenue fell by approximately $1.4 million on a linked-quarter basis and approximately $1.5 million on a year-over-year basis.

Going forward, we expect our salable mix to migrate more toward our historical norms, while our margin expectations will remain more modest given the current mortgage environment. With respect to asset quality, we had another quarter of improvement as levels of classified and criticized loans declined by 18.96% and 15.32%, respectively, on a linked-quarter basis. When comparing the second quarter of 2022 to the second quarter of 2021, the levels of classified and criticized loans have improved by 51.81% and 46.03%, respectively. Net charge-offs for the second quarter were $5,272,000.

During the quarter, we charged down the non-real estate secured portion of our C&I relationship that had a portion of its business in student loan servicing that we have discussed on prior calls. In anticipation of an expected resolution concerning the outstanding loan servicing contract between the customer and the Department of Education, the charge down we took was for the non-real estate secured portion of the relationship with the remaining amount representing the expected Department of Education resolution. We were properly reserved for this charge down, so there was no incremental impact to expense. With this charge down, our remaining relationship balance is approximately $8.8 million.

And when the funds from the expected resolution is received, our remaining exposure will be approximately $5 million secured by commercial real estate for which we are appropriately reserved for. We continue to look for signs of stress in the portfolio given the ongoing volatility in interest rates, continued inflationary pressures and overall economic uncertainty. While we continue to monitor for the impacts of these challenges, our portfolio continues to perform well, and our outlook for the third quarter remains stable. I'd now like to turn the call back over to Gary Small.

Gary?

Gary Small -- President and Director

Thank you, Matt, and I'll provide some color on our expectations for the remainder of the year. From a balance sheet perspective, when you exclude the impacts of PPP, do expect the second half of the year to see total loan growth of two and a half to 3% through year-end. Q3 visibility now looks very favorable, but similar to the first quarter, we remain relatively cautious about the outcomes for Q4, too much uncertainty regarding the effect of the Fed activity in the economy and so forth will play a conservative from our seat. Those numbers do include an improvement on the commercial expectation.

As Matt mentioned, we're looking at low to mid-teen growth for the year, which is a guidance up for that category. Full guidance or our loan growth guidance for the full portfolio was originally set at 10%, and we are guiding that up to 14% if you went from 12/31 to 12/31. Net interest income obviously will expand along with that balance sheet movement. We continue to expect to see margin improvement, not dissimilar from what we saw in the second quarter.

In the third, you'll have the full quarter impact of the second quarter yield movement and the additional Fed action that we would expect similar to what we'll hear this week, we'll just add to that. However, our deposit betas remain in check. Fee income wise, consumer bank fees continue to plot along strongly. The consumer's busy debit card, credit card, overdraft activity.

But we would expect to see the typical Q3 seasonal bump all good there. Mortgage fee income, as Matt outlined, will continue to be under pressure for all the issues noted and we really don't anticipate or are not planning on an improved fee income projection in the second half of the year versus what we saw in the first. Wealth management fees, I would say this, we've had an excellent first six months on new business activity. We've completed our marks, but again, the equity market valuations keep fee income suppressed in the near term in that business.

Expenses looked very good in the second quarter. We are bumping up our expectations to $163 million for the year, but it's relative to the success that we're having on the loan side, there's variable comp to be paid and so forth. So that's a check we're happy to stroke. The efficiency ratio for the organization, we've set a target of 52% and we'll affirm that that's where we expect to be at the end of the year.

From a credit perspective going forward, it's a benign environment from a net charge-off expectation over the remainder of the year. The loss provision is expected to grow with loan growth. And that overall for the year, including the experience that we had in the second quarter, we would expect net charge-offs to come in favorable to what was in our original plan. There is some potential for additional movement in provision depending on what happens with the unemployment rate, the general economy, that's a big variable in the CECL calculation.

So we'll leave that caveat in there. From an equity perspective, there's no specific plans regarding additional repurchase activity in the near term. I will say this relative to P&L performance for the year. We still expect to hit our earnings objectives that we set first off in '21 and would have been guiding you to as we entered the year.

We have obvious positives on loan growth and margin expectations that are going to help offset the difficult residential mortgage environment right now, along with the crimps as I mentioned, on wealth business and the bank equity portfolio and so forth. So we will continue and expect to deliver as we originally felt to it in a little different way this year. With that, we'll turn it over for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question comes from Michael Perito at KBW. Please go ahead. Your line is open.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Hey. Good morning, guys.

Gary Small -- President and Director

Good morning, Mike.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

On the loan growth side, so to get to that 14-ish percent level for the full year, I think you said, Gary, you expect the growth rate to drop in the back half of the year. But how much of that, as you guys just having limited visibility, particularly in the fourth quarter versus actual pipeline changes or line utilization changes like, I guess, the perception kind of versus the near-term reality?

Matt Garrity -- Executive Vice President, Chief Lending Officer, and Head of Residential Lending

So hey, Mike. This is Matt. So we have a tendency to under promise and overdeliver when it comes to this kind of stuff. So we are naturally conservative.

I'll tell you that our pipeline entering the third quarter in our commercial business, is about 90% of what it was when we were entering the second quarter. So on the surface, it's teed up for a very good quarter. We do expect more payoff activity this quarter and those are things that we're aware of. And it's not just permanent market activity.

It's still a very frothy market for the sale of companies. So we've got a couple of clients that are selling at very high multiples, and we're happy for them. So that will impact our business in the back half of the year. But I think the short answer is we're comfortable with the kind of growth we achieved in Q1 in our commercial space.

Is there upside there? Absolutely, there could be, but it's just not something that we're comfortable putting a stake in the ground up.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Got it. And are you guys the kind of the lack of visibility in the fourth quarter or just the uncertainty, I guess, maybe the better way to put it, is that you guys and just your observation of the macro and rates and what the Fed is doing? Or are you guys actually hearing customers start to cite that concerns about their lack of visibility beyond a quarter or three month-ish period?

Matt Garrity -- Executive Vice President, Chief Lending Officer, and Head of Residential Lending

I think right now, it's anecdotal in terms of the client conversations and what we're seeing. So there is a little bit of a healthy view of the ability, how much of that pipeline pulls through into closed business, there may be a higher percentage of business that goes away, the client decides, for example, not to move forward as rates continue to climb and the return hurdles get harder and things like that.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Got it. And then just lastly, to kind of summarize or just to work backwards a bit here. Just first, I want to make sure I heard you correctly, Gary, on the efficiency ratio, you said 52% for the full year was still achievable, correct?

Gary Small -- President and Director

Yes.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Yeah. And then working backwards from that, the non-interest income line will be down year on year because of the mortgage environment and expenses are drifting higher because of the high growth. But you expect the top line to offset, if not more than offset those two other items?

Gary Small -- President and Director

We do.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Got it. And then just last for me and I'll step back. Just on capital, obviously, there's a few dynamics ongoing. You had a huge -- you added $0.5 billion on the balance sheet.

The TCE at 7.3 here. My guess is you guys are anticipating that to kind of increase going forward potentially, particularly once you realize the full earnings benefit of all the growth you put on this quarter. But just any thoughts around that capital level, near-term expectations and where you'd like to get back to over time?

Gary Small -- President and Director

Well, Mike, before the whole AOCI issue kind of reared its head, we were sitting in the high 9s, and we really wanted to get down to a nine-ish, 9.25 kind of number. So just we always felt we were a bit over capitalized. Certainly, the second quarter growth, we didn't sit down and plan out a $500 or $500 million move in that quarter. But over the course of a longer period of time is something that we can easily absorb.

The current ratio that we're running at, we're fine with. We're not trying to make any adjustments to that or making any change in plans to our business. We have enough regulatory capital to continue to move. And as you said, we're going to earn our way back into excess capital.

It may not be visible until AOCI kind of works its way out over time. But we still have that same high-quality problem of what to do with all the capital, the stacks up. But in the near term, we'll let to replenish what AOCI has taken away. Again, the movement to the rest of this week and that we expect to see in September, we'll do nothing to help us on the AOCI front.

So I think there's still a negative chapter to be written there before we turn around and start to go in the other direction and earnings will be the only contributor going in the near term.

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Helpful. Thank you, guys. Appreciate the color.

Operator

Thank you for your question. Our next question comes from Scott Siefers at Piper Sandler. Please go ahead. Your line is open.

Scott Siefers -- Piper Sandler -- Analyst

Good morning, guys. Thanks for taking the questions. Paul, I was hoping you might be able to speak kind of more specifically about the NII trajectory from this quarter's roughly $59.5 million. Presumably, it goes a lot higher, and I know you guys had talked about it, NII and the margin expanding from here.

But just asking, just given the number of moving parts and because you've got this sort of odd dynamic of it. You had such awesome loan growth that cost $6 million in the provision, but NII was only up $1 million, right? So presumably you haven't gotten any of the or very much of the NII benefit of that stuff. So just curious on your thoughts on order of magnitude of NII acceleration.

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Yeah, yeah. No, you're exactly right there, Scott. So the growth came throughout the quarter, especially toward the end of the quarter there. And like I mentioned earlier, our ending balances were starting 3Q, $300 million higher any balance versus 2Q average balances.

So you'll see the full quarter impact of that here in 3Q as well as on the rates front, right, with the movements that happened during the quarter we'll get full year benefit -- sorry, full quarter benefit here in 3Q, and then we'll get some partial benefits from whatever happens today, primarily with the September meeting, probably not really going to impact much by the time that hits. So you're right. So NII will continue to increase. We'll see -- we should see a big spike here in 3Q and then 4Q, I guess we'll talk about that in three months, but we'll see how loan growth happens here during the quarter as well as what the actual Fed movements may be.

But you're definitely going to see us getting into the 60s, mid-60s during 3Q or into 4Q there for that growth pattern.

Gary Small -- President and Director

The rough math feels like if there's $300 million in difference between the starting point and you just took that at 350 basis points, it's like $10 million difference between the end of period cap versus the averages increase.

Scott Siefers -- Piper Sandler -- Analyst

Yes, perfect. And then maybe Paul, can you sort of update us with where you are on rate sensitivity at this point just given any changes that all that growth might have gotten you because it sounds like betas aren't really a concern right now. But just given what you put on any changes to your rate sensitivity, vis-a-vis, 90 days ago?

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Nothing significant. No, we're consistent. It came in a little bit just percentage-wise probably from not bigger numbers. But our most recent analysis, I think we've talked about it in this context before is the 100 basis point shock analysis, I think we were $15 million or $17 million before we're at $19 million annualized impact from that.

So we continue to go up. We added a good amount of C&I variable rate loan kind of stuff during the quarter, and all of our portfolio is over floors essentially for what was there. So now we're getting full benefits across the board. The Fed keeps moving as LIBOR moves, etc., that is helping to lift that portfolio.

And obviously, we've been increasing our rack rates for new loan originations. Those are going on in the mid-5s, roughly plus/minus on the type. So that continues to go up. We're still asset sensitive.

As we've talked about in the past, we don't want to be too far out on the asset sensitivity range. So we try and manage that not neutral, but leaning toward the asset sensitivity. So it's still fairly consistent with where it was previously.

Scott Siefers -- Piper Sandler -- Analyst

OK. Perfect. And then I guess final question, just so I'm clear, presumably, all the heavy lifting on the provision was done in the second quarter. And I would imagine we revert back down to something meaningfully below this, all else equal going forward.

So it's something in like that $1 million to $2 million range a quarter. I mean, that's a fair presumption.

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Yeah. Yeah, that's fair presumption. And as Gary described, we're looking at about 2% to 3% growth here in the back half of the year. So you take that against our current provision level of the 1.14%, 1.20% level, and that can kind of get you there.

But you're exactly right, it's in the 1% to 2% depending on actual loan growth.

Scott Siefers -- Piper Sandler -- Analyst

OK, perfect. Thank you, guys. Appreciate the color.

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Thanks, Scott.

Operator

[Operator instructions] Our next question comes from Christopher Marinac at Janney Montgomery Scott. Please go ahead. Your line is open.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Hey. Thanks. Good morning. Can you talk about new deposit gathering in the next couple of quarters? I know how you think about that as you manage liquidity and kind of access to liquidity on the balance sheet.

Gary Small -- President and Director

I'll take this. It's Gary. I'll make the first comment, and Paul, feel free to join in. As I mentioned, we didn't plan on a $500 million jump in one quarter.

So as that was happening, we got started a little bit earlier perhaps versus our peers on thinking about what we want to do and when we want to start to affect our core deposit repricing to go out and take new money in. Our first move though, was on the commercial side and on the public fund side. And the initial larger dollar movements that we'll see and have seen and we'll see in the first half of this quarter or in that space. So a little bit more expensive than our run rate to be sure, but preferable to the Federal Home Loan Bank.

And we'll be diligent but cautious as to how we reprice our consumer book. We'd still like to solve our funding situation relative to the balance sheet growth and keeping check the betas on our consumer deposit situation. But we do expect to grow that book to solve the issue. We haven't seen in the marketplace any unusual movement relative to promotional dollars or so forth.

There's across our markets, either with the demand or the way the balance sheets are built, there's just no impetus right now in the marketplace to raise consumer deposits in any meaningful way.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Great. That's helpful. And I guess just a quick follow-up. Does the STAR Ohio fund create any competition for you? I mean you've worked with that for years.

So I don't know if there's anything different about this environment than in the past.

Gary Small -- President and Director

No, it doesn't really. We have a few clients where we kind of we have a product set up that mirrors at a percentage of the whole movement relative to STAR Ohio. So when appropriate, we have a product that we can use to be right in step with that. But our primary product obviously is to target more traditional pricing and noninterest-bearing deposits and so forth, but no change.

Christopher Marinac -- Janney Montgomery Scott -- Analyst

Sounds good, Gary. Thank you for answering that, and thanks for all the information this morning.

Gary Small -- President and Director

Thank you.

Operator

Thank you very much, Chris, for your question. This concludes our Q&A session. I'd now like to pass back over to Gary Small for any final remarks.

Gary Small -- President and Director

Well, I want to thank you all again for joining us. I know it's a busy time and earnings season. We really feel like we have an outstanding story for the quarter. The provision issue that pops up adds a little confusion to the numbers from a high level.

But I think when you peel it back, it's a little bit more adjustable and understandable, and you can feel the momentum of the business going forward. And I thank you for your support and your interest and look forward to talking to you next quarter. Bye bye.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Paul Nungester -- Executive Vice President, Chief Financial Officer, and Investor Relations

Gary Small -- President and Director

Matt Garrity -- Executive Vice President, Chief Lending Officer, and Head of Residential Lending

Mike Perito -- Keefe, Bruyette and Woods -- Analyst

Scott Siefers -- Piper Sandler -- Analyst

Christopher Marinac -- Janney Montgomery Scott -- Analyst

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