Lakeland Bancorp, Inc. (NASDAQ:LBAI) Q2 2022 Results Conference Call July 28, 2022 10:00 AM ET
Company Participants
Mary Russell – Assistant Controller and Director, Financial Reporting
Thomas Shara – President, CEO & Director
Thomas Splaine – EVP & CFO
Conference Call Participants
Frank Schiraldi – Piper Sandler
Christopher O’Connell – KBW
Manuel Navas – D.A. Davidson
Operator
Good morning and welcome to the Lakeland Bancorp, Inc., Second Quarter Earnings Conference Call. My name is Tamia and I’ll be coordinating today’s call. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mary Russell, Assistant Controller and Director of Financial Reporting. Please go ahead, ma’am.
Mary Russell
Thank you, Tamia. Good morning, ladies and gentlemen and thank you for joining us for our second quarter earnings call. Today’s presenters are President and CEO, Thomas Shara; and Executive Vice President and Chief Financial Officer, Thomas Splaine. Before beginning a review of our financial results, we ask that you please take note of our standard caution as to any forward-looking statements which may be made during the course of today’s call. Our full disclaimer is contained in this morning’s earnings release which has been posted to the Investor Relations page on our website, lakelandbank.com.
Now it is my pleasure to introduce Thomas Shara, who will offer his perspective on our second quarter.
Thomas Shara
Thank you, Mary. Good morning, everyone, and welcome to our second quarter earnings call. I will start off the call with a high-level summary of the quarter, followed by Tom Splaine, our CFO, who will walk you through our earnings in detail. We’re delighted by our financial results for the quarter, which represents a clean quarter absent merger-related items for the 1st Constitution acquisition earlier this year. For the quarter, our ROA, ROE and ROTCE were $1.15, $10.71 and $14.45, respectively.
We posted record net income of $29 million driven by net interest income of $80 million, representing a 14% increase from the prior quarter. The increase in net interest income is attributable to our meaningful margin expansion plus our organic loan generation during the quarter, which totaled $270 million, representing a 16% annualized growth rate, while we’re able to keep deposit betas low during the quarter.
The loan growth was across all categories in commercial and consumer portfolios, except for construction and PPP loans. Construction loans decreased $33 million, as several loans converted to permanent loans during the quarter, and PPP was reduced by $26 million and now stands at only $10 million at the end of the quarter. I’m happy to report that our commercial closings for the second quarter were a record and eclipsed the first quarter total, which were also a record. The pipeline going into the second half of the year is still very strong. Our healthcare lending team and Hudson Valley lending teams had a tremendous quarter and we expect them to have a strong balance of the year as well.
Recently, we’re also starting to develop new relationships as a result of the recent large bank M&A in our markets. This will be beneficial in subsequent quarters. Overall, we expect continued loan growth to remain strong for the balance of the year with organic growth for the year expected to be in the high single digits for fall of 2022. On the residential mortgage side, originations remain subdued as refinance activity has ended and customers become acclimated to the current rate environment. We continue to retain some high-quality, well-priced jumbos and ARMs on the balance sheet while the market stabilizes.
The average FICO score in this portfolio year-to-date has been 754. On the deposit side, deposits decreased organically 3% for the quarter with some planned reductions in municipal deposits and a continued decrease in time deposits. We have not experienced any runoff in the deposit base from 1st Constitution.
Noninterest income bearing deposits increased $30 million during the quarter and now total 27% of total deposits, while core deposits now make up 91% of total deposits. On the credit side, asset quality remained very solid. For the quarter, we had a small net recovery of $141,000. Nonperforming assets to assets at the end of the quarter were 21 basis points. The allowance remained relatively stable at $69 million or 93 basis points of loans versus $58 million and 97 basis points at year-end.
Overall, the Central and Northern New Jersey economy remains strong despite implications with higher inflation.
Our commercial customers continue to report strong results and a fairly positive outlook, although there are some concerns around inflation, supply chain challenges, and in some cases, a lack of staffing, which is slowing sales a bit. Overall, the local economy remains very strong and unemployment rate in the state is now 3.9% and the state has fully recovered all the jobs lost during the pandemic. Our outlook for credit and the economy remains very, very strong.
That concludes my prepared remarks. I’m now going to turn over the balance of the presentation to Tom. Once he’s concluded with his comments, we’re happy to answer your questions. Tom, take it away.
Thomas Splaine
Thank you, Tom, and good morning, everyone. As Tom mentioned, Lakeland’s second quarter net income was a record of $29.1 million or $0.44 per diluted share, compared to the first quarter of 2022 of $15.9 million or $0.25 per diluted share, and the second quarter of 2021, which was our previous record net income of $27.4 million or $0.53 per diluted share. To crystallize the record net income for this quarter, our previous high record income of — in Q2 of 2021 was aided by a negative provision for credit losses of $6 million compared to the current quarter provision for credit losses of $3.6 million, which equates to a $9.9 million unfavorable impact to pretax earnings.
On the income statement, Q2 financial results were favorably impacted by the organic loan growth of $270 million, deployment of excess cash into higher-yielding assets and the increase in interest rates, all combining to increase yields on our interest-earning assets by 36 basis points for the quarter. As a result, net interest margin for Q2 increased 36 basis points to 3.38% compared to the linked quarter of 3.02% and the prior year quarter of 3.27%.
In comparison to the prior quarter, our pre-provision net revenue, excluding merger-related charges in Q1, increased $10.5 million or 33% to $43.2 million in Q2. The yield on our loans increased 30 basis points from the linked quarter to 4.22%, while loan prepayment fees remain elevated and combined with interest recoveries on nonaccrual loans and PPP fees had a positive net impact of 8 basis points to net interest margin compared to the prior quarter.
Deposit rates remain fairly steady with interest rates increasing only on products related to the fed funds rate. The strength of our banking franchise is the composition of our core deposit portfolio as evidenced by the total cost of deposits increasing 3 basis points to 22 basis points compared to the linked quarter. Our Q2 provision for loan losses was an expense of $3.6 million and was comprised of $1.6 million in provision for credit losses on loans, $1.5 million provision for credit losses on investments and $500,000 provision for credit losses on unfunded loan commitments.
Our current quarter provision for credit losses on loans [indiscernible] further loan growth in the portfolio for the quarter, while the provision for credit losses on investments was a result of a decrease in the market value of corporate securities based on interest rates and not related to any credit downgrades on the securities. Regarding asset quality, as Tom mentioned, nonperforming assets increased 2 basis points to 21 basis points of total assets for the quarter and the credit remains stellar.
Q2 net charge-offs were a recovery of $141,000 and would represent the fourth consecutive quarter of net recoveries excluding the accounting for the acquired 1st Constitution purchased credit deteriorated loans in Q1. At June 30, the allowance for loan losses on loans represents 93 basis points of total loans compared to 94 basis points in the trailing quarter. Q2 noninterest income increased slightly in Q2 to $7.1 million as improvements in swap fees and wealth management fees were partially offset by continued softness and the gain on sale of residential mortgages and SBA loans.
Q2 noninterest expense of $45.1 million decreased $4.9 million in the linked quarter, which reflected the merger-related expenses from the 1st Constitution acquisition in Q1. For the second quarter, lower expenses for compensation and benefits and occupancy expenses were partially offset by higher data processing and other operating expenses. Our efficiency ratio dropped to 51% compared to 58% in the linked quarter. Our Q2 effective tax rate was 24.7% compared to 23.9% in Q1.
On the balance sheet, in comparison to the prior quarter, total assets increased $98.9 million or 1%, with loans increasing $270.4 million or 3.8%, while the cash balances decreased $176.2 million to historical liquidity levels. Deposit balances decreased $247 million or 2.8% due mainly to municipal depositors reducing excess funds and the continued runoff of interest-sensitive time deposit accounts. Borrowings increased $329.4 million to fund the loan growth.
At June 30, our loan-to-deposit ratio was 87%, up from 82% at March 31. For capital management, our capital levels remain strong and we’re relatively static compared with the prior quarter with tangible capital ratio decreased less than 1% to 8.01% at June 30 compared to 8.07% at March 31, as asset growth, cash dividends and other comprehensive income changes offset earnings retention for the quarter. Based on the high degree of uncertainty regarding economic conditions during the quarter and a potential impact of interest rate changes causing additional mark-to-market adjustments in our available-for-sale investment securities portfolio as well as significant growth in the loan portfolio, we did not repurchase any common stock in Q2 under our existing authorized share repurchase program. We believe it was prudent to maintain our tangible capital ratio at 8% in light of the economic uncertainty as well as the anticipated strong loan growth and we will continue to evaluate our capital ratios moving forward.
Regarding our outlook for the remainder of 2022, we believe that we are well positioned for rising interest rates. Our projected interest rate risk position is neutral and we become more asset-sensitive in future periods. The significant increase in net interest margin experienced in Q2 is unlikely to be repeated as excess liquidity is removed from the financial system and deposit pricing reacts to the Federal Reserve’s recent increases in the fed funds rate. Deposit betas are likely to transition higher in Q3 as deposit competition increases.
As Tom discussed earlier, we expect the loan portfolio to grow organically in the high single digits for 2022 and asset quality to remain very high. Noninterest expenses for ’22, excluding the merger-related costs in Q1, are expected to be in the low $180 million range, inclusive of the higher run rate in Q1. Salary and benefits expenses are likely to trend slightly higher due to current hiring conditions and our development of our current digital initiatives. Income tax expense for 2022 is expected to be approximately 24.5%.
That concludes our prepared remarks and we’ll be happy to address any questions. And with that, Tamia, can you open the question period for us?
Question-and-Answer Session
Operator
[Operator Instructions] The first question comes from Frank Schiraldi with Piper Sandler.
Frank Schiraldi
Just like a couple of questions. Couple of questions. First on — you noted liquidity kind of back to historic levels. And I know deposit balances can be a bit volatile given some of the buckets. But a sense of where you expect or where you target the loan-to-deposit ratio in coming quarters?
Thomas Splaine
Yes. I think, Frank, we’re meandering back to our more normalized levels. For us, historically, we tend to have our loan-to-deposit ratio in the low to mid-90s, so between 92% and 95%.
Frank Schiraldi
Okay. And in terms of pressures on the deposit base in terms of pricing, I know it’s early in the quarter, but are you starting to see those pressures build? Or is that, at this point, still just an assumption as liquidity leaves the system?
Thomas Splaine
For right now, it’s — we’re starting to see competitors starting to move rates right now as early as yesterday based upon the Fed moves. And we are contemplating that as we head forward. We’ve kept our deposit betas through the prior interest rate changes at a very low level. And I think now we’re going to start seeing them start to migrate closer back to model betas as we move forward. But — so there are — we won’t have as much NIM expansion based on deposit betas going forward.
Frank Schiraldi
Got you. And then just lastly, I wonder, just on loan growth, do you get a sense that the outsized growth we’re seeing, not only from you guys, but in the industry here, is just sort of a pull forward from later in the year just given the Fed action, just trying to lock in pricing maybe? Not sure if you can comment on that and just kind of what you’re hearing on that front from your customers?
Thomas Shara
Yes, Frank, the feedback we’re getting from our customers is very positive. Maybe in the North Jersey marketplace, it’s a little different than other parts of the country, but people are very optimistic. We’re seeing sales grow. We’re actually starting to get some requests for larger lines of credit, which we haven’t seen in years. So it seems like the Central North Jersey economy is faring pretty well.
And we surveyed customers in virtually every asset class. And they’re all saying the same things, that things are quite good. They’re optimistic about the back half of the year. And like I said in my opening comments, our pipeline is continuing to stay full, even though we’re accelerating closing. So it feels pretty good, Frank.
I think the loan growth should continue.
Operator
The next question comes from Christopher O’Connell with KBW.
Christopher O’Connell
Was hoping to start off on the expense comments. I think previously, you were thinking a little bit closer to the high 170s range for the year, now low 180s. Just curious as to what’s driving that? And is there — is it a result of an improved loan growth outlook? Or is there higher revenues tied to that?
Or is it — yes, that would be great.
Thomas Splaine
Yes. I mean if you were to back out the merger-related expenses that we had for our 1st Constitution in Q1, it’s — what we’re looking at now is the $45 million of operating expenses in Q2 is a pretty good run rate for us as we head forward for the rest of the year. We are getting the cost saves as targeted from 1st Constitution. So we’re still on track for that. It’s just that some of our other expenses are creeping upward, mainly on salaries and benefits, due to the hiring constraints that are out there right now that are putting a little upward pressure on our expenses.
But overall, that’s kind of the way expenses are forecasted as we get through the rest of this year.
Christopher O’Connell
Got it. So is there still some cost saves yet to be achieved, but just being offset by the higher salaries?
Thomas Splaine
Yes. That’s the way it’s shaking right now.
Christopher O’Connell
Okay. Great. And on the comments around mortgage banking, the gain on sale going into the back half of the year, just any other color there or how we should frame kind of that line going forward?
Thomas Shara
Yes, Chris, I think it’s going to remain under pressure. I mean the refinance activity is gone and inventory in this part of the country is pretty restricted. So I think we’ll continue to be opportunistic, putting some things in portfolio, like I said earlier, we’re putting some jumbos on, some ARMs on and those rates are in the high 4s, low 5s right now. So it seems like a better place to put loans than to sell. But we’re hoping things pick up in the back half of the year, but they’re not going to be anywhere near where we projected at the beginning of the year.
And we’re also offsetting some of that loss with swaps. We’re starting to see much more swap activity in the second half of the year.
Christopher O’Connell
Okay. Got it. So like all in on a core basis, is the same $7 million to $8 million a good range or with the swaps kind of offsetting some of the lower mortgage banking?
Thomas Splaine
Yes, that’s a good assumption there, Chris.
Christopher O’Connell
Okay. And then the comments around the buyback and keeping capital ratios kind of at 8% plus on TCE, I know you guys have previously indicated wanting to start utilizing the buyback. If there’s not a ton of AOCI hits coming in future quarters or even with maybe a little bit more questionable economic environment, do you think you can start to repurchase again?
Thomas Splaine
Yes. I think you’re looking at it from the same way we were looking at it there, Chris. We were — with the economic uncertainty, we were a little hesitant. We did really want to start up on the share repurchase plan and basically we just weren’t — we weren’t there and we saw a lot of loan growth coming at us that we knew was going to put downward pressure on our capital level. So we’ll take the loan growth.
Share repurchases are good for us when we don’t have something better to do with our capital. And as long as we have a really healthy loan pipeline and we’re growing the bank, that’s the most important thing right now.
So yes, as we look into the second half of this year, if the economic uncertainty settles down as well as loan growth gets a little bit softer as we head forward, right now, it’s looking very good, yes, we’ll definitely look at share repurchases as a tool to manage our capital levels.
Operator
Our next question comes from Manuel Navas with D.A. Davidson.
Manuel Navas
So I might have missed this. What are you booking new loans at? And has that shifted a little bit into here in July?
Thomas Shara
Yes, with — we put on rates are probably in the mid- to high 4s right now, Manuel, and moving up, and that was prior to the Fed move yesterday. So we’re seeing much, much better pricing and we’re seeing that across the board.
Manuel Navas
Okay. That’s helpful. Is there a thought process of — I understand that deposit betas are creeping up, but thinking big picture, how high could the NIM get by the year-end or early next year?
Thomas Splaine
That’s a great question. If we had a look behind the curtain at the Fed, we — maybe we’d have a better indication. But I think that right now, we’re — the NIM expansion that we had this quarter was based upon the adjustable rate of our portfolio, plus we did have the tailwind for us of some nonaccrual interest recapture. So that benefited the quarter. So as we look forward, these increases, it’s all going to come down to deposit pressure with competition.
And — so for us, as we head forward, I think that for us being in the 330 range going forward is going to be — is where we’re kind of targeting right now based upon where we’re at and where we see things going as we move forward.
Manuel Navas
Do you think that there comes a point with betas catching up that you could see NIM kind of bounce around rather than keep expanding?
Thomas Splaine
I guess that’s always a possibility, but I think that there’s still a lot of liquidity out in the system. So I think deposit pressure is probably at this point of the cycle not as intense as it was when we were at the last time we were in an up-rate environment.
Operator
There are no further questions in the queue.
[Operator Instructions] We have a follow-up question from Christopher O’Connell with KBW.
Christopher O’Connell
I just wanted to circle back on those last comments on the margin. I thought if I heard correctly, the impact of PPP, nonaccrual prepays, was 8 basis points this quarter, right?
Thomas Splaine
Yes, compared to Q1, increase over Q1.
Christopher O’Connell
So backing that out, we’re kind of — we’re already in the 330 range at the NIM. So just trying to get a sense of the NIM expansion comments versus the 330 range, already kind of being there?
Thomas Splaine
Right. So if you were to back off some of that positive impact that we had this quarter because PPP is virtually going away and with the nonaccruals, the onetime nonaccrual recapture, NIM comes back on more of a core NIM basis, comes down somewhat. And then we get some expansion based upon the recent increases in rates, offset by deposit beta. So for us, I think we’re looking at keeping the NIM in the range of a low to mid 330s and we’ll be conservative on our projections. And we’ll take it from here as we move forward.
So we do still see some NIM expansion.
Christopher O’Connell
Got it. So some NIM expansion, but just not as off a core basis since one is backing out those items?
Thomas Splaine
Right. Yes. There was some positive impacts in Q2 that will not repeat themselves.
Operator
There are no further questions in the queue. So I will now pass it back to Tom Shara.
Thomas Shara
Okay. Thanks, everybody, thanks for joining us this morning. If you have any additional questions, feel free to give Tom or I a call. Enjoy the rest of the summer and thanks again for participating this morning. Take care.
Operator
This concludes the Lakeland Bancorp, Inc. Q2 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.
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