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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by. Welcome to the WSFS Financial Corporation Third Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. [Operator Instructions]
I would now like to introduce your host for today’s conference call, Mr. Dominic Canuso, Chief Financial Officer. Sir, you may begin.
Thank you, Kevin, and thanks to all of you for taking the time to participate on our call today. With me on this call are Rodger Levenson, Chairman, President and CEO; Art Bacci, Chief Wealth Officer; Steve Clark, Chief Commercial Banking Officer; and Rick Wright, Chief Retail Banking Officer.
Before Rodger begins with his remarks, I would like to read our Safe Harbor statement. Our discussion today will include information about our management’s view of our future expectations, plans and prospects that constitute forward-looking statements. Actual results may differ materially from historical results or those indicated by these forward-looking statements due to the risks and uncertainties, including but not limited to, the risk factors included in our annual report on Form 10-K and our most recent quarterly reports on Form 10-Q as well as other documents we periodically file with the Securities and Exchange Commission.
All comments made during today’s call are subject to the Safe Harbor statement. With that read, I’ll turn the discussion over to Rodger Levenson.
Thanks, Dominic, and thanks to everyone, for joining us on the call. WSFS had a very solid third quarter, reporting earnings per share of $1.01, return on assets of 1.49% and return on tangible common equity of 16.61%.
As detailed in the release and earnings supplement posted on the Investor Relations section of our company website, this performance was a direct result of our diversified business model and the incredible dedication of our over 1,800 highly engaged associates who have responded admirably to the challenges of the pandemic and related economic recovery.
Core pre-provision net revenue of $68 million represented a 7% increase over the prior quarter and translated into a very healthy 1.98% of assets. A highlight was our core fee income, which grew 13% on a linked quarter basis, driven by strong performance in our mortgage and wealth businesses. This fee income growth occurred even with the impact of Durbin, which became effective on July 1.
As outlined in the supplement on Slide 6, our fee income is very well diversified and provides earning stability and capacity through interest rate cycles.
Loan and deposit growth reflected the current economic environment. Deposit growth was of particular note even when excluding regular seasonal municipal deposit levels. Our net interest margin of 3.66% contracted 27 basis points in the quarter primarily as a result of excess liquidity related to these high levels of customer deposits and lower purchase loan accretion.
Core expenses were flat on both the linked quarter and year-over-year basis. The core efficiency ratio was 57.1%. While we remain focused on disciplined expense management, we continue to make significant investments in our franchise, including our delivery transformation and talent acquisition throughout the organization.
Overall credit trends remain stable. Loan modifications declined significantly during the quarter and currently stands at 3% of overall loans. Delinquencies, nonperformers and charge-offs remain at low levels. As a result of the completion of our targeted portfolio reviews started in the second quarter, total problem assets, which include all criticized, classified, and nonperforming loans increased to 49% of Tier 1 capital plus ACL.
Just over half of the problem loans are in the hotel, retail, retail real estate and food service portfolios, which have seen the biggest impact of the pandemic.
ACL coverage of 2.74% excluding PPP was flat to the second quarter and stands at 3.22% when including the remaining credit mark on our acquired portfolios. The provision in the quarter reflected relatively consistent economic forecasts versus prior quarter expectations and overall stable portfolio performance.
The risk rating migration in the quarter was primarily incorporated into our second quarter provisioning. Future loss content will be dependent upon the path of the economic recovery and potential additional stimulus.
Despite a very strong capital position, we prudently suspended share repurchases in the second quarter due to the significant uncertainty at the onset of the pandemic. With improved visibility into the near-term operating environment, solid operating performance and significant capital and ACL levels, the Board approved the resumption of share repurchases in the fourth quarter.
At current trading ranges, the IRR on share repurchases is very compelling. And we therefore intend to be aggressive buyers of our stock.
Looking ahead, in the fourth quarter, we see a modest decline in core pre-provision net revenue based upon anticipated lower purchase loan accretion, a seasonal decline in mortgage revenue and continued franchise investment. This outlook envisions a continuation of the current economic recovery and 20% of PPP loan forgiveness.
As has been our recent practice, we will provide our outlook on 2020 when we announce our fourth quarter results in January.
In conclusion, while the macro longer-term outlook will be determined by the length and path of the economic recovery, our entire company remains focused and energized on realizing the growth opportunity in front of us as the largest locally headquartered bank in the Philadelphia and Delaware Valley region.
Thank you. I will now turn it over to Dominic to facilitate Q&A.
Thanks, Rodger. Kevin, if you can open the line for questions.
[Operator Instructions] First question comes from Frank Schiraldi with Piper Sandler.
Good afternoon.
Good afternoon, Frank.
Hey, Rodger, I just want to follow up on your comments on the buyback. You certainly used the word aggressive. And, if I look at your presentation, you guys talk about close to $500 million in excess capital that you either have on the books or you’re going to generate over the next 5 quarters.
And, I guess, acquisition seems kind of unlikely. I would imagine net growth is as difficult as given the rundown in the beneficial portfolio. So is buybacks at this point the primary use of capital? And $500 million in excess capital, I guess, would be even greater than that 15% buyback that you have outstanding here.
Yeah. So, Frank, maybe a little bit of high-level context, I think certainly right now buybacks is one of the primary uses of capital. We feel, as we said in the second quarter, very well reserved for the economic environment and the potential losses that could occur with that. So we don’t see that certainly based on everything that’s going on now.
But I do think there is continued uncertainty out there about the path of the recovery. And so, optionality on that front, as well as optionality for opportunities is also part of the thought process on the capital deployment. Clearly, we just approved the 15%. But when we put the share – with the share repurchase suspension in place in the second quarter that gives us a fair bit of headroom here over the next several quarters, but it will be a continual process of evaluating all those factors in terms of other opportunities that might present themselves.
And then, just a follow up if I could on the migration into problem assets in the quarter. I know, if you look at the presentation, certainly you break out pieces like restaurant, retail and then go back to last quarter, I guess, and then pull out where the migration was this quarter specifically in those categories.
I think the hotel stuff had already been completed, if I recall in 2Q. So just wondering if you could maybe talk about what the greatest driver within those portfolios, and then maybe if there was a driver outside of those portfolios of the migration in the quarter.
Sure. Thanks, Frank. Steve, do you want to talk about the process that we entailed during the third quarter and where that left the metrics?
Sure, I’d be happy to. Hello, Frank. So, yeah, the third quarter was really a continuation of what we had started in the second quarter. And, Frank, you’re correct, we did complete a risk rating review of 100% of the hotel book in the second quarter. And we were about halfway through the risk-rating review for the other high-risk kind of categories.
So we had completed about 50% of the review in CRE retail, almost 40% of the review on retail trade, and about 50% of the restaurant. And again, as a reminder, these were categories we had coded red and yellow. So that review was completed in full in the third quarter. And the migration really was consistent with our expectation. The migration, predominantly about half of it, $100 million was CRE, in those high-risk categories.
And the balance was really spread across all different categories of C&I, owner-occupied with real no significant concentration in those categories.
Okay, got you. And then, is the review of those targeted categories is complete? Is there further, I mean, I guess, there’s always – you’re always looking at the loan book – but is there still a piece of that review to be completed? And then, does the provisioning that you took in the second quarter already incorporate additional risk-rating migration that we could see in 4Q or future periods?
Yes, I’ll let Dominic kind of answer the second part of your question. But the first part of your question, yes, we have completed 100% of the review of the red and yellow coded borrowers and industries. So that represents a tick over $3 billion of our commercial book. So that review is done.
Now, as you recall, we do have just our normal process. We sit quarterly with all of our RMs and credit teams, and review every RM’s portfolio on a quarterly basis. So something may fall out of those quarterly reviews positively or negatively. But in terms of the targeted review, we have 100% completed that.
Again, just to build on that, I think as we discussed after the second quarter, both the process in which Steve and the credit team took with regard to loan reviews and with our CECL ACL build, we took a very conservative view, with the objective under the CECL model to capture as much as the credit and economic impacts in the future onto the balance sheet at the end of the second quarter we had. As Steve said, we were at the end of that quarter with regard to the targeted processes, and we took that in consideration through qualitative adjustment factors such that with the review completed and the migration that occurred, though, resulted in meaningful change in our ACL coverage ratios.
Okay. All right. Thank you.
Thanks, Frank.
Our next question comes from Michael Brito with KBW.
Hey, good afternoon, guys. Thanks for taking my question.
Hey, Mike.
Hi, Michael.
I want to start on the fee income side, obviously, a really strong quarter of the investment management and mortgage verticals here. But curious, if you could maybe try and just conceptually break out a little bit how much of this was kind of COVID-related? How much of this was some of the hiring and efforts you guys have been making to grow out the fee products in Philadelphia and building on that. What’s kind of the outlook for fee growth as we kind of get towards 2021 at this point, given some of the strong trends you’re seeing today?
Sure, Michael. This is Dominic. I’ll start with that. As you see on Slide 6 on our Investor Relations material, we did see a nice step up in the third quarter across really many of our fee categories. And then, in particular, offset the onset of the Durbin Amendment, which clearly was an impact to our banking fees. So we were pleased with the overall growth from that perspective. And I think you clearly see in mortgage invest an industry wide event, I think, 2 things are happening.
One, the lower interest rate environment driving significant volumes, and then the attractiveness in the secondary market for these assets are driving the pipeline valuation a little bit higher. I think with rates staying lower, this could continue, we do see the third quarter is definitely a higher mark, and we would expect in the fourth quarter typical seasonality of lower volumes to result. I think Cash Connect, we definitely saw some nice step up, but this was a little bit of a catch up in volumes associated with coming out and reopening from of the economies nationwide as that business serves, really all 50 states.
And then wealth and trust combination of both improved AUM, the equity markets, but also a good amount of continued volume on in the trust business. So we do see the fourth quarter being lower a bit, given the outsized performance in mortgage and a little bit in Cash Connect. I think the long-term prospects, and while we provide more information regarding 2021 specifically with our fourth quarter results. In January, we continue to see the opportunity to grow both our local and national businesses at high-single-digits and low double-digits for the foreseeable future.
We’ve talked about since the combination with beneficial, the opportunity to invest in a lot of these fee based areas to further penetrate into the newer markets of the Greater Philadelphia region and we see that opportunity to continue to be there. And in fact, is providing some of the benefits we’re seeing, particularly in the mortgage business.
Okay, Dominic. Thank you. And then just [indiscernible] to clarify on the investment management side was – I know, it can move from quarter-to-quarter, but was there anything particularly elevated in there that we should be mindful of as we kind of roll our forecast forward here?
Art, did you want to talk about that?
Yeah. Michael, could you repeat your question? You came in a little blurry for me.
I’m sorry. I was just curious, the $13.3 million in investment management to share revenue, obviously, was there – I know, it can change from quarter-to-quarter. But was there anything particularly elevated in that figure that that we should be mindful of as we roll our forecast forward?
I got really it was spread across all of our businesses had a strong third quarter, the institutional trust business benefited from some bankruptcy work that increased and, obviously, we expect that to kind of continue to grow into next year, it might slow down in the fourth quarter, just seasonally.
The corporate trust business issuance of mortgage-backed securities remained very strong. We kind of predict a pretty good fourth quarter in terms of personal trust, and then the advisory businesses, so good AUM growth, and we ended the third quarter with AUM up 2%, and we usually bill in arrears. So I would expect fee income in the fourth quarter to generally, assuming all else equal, be in line with the AUM growth that we saw at the end of the third quarter.
Great, helpful. Thanks. And then just switching to the expense side of the equation, I mean, obviously, you guys continue to make investments, as you alluded to Rodger. But, I think, as the digital delivery transformation advances, it would seem to me that that there might be opportunities elsewhere to kind of gain efficiencies and reduce costs. And then just I think you guys alluded to something of that nature on the second quarter earnings call, just curious, how that process has been going and how far along you guys are on kind of reviewing your cost structure as we approach your end here?
Sure, Mike, I’ll take that. I think it’s important to remind everyone that the journey we’ve been on since the combination with beneficial over the last year and a half. As part of that acquisition, we made 2 specific efforts with regard to cost synergies, 1 in branch consolidation. We took a big step with our branch footprint with the combination where we close 25% of our branches or 30 branches. And to clarify, about one-third of that was actually your typical proximity based branch closures, where you look at coverage within 3 miles and merge those branch locations.
But the other 20 branches that we closed are about 18% of the remaining branches, were truly efficiencies. So we took that opportunity to get ahead of what we saw as the continued trend and lower transaction count and our ability to serve our customers through that remaining footprint and our digital platforms. So for us, we were a bit ahead of the curve before COVID, and we feel comfortable with where we are, however, we continue to evaluate that as digital adoption continues. As part of that, not only was it the real estate costs, but lower FTE count associated with those lower branches.
We are evaluating our non-retail office footprint, including our real estate cost IPOs and training centers, and are evaluating what – a post-COVID environment would look like and to the extent we have opportunities within that footprint. But we feel like the cost base we have today is very appropriate for us to deliver the high touch customer service we do with our high fee income and our relationship based lending model.
The 57% efficiency ratio we feel is really compelling given the low interest rate environment we are at and we’re very focused on now executing on the investments particularly in delivery transformation, and the continued fee opportunities that we see out of this.
Helpful. Thanks for taking my questions, guys.
Thanks, Mike.
Our next question comes from Brody Preston with Stephens Inc.
Hey, good afternoon, everyone.
Hey, Brody.
Hi, Brody.
So I just wanted to circle back on the buyback. Rodger, I just wanted to confirm, is there – where there – are there any conversations, I guess, maybe your – I guess, approvals that need to be add from the Fed or any regulators before you could just resume repurchasing?
So, we consult with our regulators on any significant actions that we’re taking, whether its capital related or other things. So that’s part of the normal process for us. And so, we were in conversation with them, and obviously again these conversations went well, and we’re moving forward.
Okay. Okay. Thank you for that. So, I guess, just tying that to the capital slide that you all put in there, as you noted, and Frank mentioned earlier, really strong excess capital position. But the – I guess, the ACL scenario that you have outlined in there it’s 30 basis points. Now, as of the second quarter, you had, I think is $10.2 billion in risk weighted assets that implies $30 million to $35 million, I guess, in losses in a severe adverse scenario, which is, I mean, you guys make 2 times that in quarterly PPNR in any given quarter. So is there any reason for us to assume that you would not be aggressive on the buyback in the fourth quarter and beyond that?
So, I’ll start now, and Dominic, please chime in. So in the near-term, there’s nothing that we could see that would prevent us from being aggressive. One of the – I should have said this is part of the initial response to Frank. But one of the things and the reasons that we like buybacks, as a way of returning capital to our shareholders, is it’s optionality. It gives us the option at any time to respond to opportunities or challenges and re-divert that capital to address those situations. I think, Frank said it well, nothing when that front is obvious right now, so buybacks is where we’re headed. But it’s always subject to change based on circumstances and things that can play out in the future.
Sitting here today there’s nothing in the near-term that would steer us away from being aggressive on buybacks just obviously give it a caveat. A lot of this is very dependent upon the external macro environment and how that all plays out. But what’s sitting here today, we feel very confident in being aggressive in the near-term.
Okay. Just flipping back to the trust business, real quick. I wanted to ask, is there a – I guess, a tax arm within that that helps people with their taxes at all, and this show could that become a tailwind if we get another change in the tax code under a potential Biden presidency?
Art, would you like to take that?
Sure. I’ll take that. Brody, we definitely see that opportunity, generally the fourth quarter for us is one of our more active quarters on the personal trust side, and we are already seeing in September and October an elevated level of volume with people setting up marital trust, in anticipation of higher tax rates going forward. So that’s certainly an element of our planning.
Okay, great. Thank you for that. And then, Dominic, on Cash Connect, I think last quarter, we talked about bottoming on net revenue with the rates going to zero, and then moving higher from there with growth, which was good to see this quarter. So just wanted to get a sense for how the growth outlook for new ATMs and smart safe looks and also wanted to ask if there was any potential for gaining wallet share with existing clients in the Cash Connect business?
Sure. Great question. What I’d say is, we – to reiterate what we saw this year in this unique environment was the resiliency of both cash in our economy along with Cash Connects’ ability to serve through various cycles. And we definitely saw the rebound play out in the third quarter, not only bringing more units back online, but supporting our ISO customers and filling their ATMs, and then reengaging on the smart safe program. We absolutely see the same growth trajectory in the future, as we’ve seen in the recent past, in fact, this year alone during this COVID environment, we see opportunity to grow our unit served around 7%, which is a nice growth rate considering we serve a lot of retail and location-based services.
We also do look to deepen our relationship with our existing ISO customers, just with the volume of cash, but with increased services, as you know, we provide our armored carrier services along with insurance, reconciliation and optimization, so non-asset based fee services that continues to improve our performance margins and on our way, and then, we will continue to look for that further penetration within those customers, and then diversify as well.
Okay. Thank you very much for that. And the last one for me, I just wanted to get a sense for how much was left in deposit and borrowing related accretable yield?
The accretable yield on the deposits?
Yeah, just from the…
…or just loan accretion in general?
Yeah, just wanted to get a sense for – of the total accretable yield, if there was any still left from the beneficial related CDs and borrowings?
Yeah, I have to follow-up with you on this specific amount, most of them were short tenured accretion. So we can follow up offline with that, but we continue to have a purchase loan accretion portfolio, just under $90 million, both on the yield and credit side, which creates that a long dated tail to the purchase loan accretion impact to our net interest margin.
Okay, that’s fair enough. But it sounds like it’s mostly related to the loan portfolio at this point, and so just for calculating a core loan that would be safe to back the majority out of there?
That’s correct.
Right. Thank you very much, Dominic. I appreciate the time, everyone.
Sure. Thanks, Brody.
Thank you.
[Operator Instructions] Our next question comes from Russell Gunther with D. A. Davidson.
Hey, good afternoon, guys.
Hey, Russell.
Hi, Russell.
Just quick follow up on the extended line of conversation. I believe in the comments around the PPNR guide for next quarter. You mentioned continued franchise investment been running just shy of -- kind of $91 million on a core expense basis in the last couple of quarters. Get your thoughts on the sustainability of that and where that is likely to head in the fourth quarter. And then, Dominic, in the follow up you mentioned the 57% efficiency is as a good place to be in a zero-rate environment
Can you talk about your ability to improve upon that as we look into 2021? Or at least commit to kind of holding it where it is?
Sure. So first on the non-interest expense, we have been in the low-90s close to $90 million for the last few quarters. We do expect that to increase and that’s part of the step-down from the third quarter and fourth quarter core PPNR ex-PPP.
But that increase in cost base is primarily the continued investment in delivery transformation and supporting the growth in our fee businesses. So it may step up a couple percentage points in the fourth quarter. And then, as we mentioned earlier with regard to 2021, we’ll provide a more comprehensive discussion on our outlook, once we complete our plan for next year.
Clearly, there’s a lot in play with regard to the economic environment and banking environment. But most importantly, we continue to see the opportunity ahead of us, as Rodger mentioned, as the largest locally headquartered bank in the Greater Philadelphia region and in state of Delaware. And we see the opportunities from those business cases that we’ve been talking about for the last few years to be there and we’ll continue to make those investments.
Got it. And I appreciate the near-term thoughts. I guess, just with the ability to kind of harvest the franchise investment that’s already been made, on the top-line, do you think you can, again, at least commit to holding that 57% efficiency ratio, if not improve upon it?
Yeah, so, I think typically as we’ve said before, we do focus on efficiency ratio. We’re pleased with the results for the third quarter. And when we do look forward in our investment base, we look for positive operating leverage. However, what I will say is we also have demonstrated our ability to accelerate investments when we see opportunities, particularly when there’s disruption in the economy or in our markets.
And that could affect the near-term shape of that. But it would all be revenue generating investments that may just have somewhat periodic lag. So we are evaluating all those opportunities. So as I mentioned, it’s a bit early to commit to kind of that near-term expectation, but I think you could see in our track-record and our historical expense management discipline that we do typically manage to positive operating leverage, except when we see those opportunity for accelerating growth investments.
Understood, okay. Yeah. Thanks for the follow-up. And then, just switching gears on to the organic growth outlook, we’re able to show a little bit of positive momentum on the core portfolio. I guess, one, if you could just address where you’d expect C&I to pick back up or if that’s to remain a headwind going forward; and then beyond that, the remainder of the core portfolio, if there’s opportunity to sustain positive growth in the near-term.
Sure. Steve, do you want to take that?
Sure, Dominic. Yeah, regarding commercial growth opportunity, we still see almost weekly opportunity in CRE, multifamily, residential land and land development, residential construction, and a little bit of kind of neighborhood retail. Looking at all that through a pretty, call it the COVID lens. The C&I side still is, I would say, headwind, and not a lot of investment going on by our borrowers.
So any opportunity, it’s really kind of market share opportunities. But we are seeing instances where PPP loans, which have not yet been forgiven, are precluding companies from transferring banks. So I think C&I in the short term will still be very, very muted in terms of growth.
Okay, great. Thanks for taking my questions, guys.
Thank you, Russell.
Thank you. With no further questions in the queue, I’d like to turn the conference back over to Rodger Levenson.
Thank you again, everybody. We will be attending a couple of investor conferences in the coming weeks and look forward to seeing many of you soon. As always, if there’s any follow-up questions please feel free to contact any of us directly. Have a nice weekend. And thank you again for your interest in WSFS.
Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.