First Connecticut Bancorp's (FBNK) CEO John Patrick on Q1 2016 Results - Earnings Call Transcript

| About: First Connecticut (FBNK)

First Connecticut Bancorp, Inc. (NASDAQ:FBNK)

Q1 2016 Earnings Conference Call

April 21, 2016 10:30 AM ET

Executives

Jennifer Daukas - Investor Relations Officer

John Patrick - Chairman, President and Chief Executive Officer

Gregory White - Executive Vice President, Chief Financial Officer and Treasurer

Michael Schweighoffer - Executive Vice President and Chief Lending Officer

Analysts

Travis Lan - Keefe Bruyette & Woods, Inc.

Matthew Breeze - Piper Jaffray

Laurie Hunsicker - Compass Point Research & Trading LLC

Operator

Good morning and welcome to the First Connecticut Bancorp, Inc. First Quarter 2016 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I’d now like to turn the conference over to Jennifer Daukas. Please go ahead.

Jennifer Daukas

Thank you. Good morning, everyone. I’m the Investor Relations Officer for the company. Before we begin our presentation, we’d like to remind you to read our Safe Harbor advisement and the forward-looking statements on our earnings announcements. Forward-looking statements by their nature are subject to risks and uncertainties. Certain factors could cause actual results to differ materially from expected results. Our comments today are intended to qualify for the Safe Harbor afforded by that advisement.

Thank you. And now here is John Patrick, our Chairman, President and CEO.

John Patrick

Thanks, Jennifer. Good morning, everyone, and thank you for joining us on our call today. We’re pleased with our first quarter results this year, and then I just want to touch on a couple of key bullets and then I’ll turn it over to Greg for some color, and we know, you’ve got a busy day. And so, we’ll get your questions underway. Again, pleased with where we are with the quarter considering the operating environment that our financial institutions are operating under today.

I think you can see from the quarter on an ongoing basis for a period of time, we’ve been talking about the scalability of our company. And I think it’s demonstrated in our year-over-year growth, but also over a longer period of time, where our operating expenses have continued to come down nicely, as it relates to overall and efficiency ratio pickup and improvement a little bit, but operational expenses to overall assets.

And then relating to that, the reason that that continues to happen. And when I take a look at, year-over-year FTE, we kind of remain very, very flat over the last many, many quarters and year-over-year. We’re flat, even though, we’re adding new offices and we’re adding capabilities within the organization relative to risk management compliance and BSA. The operational efficiency is really coming from our employees who we’ve engaged to help us become better at what we do and try to reduce processes and procedures within the organization and really engage them to be decision-makers within our company.

Although we had in the fourth quarter – late in the fourth quarter and interest rate hike, we don’t – we’re not predicting future – what the future is going to hold relative to interest rates. But I will tell you that, we’ve worked hard to be an asset-sensitive company. We’re going to continue to remain to be asset-sensitive. It’s kind of up in the air. Everybody has got their own opinion upon where rates are going to go. We believe in building long-term tangible book value. And that to change our strategy now, where we work so diligently to remain asset-sensitive kind of doesn’t make sense to us. We’re going to continue to put on the road we’ve been on.

The – during the quarter from a capital deployment perspective, we’ve always felt that our best deployment of capital and return on capital was to grow our loan portfolio. But we say, if we weren’t going to grow our loan portfolio, it’s aggressively and prudently as we did before that we are going to use capital in the other two levers that we had in both by using buy backs and share dividend.

So during the quarter, while loan growth was relatively flat, year-over-year we had some growth. But we also use share buy backs very, very prudently, as we have historically, as well as increased our dividend in the quarter.

And lastly, I want to touch upon what we’re seeing from a loan growth perspective and might add some more color a little bit later is that, it’s just not rates that kind of restricting some of the loan growth. We talked to investors and analysts probably in June or July of last year and said, we would anticipate that. A, number one, our loan growth is going to slowdown more importantly because of slippage in credit standards, and we’re certainly seeing that right now. Pricing is one thing, but credit standards are certainly being stretched, and that’s the main – one of the main drivers of that.

So, again, as I made comments in our press release, we’re not going to give up the hard work that we’ve done in building a good book of clean assets in the asset quality that we have to chase just revenue and loans. And I think a classic example of that is, we have some pretty sophisticated real estate developers in our portfolio. They have properties throughout the Northeast in Connecticut, and they’re getting offers on some of these properties that they can’t refuse.

So when you see prepayment activities and you see low, very, very low cap rates in terms of being extended, I think it’s time and it is indicative of a cycle coming, maybe won’t be a deep cycle, but one that we’re taking extreme caution and utilizing a lot of prudence around so.

The – and then lastly also just as it relates to that in – the first quarter is historically coming out of the holiday season. It’s typically slow in mortgage banking, slower in mortgage banking. And I think that we saw that in our C&I business, where we do some lending on warehouse lines and those were off about $16 million, I think, it was from the fourth quarter to first quarter, but the pipeline is rebuilding and those are rebuilding nicely.

So we still are on track for what we believe is a good loan growth this year. We’ve indicated, we’re looking to have $150 million in loan growth or $175 million in deposit growth, and we’re on track for that. And we’re very, very pleased with our progress in Western Massachusetts. Our two branches have an excess of $80 million in deposits today or at the end of the quarter, and that doesn’t include any type of municipal business, we’re just growing that business up in that marketplace.

So that’s net of any municipal, that’s good core transaction. So the retail group is doing a great job of continuing to grow the bank and grow their franchise. And we hope to have our Vernon, Connecticut branch open in the third quarter of this year.

With that, I’ll turn it over to Greg and then we’ll go from there.

Gregory White

Thanks, John. Good morning, and I agree with John, we had a really good quarter. It kind of speaks for itself and that there’s really no material non-core items to be explained or discussed. So very clean representative quarter in that respect.

John kind of touched upon the below trend loan growth for Q1. Correspondingly, our provision expense was lower than what is typical for us. So that did help the quarter a little bit there. Other than that, I’ll just touch upon margin, which as expected, it did go up, it went up by 6 basis points versus the prior quarter.

I will mention that the vast majority of the benefit from the Fed tightening in December, probably 95% of that benefit is in the quarter one margin. So if interest rates stay here, I would expect that loan yields would grind a little bit lower, and that’s mainly because our origination yields for the most part are below our portfolio yields at this point.

So, again, good quarter, and I’ll turn it back to your John.

John Patrick

Great. I’m fine Jennifer, if we want to open up for questions, we’d be happy to do so.

Jennifer Daukas

Okay, operator, we’re ready for questions.

Question-and-Answer Session

Operator

We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Travis Lan of KBW. Go ahead.

Travis Lan

Yes, thanks. Good morning, everyone.

John Patrick

Good morning, Travis.

Gregory White

Good morning, Travis.

Travis Lan

We’ve seen recently some, I guess, some weaker economic commentary coming out of Connecticut. I know you talked a lot about the competitive pressures in the lending environment. But just from a broader economic outlook perspective, does that kind of in line with what you’re seeing and have those local challenges kind of impacted your business at all?

John Patrick

I wouldn’t say, it’s impacting our business a little bit. We have some very strong companies here that we bank with. This is nothing unique. I mean, it’s getting a lot of press right now, I think, Travis, because the rest of the country kind of rebounded nicely.

In Connecticut, and you can track it. The only time we went – we’re ahead of the country over the last 20 years within the – coming right before the crisis of – in the late 80s, early 90s. And so, we’ve always had slow economic growth and slower than the rest of the country. We have some truly physical issues and relative to pension and state obligations regarding pension. So we’ve got the legislature and the governor or both democratically – both democratically controlled kind of fighting it out between each other and it’s appearing in the press and it’s appearing in the press all over the news.

So there maybe some challenges whether relative to towns and cities. There maybe some – everybody is saying no increase in taxes, the governor is standing hard behind that. But where we see is, quite frankly, we deal with some manufacturers, distributors, wholesalers Connecticut, there’s a lot of exporting, and the strong dollar has reduced some of their sales and things like that. And so, that’s where we see overall the strength of the dollar and a slowdown in exports affecting some of the business more than what’s happening in the state legislature.

Travis Lan

Okay, interesting. That’s helpful. Just on the expense outlook, I mean, you guys have done a really good job, as you mentioned kind of keeping expenses flattish over the last year. So what’s the outlook from here? I mean, is there – are there places where you need to be investing, or do you think you can offset some of that and just kind of maintain some low single-digit expense growth?

John Patrick

I think we can try to maintain some low single-digit expense growth. I think that, we have liked our brand strategy. Our brand strategy isn’t just sticking them all over the place, we’ve been pretty successful with it. It’s the oxygen those deposits – is the oxygen that’s provided our loan growth, and we’re establishing and we continue to build the franchise. And when I talk about that, it’s really taking a look at the net new accounts on a quarterly basis.

And when you see net new account growth in approaching what we do every quarter, those customers aren’t even cross-sold yet. And so, I still think that it’s a good opportunity. But outside of that, we have focused and strategically since we have started to grow our company, built the foundation for a very, very, very strong risk management program. We’ve invested early in upfront for compliance in BSA and all things you need to have in place today, information, security, all the things you have to have in place today and we strive to be a regulatory best practice this company, and I believe we are.

So, I think, we’re well staffed in those areas, obviously, growth dictate some of that. But quite frankly, we’re not talking about adding high level positions, as we continue to growth. Even when we open branches today, you’re talking about three FTE. So it’s very manageable. And the approach that we’ve had and we’ve taken over the last year is a fact that the branch staff can do anything. So we don’t have it segregated relative to just duties there and all around banker, and that debt mile is working really well for us.

Travis Lan

Great, okay. And then last one, just on the outlook for reserve to loans, any kind of held in this mid-85 basis point range? Is there a point at which you need to begin to rebuild that ratio, or you comfortable with the credit outlook is here kind of maintain mid-80 basis points?

John Patrick

Right now I’m comfortable with where the credit outlook is. And I’ll let, Greg, talk a little bit more about that. But I’m comfortable with the credit outlook. I think our portfolio from a weighted-average risk rating perspective is continues to get stronger and has gotten stronger over time with the assets that we’ve added. But, I know what my gut tells me and I also would know what the accountants tell me. So, Greg?

Gregory White

Yes, I just add Travis that our credit performance is driving that down. It’s a challenge if we want to reverse that. We work with our accounts, but it is – our performance is driving that down, it’s a formula. And unless we change the formula, it’s – which we can tweak, but to make a programmatic change to what is not easy nor in theory, nor should we contemplate that. So, again, its credit performance that’s driving that lower.

Travis Lan

Okay. Thank you all very much.

John Patrick

Okay.

Operator

The next question comes from Matthew Breeze of Piper Jaffray. Please go ahead.

Matthew Breeze

Good morning, guys.

John Patrick

Hey, Matt.

Gregory White

HI, Matthew.

Matthew Breeze

Can we just talk about the current mix of loans being added to the balance sheet in terms of fixed rate and variable rate. And what are the two – the terms on those? I know just thinking about Greg, your commentary about the margin popping because of the Fed hike and in the past you’ve talked about perhaps managing the margin a bit more. So I just want to get a sense of what’s the mix of fixed and variable rate and the terms on those

Gregory White

Yes, our total loan book about 60% of that is variable, but obviously a loan repricing in five years is variable too also. But about half of that variable piece, so 30% of the loan book adjusts immediately. In our current trends like, for example, two-thirds of our pre-originations during the quarter, obviously, we had some payoffs, but two-thirds were swapped.

On the resi side, the same trends that you saw last year the vast majority of the growth has been coming in a high – in the hybrid book, that should continue as well. As John mentioned, we don’t want to give up our asset-sensitivity here. We think on the commercials – when you look at a swap, you’re basically taking a spread over the swap rate or a spread over LIBOR, and it’s the same spread, so let’s just call it 200. The fact LIBOR is up 25 basis points from four months ago and the 10-year is down 50 basis points.

We think the smart transaction is trying to take the spread over LIBOR here, because that curve has flattened 75 basis points lower for longer. We’ll see how long that last too. We’re not making rate forecasts here. We’re doing what we think is prudent economically drive balance sheet value as that swap up matures, if rate stay here, it accretes value every day, as it shortens.

Matthew Breeze

Right. So the message is majority of what’s being put on is still based on LIBOR?

Gregory White

Yes.

Matthew Breeze

And so long as the Fed doesn’t move, we will see continued loan yield deterioration?

Gregory White

That would be, yes. But, again, I’d look at LIBOR versus 10-year swap rate today. You’d pick up – you pick up a 100 basis points by taking the fixed end, LIBOR being 47, swap rates being 147, roughly.

Matthew Breeze

Right.

Gregory White

To me that’s not getting paid for interest rate risk. We think it’s a prudent thing to do, both short-term and especially long-term.

Matthew Breeze

Okay. So absent a rate hike, do you think the margin compression could be anything north of 2 or 3 basis points a quarter, or is even that too pessimistic?

Gregory White

That wouldn’t surprise me in the near quarters even if it exceeded the three. I mean a lot of that depends on our cost to funds, which – are you talking about asset yield compression?

Matthew Breeze

Total margin compression?

Gregory White

Yes, I almost need to bifurcate that. I mean, the asset yield compression, it could exceeded the 2 to 3 near-term. And as you know, we’ve had a history of offsetting that with volume. We would think we could do that, again, meeting our historic pattern, obviously Q1 was a low volume quarter for us.

Matthew Breeze

Right.

Gregory White

If we go back, as John mentioned, the pace of 150, I would think the volume should offset the compression that we see in asset yield and then kind of cost of funds, we’ve done a good job there as well.

Matthew Breeze

Right, okay. And then considering your loan growth guidance for $150 million, but there has been some more recent disruption in the Western Massachusetts markets from consolidation. Does that give you a more optimistic look on what you can achieve?

John Patrick

Yes, I think we can – we’re targeting that. So the key for us is, if we can grow deposits quicker than the 175, I think one of the other things I didn’t touch on earlier, I’m pleased with the reduction in our loan-to-deposit ratio. Again, we have prudent risk management controls around that process. And so what we’ve indicated is that, we wanted to make sure that, we brought that reduced that loan-to-deposit ratio.

And so, if we can grow deposits quicker – at a quicker pace and maybe growing deposits at a quicker pace, maybe the result of that consolidation in western Massachusetts, we’ll certainly take advantage of that. And then if we can do that, we’ll put those deposits to use from a loan perspective. So I do think we could have opportunity there. Matt, it’s a little too early to tell. Again, I know my gut tells me, I think, we will have some good opportunity down the road.

Matthew Breeze

Got it, okay. And then last just big picture, John, you mentioned some slippage in credit standards. And I know it’s always tough to say how, but you’ve been around long enough and are in the flow. What do you think some of the catalysts are that could cause slippage in credit standards to turn into deterioration in credit quality for some of your peers?

John Patrick

People believing in the low cap rates at the phrases are using today, I talked about on other calls and I talked about with investors, we actually stress test our cap rates, so we’re not hitting ourselves from a loan-to-value perspective. As I said, I’ve never foreclosed on a five cap building before. And so we use a 10% cap rate on our commercial real estate. We’re taking a look at it to get what we believe will be a true loan-to-value and stress – more of a stress situation.

Secondarily, I think and Mike can comment too, I’ll finish up by saying, guarantees dropped, limited guarantees going out 30 years, and we’re seeing some of the REITs coming back in. You’ve got to keep in mind, in this overall interest rate environment, the life insurance companies are really mismatched. And so we see them just getting back into the commercial real estate market and being much more competitor than they have been before. And I think we’re seeing some of that also in some of the buying.

So that’s what we’re seeing it. I mean, we have some competitors in our marketplace who have never been commercial lenders before, and then also they’re having 10% and more commercial loan growth. And quite frankly, I know, I’d be critical of them, but I do think, we have a good pool of talent that this is not their first rodeo we’ve been through a downturn before. And so we’re going to capitalize on that experience.

Greg and I talk about that all the time. I think that when you look at a company experience matters and living through these cycles, hopefully, we have learned our lessons before. We don’t want to go through that again.

Matthew Breeze

Got it. That’s all I had. Thanks, guys.

John Patrick

Thanks, Matt.

Gregory White

Thanks.

Operator

[Operator Instructions] Our next question comes from Laurie Hunsicker of Compass Point. Please go ahead.

Laurie Hunsicker

Hi, good morning. I’m just staying on credit, if you could give us an update on your commercial lending bankruptcy from last quarter, that would be great?

John Patrick

Mike, can you?

Michael Schweighoffer

Hi, Laurie, it’s Mike, Laurie.

Laurie Hunsicker

Hi, Mike.

Michael Schweighoffer

Yes, it continues to progress slowly – our geo balance is down to little over million bucks. On that we did take a total charge-off to-date of 445,000. We’ve got another, almost less than 150 reserve for that loan. But it’s progressing, I’ll call it slowly, slower than we would like or our lead bank would like, but that’s to be expected I think.

Laurie Hunsicker

Okay. And that’s on resolution this year?

Michael Schweighoffer

I would like to think so. I would hope so, but it’s hard to say right now.

Laurie Hunsicker

Okay.

Michael Schweighoffer

And the balance continues to come down, because we continue to receive payments albeit sporadically.

Laurie Hunsicker

Okay, great. And then just wondered, if you guys could touch on tax rate 26.5%, is that going to be a good number, I think I was at 28%, How should I think about tax rate?

Gregory White

Yes. Sorry, no, Laurie, and I obviously I mentioned the 28%. I still – 28% is probably the high-end of the range. But as the year goes on, I would expect to see that tax rate increase and end up in the 27% to 28% for the year, so the 26.4% was a little low. We had a little more tax exempt income that we – than we originally expected. But that should assuming our earnings grow, you’re going to see that tax rate increase as well.

Laurie Hunsicker

Okay, great.

Gregory White

Probably 27.5% is a reasonable target here.

Laurie Hunsicker

Okay, great. Okay, and then yes your loan-to-deposit, but seeing that come down, what is your goal on that? I mean 113 is obviously better than where you were, but how do you think about that?

John Patrick

We actually look at that more – we look at it a little differently than others. I think that we’re comfortable where we are and we love to bring that down a little bit, because I think that that maybe one thing that spooks a street a little bit.

But when we meet and talk with our regulators, they like our process around that. I cannot go too deeply into it, but we’re not getting beat over the head to bring it down. We just think its good prudent business practice, Laurie. And we would like to get it down to more normalistic levels and we’ll certainly look to do that. As I said before, we’d love to grow deposits quicker than loans and as long as we can do that that will bring that loan-to-deposit ratio down.

But if it was where it is right now at the end of the next quarter, I would not be dissatisfied at all, because we continue to grow. I think dependent upon where the pipelines continue to remain strong, where loan volume is I’m hoping that and in that Vernon is going to come out pretty strong that we’ll continue to see that slide, maybe not as much as we had it slide in the first quarter, but I think it will continue to come down.

Laurie Hunsicker

Okay, that’s great, and obviously your two Massachusetts branches sitting at $80 million, I’m just looking linked quarter at the breakdown in your deposits. I mean your percentage stayed the same so is it safe to assume that this wasn’t some city special that it was across every category that your $80 million came in?

John Patrick

Yes, we have a kind of a formula that we use every time we open the branch and I think that was – East Longmeadow was 12th or 13th one that we’ve opened. We use a same formula every time. The first branch that we opened, I think with Glastonbury, over $100 million in deposits sit now, or close to it and so that has worked very, very well for us and I would expect it to continue to do that. So you lead with a special and then we kind of work it from there. But our folks do a great job of cross-selling people.

And fortunately for us in some of the markets that we’ve chosen, A number one we’re again the people that work for us are known entities and we have a very good commercial contacts in those marketplaces or usually have a commercial business in those marketplaces before we open up a branch.

And I think that where we are in West Springfield and East Longmeadow is indicative of fact that that commercial team joined us probably a year before. We opened those two offices and a lot of that has been through their hard work also. So I’m happy with our recipe for success there we’ll continue as long as it is prudent.

We try to drive that ranch cost down every chance we can Ken Burns and his staff does a great job in driving that cost down and being able to open those branches. And quite frankly as I said before, we look at those as customer acquisition investments and marketing investments. I could put four billboards up for a year on a 91 and 84. It’s going to cost me the same as it is so in one of those branches. So I think this is a – more of a permanent billboard in the community and it works nicely for us.

Laurie Hunsicker

Okay, and then you’ve got Vernon is set for sometime in on about June and then you got another one coming on in September?

John Patrick

Yes, Manchester Connecticut right around in that timeframe, yes.

Laurie Hunsicker

Okay, and then is there anything else on the site at the moment?

John Patrick

Not right now.

Laurie Hunsicker

Okay, and then just going over the loans – your loan growth obviously was flat in the quarter, what is your pipeline looking like?

John Patrick

We don’t give a lot of forward guidance on the pipeline. I will tell you, it remains strong. Mike want to comment on it a little bit further. As I said, I think one of the things that we saw in the first quarter was the effect of the mortgage banking market with our warehouse lines. I think there was a $16 million swing from end of the fourth quarter to the end of the first quarter. My indicator show that that’s rebuilding very, very nicely. Our mortgage book is actually growing.

So pipelines, I think, remain strong. It’s just a matter of making sure that we take a look at a lot of credits. We process a lot of looks and proposals. But that we’re bringing the right ones on Board and the relationships on Board. Mike, I don’t know, if you want to comment too much further on that?

Michael Schweighoffer

No, I would absolutely agree that pipelines are strong, it’s not rebuilding seasonally, if you will. We look at on the commercial side of loan last year over $1 billion in transactions, both on the CRE side, invest in CRE and C&I side. And that pace is pretty much consistent in the first quarter. so we’re getting a lot of works, it’s just a matter of selectivity in what we want to do, where we want to do and how we want to do it. So I hope that answers your question.

Laurie Hunsicker

Yes, yes. And so – and to the extent that you’re selective, i.e., the credit screen and so forth and loan growth remains flat to your earlier comments, John. Could we expect to see you potentially continue to repurchase somewhere in the neighborhood of what you did this quarter 150,000 shares, or how do you think about that?

John Patrick

We think about that depending upon where the stock price is and where we’re trading. And so there were times where we trade, where we’re going to take advantage of our low multiple and do that. And I think if you go back and take a look again on that, I don’t give forward guidance too much on that. But we’ll use the levers prudently for capital deployment and buybacks has always been one of them.

And so, Greg has a kind of a plan in place that we take a look at depending upon where we’re trading. So if you were not just diluting tangible book value and stretching an earn-back on that from a buyback perspective. We think, if we can use capital for loan growth, that is – give us some a very good return and then we think it’s – that’s a prudent way to deploy our capital right now. So our recipe, which we’ve used over the last five years is really not changing. We’ll take advantage of the market opportunities as they present themselves.

Laurie Hunsicker

Great. Thank you.

John Patrick

You bet.

Operator

[Operator Instructions] This concludes our question-and-answer session. I’d like to turn the conference back over to John Patrick for any closing remarks.

John Patrick

Thank you. Again, I appreciate everybody’s time and patience. So I appreciate your thinking about First Connecticut Bancorp for those investors out there. I appreciate your investment in our company. As we said before, we’re going to do things very prudently. We believe in growing tangible book value – long-term tangible book value. There are no magic bullets. We’re going to take in deposits and make good loans and that’s going to remain our focus, as we go forward.

We’ll deploy capital prudently to get the right returns in the markets and with the economic challenges and interest rate environment that we’re in. We believe that we built and will continue to build a very, very solid franchise, it’s going to payoff tremendous dividends in the future. So thank you for your interest in our company and have a great day.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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