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Good day. And welcome to the WesBanco Fourth Quarter 2019 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]
Please note, today’s event is being recorded. I would now like to turn the conference over to Mr. John Iannone, Senior Vice President of Investor Relations. Please go ahead, sir.
Thank you, Rocco. Good morning. And welcome to WesBanco, Inc.’s fourth quarter 2019 earnings conference call. Our fourth quarter 2019 earnings release, which contains consolidated financial highlights, reconciliations of non-GAAP financial measures, was issued yesterday afternoon and is available on our website wesbanco.com.
Leading the call today are Todd Clossin, President and Chief Executive Officer; and Bob Young, Executive Vice President and Chief Financial Officer. Following our opening remarks, we will begin a question-and-answer session. An archive of this call will be available on our website for one year.
Forward-looking statements in this report relating to WesBanco’s plans, strategies, objectives, expectations, intentions and adequacy of resources are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
The information contained in this report should be read in conjunction with WesBanco’s Form 10-K for the year ended December 31, 2018, and Form 10-Q for the quarters ended March 31st, June 30th and September 30, 2019, as well as documents subsequently filed at WesBanco with the Securities and Exchange Commission, which are available on the SEC and WesBanco websites.
Investors are cautioned that forward-looking statements, which are not historical fact involve risks and uncertainties, including those detailed in WesBanco’s most recent annual report on Form 10-K filed with the SEC under Risk Factors in Part 1, Item 1A.
Such statements are subject to important factors that can cause actual results to differ materially from those contemplated by such statements. WesBanco does not assume any duty to update forward-looking statements. Todd?
Well, good morning. Thank you, John. On today’s call, we will be reviewing our results for the fourth quarter of 2019. Key takeaways from the call today are, we reported record net income for 2019 of $172 million, excluding merger-related costs. Key credit quality metrics remained at low levels.
We successfully consummated our merger with Old Line Bancshares and are excited about our opportunities in the Mid-Atlantic market. It’s important to note that 75% of our projected cost saves will not begin to be realized until after the systems conversion that will occur at the end of the first quarter of 2020.
Since 2009, we have grown from $5 billion to nearly $16 billion in total assets, while generating positive operating leverage that lowered our efficiency ratio approximately 750 basis points to 56.7% during 2019.
We accomplished this tripling in size by expanding from three to six states, spanning in the Midwest, the Mid-South and now the Mid-Atlantic, with substantial deposit market shares, while maintaining balanced loan and deposit distribution across this diverse regional footprint. This geographic expansion was done methodically, with a critical focus on shareholder return.
During the last four years, we have moved into two fast-growing regions, the Louisville-Lexington Corridor in Kentucky and the Baltimore-Washington DC Corridor in Maryland. In fact, we have expanded many of our revenue generating functions into diversified major markets with growing populations and positive demographics, while keeping the majority of our back office and support staffs based in our Wheeling headquarters.
We have focused on developing and expanding our earnings streams through the diversifying of our loan portfolio and enhancing of our fee-related businesses. Commercial and industrial loans have increased nearly 260% to represent 16% of loans, as compared to 13%, 10 years ago through a combination of acquisitions, entering major markets, hiring excellent teams and developing a full suite of commercial products.
We now provide our Commercial customers, the services they need to effectively and efficiently run their organizations including loan swaps, money management, treasury management, investment and retirement and foreign exchange services.
In addition, we have made significant investments in our fee-based businesses, where we have added securities brokerage, license banking services and we developed private banking services as well, which is growing at a 40% compound annual growth rate since being launched in 2013.
We have grown our residential mortgage lending program and capabilities, which has allowed mortgage banking volume to increase three-fold over the last few years that we are focused on taking advantage of new markets and added talented mortgage origination officers in order to balance the growth between secondary market loans and portfolio loans.
We have invested in scalable technology that meets the needs of our regional franchise, as well as the needs of our customers when and how they want those needs met. Years ago, we implemented video conferencing, thin-client technology and cloud-based infrastructure to how to operate efficiently and effectively as we have grown.
We were one of the first banks to utilize Apple and Google Pay, and have enhanced the digital offerings to our customers to include online applications for residential and small business loans, online deposit account opening, P2P payment capabilities and online budgeting tools.
Our company is evolving and will continue to evolve as we develop new revenue streams into higher growth markets. Our very recent recognition as the Number Seven Best Bank in the country by Forbes, coupled with our seventh consecutive outstanding CRA Rating, demonstrate our continued commitment to our customers and our communities during this evolution.
We are proud of our long-rich history. We are excited about our future opportunities as we continue to transform our institution to meet the needs of our customers with a community bank feel.
I’d now like to turn the call over to Bob Young, our CFO for an update on the fourth quarter’s financial results. Bob?
Thanks, Todd, and good morning to all of you. Our fourth quarter core earnings performance improved and was above our expectations as execution of our fundamental strategies, control deposit costs and expenses and accretion from the Old Line acquisition, drove improved earnings over the third quarter and assisted in our record core net income performance of $159 million for all of 2019.
During the fourth quarter, we experienced a continued declining rate environment and a relatively flat yield curve, although it did improve somewhat later in the quarter. The impact of another 25 basis point Federal Reserve short-term interest rate cut in October, a pickup in commercial real estate projects being refinanced or sold earlier than expected due to the current rate environment. And the full quarter’s impact of the mandatory limitation on interchange fees for large banks above $10 billion in total assets.
For the three months ended December 31, 2019, we reported GAAP net income of $36.4 million and earnings per diluted share of $0.60, as compared to $43.9 million and $0.80, respectively, in the prior year period.
Excluding after-tax merger related expenses from both periods, net income increased 1% to $45.5 million with earnings per diluted share of $0.75. The year-over-year decrease in earnings per diluted share was primarily due to the additional shares issued for the Old Line acquisition as well as before our anticipated expense savings.
In addition, for the 12 months ended December 31, 2019, we reported GAAP net income of $159 million and earnings per diluted share of $2.83, as compared to $143.1 million and $2.92 respectively in the prior year period. Excluding after-tax merger-related expenses from both periods, net income increased 9.3% to $171.8 million with earnings per diluted share of $3.06.
Financial Results for First Century and Farmers Capital have been included in WesBanco’s results subsequent to their merger dates of April 5th and August 20, 2018, respectively, and the financial results for Old Line have been included in our results since its November 22, 2019 merger date.
Total assets as of the end of the year of $15.7 billion increased 26.2% year-over-year due to the Old Line acquisition. Furthermore, total portfolio loans of $10.3 billion increased 34.1%, while total deposits increased 24.6% to $11 billion compared to the prior year, also due to the acquisition.
Total organic loan growth was 1.1% year-over-year, primarily in C&I and residential real estate loan categories, partially offset by elevated levels of commercial real estate loan payoffs. Excluding the Old Line acquisition and certificates of deposit, which we continue to allow to run-off over time, our organic transaction account deposits increased slightly year-over-year, while non-interest bearing demand deposits increased 2.2%.
During the fourth quarter, we reduced certain higher cost rates for private banking, public funds, institutional and repo sweep accounts, as well as certain higher cost CD rates in our new and Mid-Atlantic market.
For loans, we realized strong total production during both fourth quarter, as well as for the full year of 2019. Total commercial production of approximately $1.6 billion increased 40% year-over-year and total residential real estate production increased 34% year-over-year to approximately $650 million. This growth in production was driven by the caliber of our lending teams, as well as the continued strength across the diverse economies of our six state footprint.
Both commercial and residential production was higher during the fourth quarter and the same period last year, while year-end pipelines were also stronger than at year-end 2018 at $680 million and $85 million, respectively.
So far, new loan production in the Mid-Atlantic market continues at a similar pace to what they have recorded before the acquisition. While commercial and industrial lending typically has long sales cycles, we are seeing the benefits of the prior investments we have made in the expansion and quality of our commercial industrial lending teams and launching of our online lending application capabilities earlier in 2019. These investments contributed 5.9% year-over-year organic growth in our C&I lending categories.
The Federal Reserve rate cuts during the second half of 2019 have continued to both attract from and benefit our residential real estate loan categories. Organic home equity lending decreased 1.8% year-over-year, primarily due to the low interest rate environment, driving an increase in residential mortgage refinancing as homeowners trade variable rate HELOC balances for fixed rate, first-lien mortgages.
On the flip side, the expansion of our mortgage origination teams has resulted in higher gain on sale income, up almost 41% for the year on record production, as well as retained loans for the loan portfolio, which grew organically 1.9% year-over-year.
In addition, mortgage refinancing volume, which represented about 42% of total fourth quarter production is now nearly four times the volume realized during the prior year period. Application activity to-date in our Mid-Atlantic market bodes well for their contribution to 2020 residential mortgage loan growth and gain on sale income.
As a result of the current rate environment highlighted by three recent Federal Reserve interest rate cuts, we have continued to see a pickup in commercial real estate projects, going to the secondary market or selling outright earlier than expected.
In fact, the acceleration we experienced during the fourth quarter of 2019, was almost tripled the more normalized quarterly average rate we experienced the first half of 2019 and it exceeded $200 million in the fourth quarter, which negatively impacted total organic fourth quarter loan growth by approximately 2 percentage points.
We expect the current elevated level of commercial real estate payoffs to continue through at least the first half of 2020. However, it could last longer depending upon the interest rate environment.
Despite the headwinds created by the low interest rate environment and aggressive secondary commercial real estate market, we do expect to see a return to our normal low-to-mid single-digit total loan growth over the long-term due to our new Mid-Atlantic market, the strength of our lending teams and the record levels of both our total commercial and residential mortgage pipelines, as I previously noted.
As we are seeing across our industry, net interest margins are being negatively impacted by the three cuts of Federal Reserve’s target federal funds rate during the second half of 2019, as well as the relatively flat yield curve.
Reflecting these industry-wide headwinds, our net interest margin for the fourth quarter of 2019 decreased 17 basis points year-over-year to 3.55%, but only 1 basis point on a sequential quarter basis.
The net interest margin for the full year of 2019 was up 10 basis points year-over-year to 3.62% due to the Federal Reserve short-term rate increases during 2018, the higher margin Farmers Capital acquired net earning assets and higher purchase accounting accretion for the full year of 19 basis points versus 2018’s 14 basis points. Excluding such purchase accounting accretion, the core margin was 3.43% for all of 2019, as compared to 3.38% in the prior year.
Purchase accounting accretion from the acquisitions benefited the fourth quarter net interest margin by approximately 22 basis points, as compared to 23 basis points in the prior year period and 13 basis points in the third quarter.
Furthermore, the accretion during the fourth quarter of 2019 included 4 basis points of accretion from acquired loan payoffs and approximately 6 basis points from the Old Line merger. Excluding purchase accounting accretion, we reported a core net interest margin of 3.33%, down 16 basis points year-over-year and 10 basis points on a sequential quarter basis.
For the quarter ended December 31, 2019, non-interest income increased 16.1% from the prior year to $30.8 million driven by organic growth and the Old Line acquisition, which accounted for approximately one-third of such increase.
Mortgage banking fees increased $1.4 million compared to last year’s fourth quarter as noted previously due to growth in residential mortgage origination dollar volume and the associated sale of approximately one half of those originations into the secondary market.
Electronic banking fees decreased $2.3 million as compared to the fourth quarter of 2018 reflecting an approximate $2.8 million quarterly impact from the limitation on interchange fees for debit card processing that resulted from the Durbin amendment to the 2010 Dodd-Frank Act and that was partially offset by higher point of sale and ATM transactions.
Other income increased 84.1% during the fourth quarter to $5.8 million due to higher commercial customer loan swap related income.
Net securities gains increased $1.8 million to $0.5 million from a loss in last year’s fourth quarter, primarily from market adjustments for the company’s Director and Key Officer deferred compensation plan. The treatment of this adjustment was neutral to operating income as an offsetting $1.1 million was recorded as a credit within employee benefits expense.
Net securities gains for the year also include a $2.6 million gain in the second quarter of 2019 for the sale of our Visa Class B share ownership position. Excluding merger related expenses, non-interest expense for the fourth quarter of 2019 increased $11.4 million or 16.4% to $81 million compared to the prior-year period, primarily reflecting the Old Line acquisition, which accounted for approximately 42% of that increase.
The 16% year-over-year increase is primarily due to higher salaries and wages, employee benefits and occupancy, equipment and other operating costs associated with the additional staffing and financial center locations from the Old Line acquisition. In addition, salaries and wages reflect the annual midyear merit increases and higher incentive and stock compensation.
Employee benefits of $9.9 million increased $2.6 million quarter-over-quarter due to a similar $1.1 million reduction in deferred compensation plan obligations as noted in my prior comment about net securities gains, as well as higher health care expenses of $3.7 million, which is partially reflective of the 2018 acquisitions and their impact for the full year of 2019.
Lastly, as mentioned last quarter, we recognized FDIC insurance credits of approximately $0.7 million during the fourth quarter. The efficiency ratio was 58.3% for the quarter, reflecting the Durbin fee income cut and the inclusion of Old Line’s expenses prior to any associated cost savings.
Credit quality ratios remained strong at year end as we balance disciplined loan origination in the current environment with prudent lending standards. As of December 31, 2019, both non-performing loans and non-performing assets as percentages of the portfolio and total assets at 0.49% and 0.35%, respectively, remained relatively low and consistent for the past several quarters. These percentages included approximately $3.8 million of non-performing loans and $0.5 million of other real estate loan from Old Line.
On a positive note, the provision for credit losses for the fourth quarter benefited from approximately $1.1 million associated with the release of the specific reserves assigned to three previously acquired credit impaired loans that paid-off during the quarter.
Additionally, total net charge-offs for the fourth quarter included specific reserves of $2.8 million taken in prior periods. For the year, net charge-offs as a percentage of average loans were low 0.9%, as compared to 0.6% in 2018.
WesBanco continues to maintain strong regulatory capital ratios as both consolidated and bank level regulatory capital ratios are well above the applicable well capitalized standards promulgated by bank regulators and Basel III capital standards.
During the fourth quarter of 2019, our Tier 1 leverage and Tier 1 risk-based capital ratios decreased by approximately 108 basis points and 122 basis points, respectively, due to the movement of $136.5 million of trust preferred securities from Tier 1 to Tier 2 risk-based capital, as required by the Dodd-Frank Act for financial institutions with total assets greater than $15 billion. Also, pro forma Tier 1 leverage capital would be just below 10%, due to period end assets were used in the calculation, instead of averages as required.
On December 19, 2019, the Board of Directors authorized the adoption of a new stock repurchase plan for the purchase on the open market of up to an additional 1.7 million shares of WesBanco common stock, representing approximately 2.5% of outstanding shares, which is an addition to an existing plan approved in 2015.
During the fourth quarter of 2019, we repurchased roughly 255,000 shares of our outstanding common stock at a total cost of $9.5 million, and as of year-end, approximately 2.5 million shares remained for repurchase.
We currently anticipate we will continue to repurchase shares during 2020 as permitted by securities laws, subject to market conditions and other factors. The timing, price and quantity of any such potential repurchases will be at WesBanco’s discretion.
Well, I wouldn’t be an accountant if I didn’t bring up to-date on CECL. The current expected credit loss model became effective for WesBanco on January 1, 2020. As part of our implementation process, we previously disclosed a range of up to a 30% increase in the allowance for loan losses, excluding the impact from Old Line.
Including our fourth quarter of 2019 acquisition of Old Line in the analysis and subject to purchase accounting adjustments, we now expect an increase of approximately 40% to 60% as of January 1st, in the allowance for credit losses, including loan commitments, which represents about a 20 basis point to 25 basis point decline in Tier 1 risk-based capital is applied on a pro forma basis as of December 31, 2019.
The ultimate impact of adoption will depend on the finalization of purchase accounting and impaired loans for Old Line, which could impact the estimated initial adoption range. Also, the impact on regulatory capital will be spread over three years as permitted by regulatory actions taken after CECL’s initial adoption.
I would now like to provide some thoughts on our current outlook for 2020. As a slightly asset sensitive bank, we are not immune from factors affecting industry margins including a relatively flat spread between the three-month and 10-year treasury yields and continue to overall lower long-term rate environment.
While we continue to believe that our core deposit funding advantage, combined with our lower loan to deposit ratio, should help control overall deposit funding costs. I want to remind you that we did not experience a high deposit beta when rates were moving up during 2018, so our core deposit rates cannot be lowered as much in the current rate environment.
Our GAAP or stated net interest margin for 2020, as indicated by our asset liability model may decrease by 2 basis points to 3 basis points per quarter due to lower purchase accounting accretion from a starting point of 20 basis points to 22 basis points during the first quarter of 2020, including the impact of Old Line’s purchase accounting.
We are currently anticipating one more Federal Reserve rate cut of 25 basis points in late June 2020, which if such occurs, would cause the margin to decrease by an additional 2 basis points to 4 basis points in the back half of the year, depending upon the shape and overall level of the yield curve at that time. Core margin should otherwise remain relatively flat, assuming we can offset any further loan yield reductions with deposit and other funding cost decreases.
We will continue to focus on expense trends to ensure positive operating leverage, while positioning the company for long-term growth. We expect to achieve the planned 31% Old Line cost savings during 2021 with approximately 75% realized by the end of 2020. We are planning for systems and branch signage conversions to occur by the end of the first quarter and anticipated cost savings should begin shortly thereafter.
Typical mid-year merit increases will be effective across our entire organization, and in addition, we expect total marketing expenses to increase from 2019’s level, reflecting additional marketing spend in our various markets and our approximate 25% larger company size. Furthermore, FDIC insurance expense will increase from the levels recorded during the second half of 2019, which reflected the $3.1 million assessment credit we received from the FDIC.
We also anticipate making additional revenue generating hires as we enhance lending and Wealth Management teams and associated support staff in our new Mid-Atlantic market. There is typically a lag between when lending and wealth management personnel are hired and when they begin building a revenue-generating book of business.
We do currently estimate the quarterly reduction during 2020 in electronic banking fee income from the limitation on interchange fees due to the Durbin Amendment will be relatively consistent with the impact recorded during the fourth quarter of 2019, which will continue to have a slight negative influence on the efficiency ratio. As a reminder, we will anniversary the impact from the Durbin Amendment, during the third quarter of 2020.
We do not anticipate that our credit quality measures will increase significantly in 2020. Although, due to prior low levels, there may be some variability from quarter-to-quarter, but it should remain comparable or slightly better to our peer institutions.
Quarterly loan loss provisions after adoption of CECL will be highly dependent upon forecasted economic assumptions and other model factors such as loan growth by category in term, net charge-offs and changes to criticized and classified loan losses.
Lastly, we anticipate our effective full year tax rate to be approximately 19% to 20% subject to changes in certain taxable income strategies, as we have now added in Maryland to our state income tax provision.
Todd, I will turn it back to you.
Thanks, Bob. Before I open the call to your questions, I want to provide a brief update on the changes in our internal loan classification methodology. As we discussed last quarter, as well as bank was grown and transformed into a $16 billion institutions spanning six states, we believe it was important on a go-forward basis to heavily weight quantitative measures in our loan risk rating process, in particular debt service coverage. Therefore, we initiated a project during 2019 to review and re-grade all loans under this revised methodology.
The shift in factory utilization, that’s what it was, it’s not credit deterioration is what drove most of the changes in the loan risk ratings and associated criticized and classified loan levels that we experienced the last few quarters.
We have now completed the majority of this re-grading project, we have gone through all loans greater than $1 million and within criticized and classified, as well as two great levels above criticized and this is reflected in our fourth quarter results.
For the quarter ending December 31, 2019, our criticized and classified loan to total loans ratio was 2.17%, which included approximately $31 million of criticized and classified loans from Old Line that declined 7 basis points sequentially from the third quarter and is still favorable when compared to the average of all banks with total assets between $10 billion and $25 billion.
During the first quarter of 2020, we will apply the same revised methodology to the larger Old Line ones, and going forward, we will be utilizing the new methodology during the normal course of business.
I’d like to personally welcome the customers and employees of Old Line into the WesBanco family. In addition to maintaining strong commitment to customer service and community banking, I am excited about our opportunities in the Mid-Atlantic market as we work to build on Old Line’s market presence and enhance customer relationships through new and expanded products and services. I am thrilled to have the Old Line employees as part of our new Mid-Atlantic market and I look forward to the longer term benefits of this merger.
We celebrate our 150th Anniversary this year as an emerging regional financial institution ready to compete, not only in the Midwest, but also in the Mid-South, and the Mid-Atlantic markets. We have the markets, the employees, the products and the infrastructure to continue our evolution as a company.
Now we are ready to take your questions. Rocco, would you please review the instructions.
Yes, sir. [Operator Instructions] Today’s first question comes from Casey Whitman of Piper Sandler. Please go ahead.
Good morning.
Good morning, Casey.
First question, I just wanted to touch on the swap income you guys got this quarter. Was that higher volume just a function of demand this quarter or was there something else that play in and just what do you think about the sustainability of those fees?
Yeah. It’s all driven by obviously the shape of the yield curve and there is a lot of demand out there on the part of customers. So it is a little bit bumpy quarter-to-quarter based upon the size of loans and whether it’s swap or a variable rate or fixed rate or whatever the case might be.
But we have been seeing some nice trends with that and we are just introducing it into the Mid-Atlantic market now, actually it was out on calls last week with some of their lenders and some of their borrowers are utilizing swaps, but that’s not something that Old Line has offered in the past. So we think we have got some opportunity there as well. But it is going to move around a lot based upon the shape to yield curve, right now, it’s in a pretty positive area.
There also was a positive fair value adjustment associated with the existing book of sweeps -- swaps in addition to the higher fees for the quarter as compared to the prior quarter, Casey.
How big was that, Bob, the fair value adjustment?
It was $500,000. So and that was a negative adjustment in the third quarter due to the yield curve shape at that time.
Got it. Thank you. And then, Bob, maybe help us out a little bit with the expenses. So the growth this quarter was maybe a little more than I was thinking, and as you mentioned, you got the FDIC expense, some marketing expenses, annual merit increases. I guess, how should we think about a good range for the quarterly run rate for expenses once we have got the majority of the Old Line cost saves realized, so as we look at like the back half of 2020 or maybe if you don’t want to give a range just how should we think about maybe where the efficiency ratio kind of lands then?
Well, we have given prior guidance on the efficiency ratio being above the historical rate because of Durbin and I think with the margin being down last year, there is some adjustment to the efficiency ratio there as well. So I think that fourth quarter run rate for the efficiency ratio until we begin getting our cost savings is good for now, as we start the New Year.
In terms of dollars, we spent some time analyzing both the third quarter run rate, as well as the fourth quarter run rate. And as is my want, I made some adjustments that you could either agree with or not, but we had -- I called out the deferred comp adjustment, which was different in the fourth quarter as compared to the third quarter.
I think we were showing additional marketing expense in the fourth quarter. That’s probably going to run rate higher as compared to the total 2018 and so the amount you see there in the fourth quarter is probably a fair run rate, maybe a little bit less for 2020 as we did advance some customer surveys and market research work in the fourth quarter, so that’s item two.
And then additional incentive comp, we adjust in the fourth quarter as we are going to provide an adjustment for our non-officer employees this quarter and so when you add all those items off and then you do a difference calculation on the FDIC, we come up with somewhere around $74 million in the fourth quarter for our own expenses. And Old Line has been relatively consistent at around $14 million for the last two quarters to three quarters.
And so that basically puts you at $88 million to $88.5 million and [Technically Difficulty] New Year, with higher accruals and payroll taxes, in the first quarter, adjust for the day count and a couple of other minor savings.
And so you kind of start the year just under $90 million, you get some cost savings beginning in the second quarter and as we have typically said in the past and as I have guided in the script, the second quarter is when we start our annual officer increases with the non-exempt then following in the third quarter. So there is that run rate difference as we proceed through the year.
And so you are starting the year at around $89 million to $90 million and are consistent with that in the second quarter adjusted for the day count. And then the third quarters and the fourth quarters are slightly higher because of those aforementioned merit increases for the teams. I don’t know if that’s helpful or not.
No. It is. Sorry, in the second quarter you should see a slight decline though from the cost saves coming in from the $89 million or so in the first quarter, correct?
That’s right. You could see a slight decline in the second quarter as compared to the first quarter run rate.
Yeah.
But you do have an extra day in the second quarter as compared to the first even with leap year in the first. So, and as mentioned, the salary increases start basically in the middle of May for the officers, so there’s half the quarter.
Okay. Very helpful. I will let someone else jump on. Thank you.
Thank you.
And our next question today comes from Brody Preston of Stephens, Inc. Please go ahead.
Good morning, everyone. How are you?
Good morning, Brody.
Hey. Bob, I just want to follow up on the expenses real quick, I guess, just taking all your comments that you just provided Casey, it sounds like all-in, we should expect expenses to sort of bounce around between $88 million to $90 million per quarter through 2020, is that fair?
Yeah. A little bit higher in the back half of the year, but I do have 75% of cost savings in by the end of the year. So that number has -- to get there that number has been decreased by a total of about $13 million of cost savings related to Old Line and then the rest of it would be in 2021.
Okay. So, I guess, as I think about the run rate heading into 2021, is it -- I guess, that’s above or below $88 million per quarter?
For ‘21?
Yeah. Heading into ‘21.
So, I haven’t -- I don’t have that in front of me, but I have in the second half this year between $91 million and $92 million after typical midyear salary increases and stock compensation awards.
Okay. All right. Thank you very much for that.
And then I guided to the higher marketing for the 2021 year and you have got to put in a normal run rate on FDIC insurance for the year as well. That’s the guidance. I am just re-emphasizing those two factors as being different from 2019.
Okay.
I guess, I am telling you that for ‘20 but that’s run rate for ‘21.
Right. Okay. I guess, just real quick on the loan book, could you remind us what percent of the loan portfolio is tied to one month LIBOR and what percentage is tied to prime?
The loan book is -- this is all our loan book, I don’t have Old Line share. I can tell you, Old Line’s is primarily fixed rate and so it will reduce our asset sensitivity. We just don’t have the books combined yet on an instrument by instrument level.
So I have had -- bear with me, but 30% of our portfolio -- commercial portfolio is fixed and 70% is variable. And of the variable, 48% re-prices less than three months and so that’s a proxy for both prime and LIBOR adjustment.
Okay. All right.
Okay? I can give you the whole book, but I think you are primarily interested in the commercial.
Yeah. That’s right. I guess, as I look at the loan yield this quarter 4.75% and think about the run rate moving forward. Just wanted to get a sense for what new origination yields were across the footprint?
So we have loans -- over the course of the year, loans paid off at a 4.97% rate, new loans came on to a 4.33%. So that gives you some idea where we ended up the year.
Okay. And then just thinking about the CD book, CD costs were down a little bit more than what I would have expected just given the higher cost nature of the Old Line portfolio. I just wanted to get a sense for what drove that and what current offerings are in legacy markets and in the newly acquired Old Line markets?
Yeah. I will start and Bob can add to that as well. But, yeah, part of what we are doing is kind of managing the loan to deposit ratio with the deposit flow, right? So we are about 93% -- 93.3% at the end of the year on the deposit ratio.
So we still got a little bit of room to grow at the end of the year two of pretty robust loan growth, which hopefully we are going to get out of our legacy footprint in our acquisitions here in the next couple of years and our low-to-mid single-digit loan growth. If we did that and didn’t significantly grow deposits, that start pushing the mid to upper mid loan to deposit ratio.
What we are seeing so far is in the Old Line book, we want to make sure that we are taking care of some of the strategic customers that they have got as well too. But, overall, we are not offering the kind of deposit rates that were being offered prior to the acquisition on CDs. So that is starting to have an impact. I don’t know what that’s going to do volume wise, but it will start having an impact on the margin to some degree, as Bob has talked about previously.
So we are going to watch it on a monthly basis and one of nice things we have with our legacy footprint because of so deposit rich and we haven’t had to do a whole lot to try to generate deposits there.
As I go a couple of years out and need to raise deposits, we can do so in our legacy footprint, I think fairly easily without having to do at a high-cost markets to raise deposits, because we have got still some relatively low cost deposit markets that we can use to raise deposits to continue to fund the bank long-term. So we are reducing CD rates in the Mid-Atlantic market across the Board that means selective with regard to some key customers.
Okay. And then, as I think about CD growth moving forward sort of taking your comments about being cognizant of the loan to deposit ratio and thinking about the run-off of some of those higher cost, Mid-Atlantic CDs, how do you sort of -- what’s the outlook for CD growth as we head forward into 2020, is it flattish or do you expect to see some low single-digit growth in that portfolio?
Yeah. That’s a great question. We have been able to hold off trying to, I guess, I’d say, stabilize or grow the CD book because we haven’t had to. There will be a date and time where we will probably need to do that although we will continue to focus on growing demand deposits and still 50% of our book post merger is demand deposits. We realize that at some point, we may need to raise some CD rates in order to fund our loan growth.
One of the interesting things about doing that is it’s -- when you go into some of our legacy footprint and you go out there with a higher CD rate, you are going to price a lot of your existing book and your existing deposits that aren’t in CDs.
So it’s not a matter of raising deposit rates a little bit on the CD side, it cost you more on the interest rates for the interest expense. It will cost you more than just the amount of the increase in the CD rate because again you are going to cannibalize some existing deposits that are going to start rolling into that.
So that’s why we have kind of resisted it and used Federal Home Loan Bank, a little bit more, even though some of the CD rates might be a little bit lower at times then you would be able to get from the Federal Home Loan Bank. Federal Home Loan Bank, you don’t have to re-price a big chunk of your book by changing your interest rates. You are going to change your interest rates on deposits, again, you risk cannibalizing your existing book.
So we are going to kind of balance that based upon the loan to deposit ratio, and I would say, once we get to mid to upper 90s on the loan to deposit ratio, then I think, we are going to start getting more aggressive on the CD side and we will pick the markets we want to do that in.
The markets where I think we can generate a lot of deposit growth without maybe having a significant market share in that market, that way then we can attract deposits in, but not re-price the book in that market.
Okay. And then one last question from me, it’s a bit of a two-part about the day one CECL update, Bob. Just wanted to ask, is it fair to say that the delta between the 3Q guidance and the 4Q guidance is due primarily to include an Old Line in the analysis?
Yes. That’s exactly what it is. I have done some analysis on there. And yet, what you have to keep in mind is that, they are coming on with a zero reserve. So because in purchase accounting we are eliminating there basically $8 million to $9 million existing allowance.
So you are starting from scratch if you will and the bulk of their loans are the good book clients, so there is a doubling up impact there between the credit mark of about 1% and the initial allowance.
So there is about a $17 million addition to our guidance at the end of the third quarter. The increase for WesBanco alone is about little bit less than $10 million and the increase for Old Line is about $17 million.
And yet what I am done with that, reflecting the quality of the Old Line portfolio, they are coming on at basically 71 basis points while our number would be 81 basis points. So the delta is just because of Old Line and because you are starting from zero there as opposed to having an existing $52 million reserve at legacy WesBanco. Is that helpful?
Yeah. That’s helpful. As I think about the entirety -- the entire company though, it sounds like $7 million is a bit of a true-up from a credit mark perspective and shifting it to the reserve bucket. But just with the other acquisitions, just wanted to get a sense for what the total dollar amount was in that increase in the reserve that was coming from credit marks versus an originated perspective?
Well, the bulk of the increase in WesBanco only, which is as I said, between $8 million and $10 million is all due to prior acquisitions, where you don’t have -- there is only about $4 million of that $52 million related to prior reserves or prior acquisitions and those are just reserves that have been booked after the acquisition on those loans.
So you are adding between $8 million and $10 million. It’s actually a reduction in legacy WesBanco, I don’t have that memorized and an increase in the five or so prior acquisitions in the last few years that we have done prior to Old Line.
And you could probably think about that the total amount again for WesBanco is $8 million to $10 million, all of that is related to prior deals, but because it’s a negative amount for legacy WesBanco and a slightly higher amount for the acquisition, it’s probably more like of that, let’s call it $10 million, be more like $15 million for the prior acquisitions and minus $5 million for legacy WesBanco.
That’s probably throwing around too many numbers, but the thought is similar to Old Line in that, what you are adding for CECL is related to the good book of the acquired acquisitions that basically don’t have any significant reserves that have been built up since their acquisition date.
And today’s next question comes from Catherine Mealor of KBW. Please go ahead.
Thanks. Good morning.
Hi.
Good morning.
All right. I don’t mean to beat a dead horse but I just wanted to circle back to the expense guidance to make sure I am thinking about this right. So we are coming into this quarter excluding Old Line at about a $74 million expense base.
Right.
And then Old Line has about 14.5% pre-cost savings and then, if we assume -- and remind me Old Line had about 30% cost savings, is that right?
Right. That’s what we spent.
Okay.
That’s capital.
So then if I do 30% of that 14.5% and then only realized 75% of that, maybe let’s just say, by the end of this year then on adding about $11.4 million to that $74 million base, which gets me to about $85 million. So why would we not be ending the year at about an $85 million quarterly expense run rate versus the $88 million to $90 million that you mentioned?
Well, absent to any core efficiencies on the WesBanco side, which we will have. What I was guiding to was the earlier changes you have in the $74 million run rate, you will have higher FDIC insurance next year then the run rate in the third and fourth quarters, excluding the credits, right, just based upon the higher size, the organization and risk factor changes in the calculation.
And you will have the mid-year salary increases that typically for us are in the 3% to 3.5% range, plus stock compensation. Those are the major changes that would increase the core growth rate higher as we proceed through the year, Catherine.
Okay.
And there’s about, as I said, about $13 million of cost savings factored into my model to get to that run rate on a quarterly basis.
Okay. So the $85 million is too low so we really need to keep -- you are saying, if we need to keep operating expenses in the high 80s then for the full year we have got expenses in like the $350 million range, which would -- is about $10 million to $12 million higher than where our consensus is right now. Does that feel right?
It does to me. I am not saying consensus is right or wrong. I am just saying this is what our build is.
Okay. All right. So, sort of what was dry -- so you started ‘19 at an expense range of kind of more in the 71%, 72% range. Just from a core basis what’s been driving maybe the underlying growth, higher than perhaps we expected? Have there been more higher than it was appreciated or regulatory kind of cost?
Certainly, as you go over $10 billion there are higher regulatory costs. We have been building risk management, BSA, AML and other compliance related teams of individuals to meet regulatory expectations.
But as I hinted as well in my script related to Mid-Atlantic market, we would have done this in Kentucky in 2019 adding revenue producers, they take a while to produce bottomline net income, so that would be the wealth management staff that we have hired in some additional commercial lenders.
Okay. That’s helpful. And then maybe circling back on the margin, I think, as we were thinking about Old Line coming on a core basis, let’s just strip out accretable yield, but as we bring on Old Line, I think we had thought about Old Line being NIM enhancing, just given their asset sensitive and the ability to maybe bring down some of their deposit cost. So has anything changed since then or do you still believe that there is upside to the core margin as you kind of put these two balance sheets together and realize some those enhancements?
So there was actually 1 basis point or 2 basis point of core margin expansion in the month of December, which with the model as well showing that the first quarter starts us off a couple of bps higher and then drifts from there, Catherine. So, first of all, lot of loan accretion will come down slowly over three-year to four-year timeframe, the CD accretion comes down very fast.
In fact there will be a significant portion of that recognized in the first half of the year and more than 50% of the total accretion recognized by the end of the year. So that purchase accounting number which starts the year at 22 basis points is expected to end the year at 14 basis points.
We are also experiencing lower accretion from the prior acquisitions. They are down on the core a couple of basis points here to start the New Year. Core -- I am sorry, they are down relative to purchase accounting, I shouldn’t confuse the word core with that, but they are down a couple of basis points the prior acquisitions are.
Okay. But just all else equal, you think a more stable core margin in the low 330s [ph] is appropriate.
Yes. Without a back -- if you -- we have one cut in midyear, so that produces a reduction in our model. But if you don’t believe -- KBW has one cut as well, but if you don’t think that then the stable core margin is what I said in my comments and reaffirm and that’s the 330s, yeah.
All right. Great. Thank you.
Our next question today comes from Steve Moss of B. Riley FBR. Please go ahead.
Good morning, guys.
Good morning, Steve.
Just one thing on the margin here, in particular just on the Federal Home Loan Bank borrowing costs, they seemed a little bit high for the quarter to me and I was just wondering when does that re-price lower?
Well, our $1.4 billion in [inaudible] advances, two-thirds of that re-price is in 2020. There are still are some 220s, 240s in there of one year or less, as well as some 18-month and two-year CDs that will re-price this year that’s factored into our model currently.
And so that you just take a look here the Federal Home Loan Bank should come down next year. As we proceed through the year, starting the year in the low 220s and ending up the year just under 2%. Is that -- I don’t -- sure if you are looking at the total interest expense, which is influenced by volume in addition to rate or you just request…
Just the average balance sheet with the 243 rate caught my eye, so that’s where I was going. So, that was helpful, Bob. And then in terms of the buyback here, tangible capital around, call it 10%? I am just wondering any updated thoughts on targeted capital, your appetite for the buyback here. I mean, obviously, I hear subject to market conditions, but kind of curious for a little more color?
Yeah. Historically, we have kind of used our capital for acquisitions, dividends and buybacks obviously with Old Line and some of the prior acquisitions we want to stimulate those 2020 is all about Old Line. So when you look at kind of the acquisition piece of that being a couple of years out that really heightens the other uses of capital, because we are building capital fairly, fairly quickly, so that at least the buybacks in the dividends.
So with 2.5 million shares left remaining in, I guess, our total in terms of authorizations, we are going to be continuing to utilize that opportunistically as we feel needed. But it’s not something we have done a lot here over the last few years, but given the capital position and the fact that we are on the sidelines for M&A perspective for a little bit, we think that’s an appropriate use, which is why we got the authorization increased.
So in terms of just thinking about that tangible common equity ratio, do you think it’s more likely to head towards 9%, 9.5% or keep it steady around 10% as we think about throughout the year here?
Yeah. I would tend to say, I said a couple of years ago, I was happy in kind of the mid-8%s, but I would tell you that in 9% to 10% in that range, because we are continuing to build it, but offsetting that will be, will be the buyback, so you will -- obviously 9% to 10%.
Okay. That’s helpful. And then just on the, I mean, credit was good, but in terms of the charge-offs for a specific reserve loans, just wondering what types of loans were charged off and any color you can give there?
Well, they are all from prior acquisitions. One is in the Nursing Home business and they are basically commercial real estate, not C&I.
And there were three during the quarter, and again, it’s interesting because you get your own questions, tenant working through when you see questions around an increase in charge-offs 20 basis points we have been a lot lower than that.
The key important thing to remember here is that these were already had specific reserves, right? So the charge-off amount was already identified and reserved for. So that’s why you had the release, but the charge-off number being -- these weren’t surprises.
The dollar amount wasn’t surprising. I kind of don’t like the fact that accounting treats them as charge-offs because from my perspective, it’s kind of a, that gives you misleading look at it, but it’s just the way the accounting has to work in a way the accounting has to show.
But there were specific reserves allocated to these that were then just covered the charge-off amount. We don’t expect that to be any kind of repeatable on a regular basis. I think what you have seen with us overall, I think, was like, we had 9 basis points of charge-offs in the last year. I guess maybe 6 basis points the year before and I think our trends will continue to be -- should be well below the industry based on what we see right now, but it was a little bit of a noisy quarter because of those three, that paid off.
Okay.
$0.8 million of the plus $4 million net charge-offs numbers related to those three credits Steve, as we said in the script.
All right. Thank you very much. I appreciate that.
Sure.
And our next question today comes from Russell Gunther of D.A. Davidson. Please go ahead.
Hey. Good morning, guys.
Good morning, Russell.
A couple of quick follow-ups here, the first you -- so I’d start by saying I appreciate all the color on the expense glide path. You also commented you guys continuously strive for positive operating leverage. So tying all of that together, is that something that you anticipate being able to achieve for 2020 that core efficiency ratio ending the year lower than the 2019 result?
Yeah. I would say, one of the things that we continue to do is continue to optimize our branch network as well too. I mean, we have closed 15 branches in the last three years since January 2017, roughly 7% or so of our franchise.
We are looking real hard at that in terms of our branch infrastructure obviously having 237 branches on a $15 billion bank is a lot of branches, but we benefit from a lot of rural areas where we have got branch deposits and things like that.
So we are evaluating that. We are looking at all of that. But I am very strongly want us to during we can to maintain a positive operating leverage, not just because we are doing M&A, I mean, M&A by its very nature is going to generate positive operating leverage, but outside of that from an organic perspective, it’s something that we really look hard.
So we are looking hard at the expense side of the branch optimization piece of it and then, also the key is, I think particularly with Old Line is to not hit any bumps on the revenue production side as we finish the conversion and move forward with them and so far that looks really good and we are getting a nice lift from some of our prior acquisitions now, as well as well too. It takes a year or two to kind of assimilate them through before you start seeing growth. I don’t think that will happen with Old Line but that has been the case with our prior acquisitions.
But I am still very much believe in positive operating leverage and on a long-term basis, we think that’s very important to us and have an efficiency ratio that’s something we can be proud of even though it’s impacted a little bit by Durbin right now and the margin had a big impact on everybody’s efficiency ratio last year. So you kind of everybody had to level set to a new level.
Got it. Okay. Thank you, Todd. Appreciate it. And you kind of touched on my final comment which or question circling back to the loan growth expectations you guys laid out. I am just wondering if you could parse it a little bit in terms of sort of growth expectations within the newer Mid-Atlantic footprint and what that would then imply for some of the legacy markets and growth rates there?
Yeah. I mean, I look at the loan growth, overall, we had from, obviously, 1% organic loan growth but that’s with those heavy payoffs right, things go into the secondary market and over $200 million in the fourth quarter. So if you were to just use more of a normalized rate for that, you would be looking at around 3% low-to-mid single-digit growth rate.
But those large commercial real estate payoffs, we think that trend is going to continue at least for the first half of this year. But when I look at the momentum that I feel we have got at Old Line and just our production, overall, I think is very good, we did $1.6 billion in production last year, which is a 40% increase over and above the year before.
So from a production standpoint, I don’t see it being a big issue at all from a C&I perspective, we are up 5.9% year-over-year on an annualized growth rate. So we are getting that mid single-digit growth rate in C&I. It’s just -- the things that are going to the secondary market that’s a big headwind for everybody.
So when I look at Old Line’s portfolio, obviously, it’s heavily real estate oriented. So they are going to have things going into the secondary market. They are going to continue to have those headwinds as well, but we have got a lot of growth opportunities.
I think what really matters is, when does the slowdown in things going into the secondary market occur. When do the rate scenario get to the point or when is the marketplace get to the point where everything that’s going to go to the secondary market or the majority of it has actually gone to the secondary market. So you don’t see that big headwind that everybody continues to face.
Right now I would tell you with total of $600 million or so last year that went to the secondary market to outgrow that and to show mid single-digit loan growth with that kind of volume going into the secondary market.
I personally think that’s unsafe and I think that if banks that are showing that kind of loan growth with that kind of money going to the secondary markets, you really got to ask what are they doing.
Because they do think that’s a real headwind that we don’t want to change our underwriting standards, just because more loans are going to the secondary markets, it’s a worse thing we could do.
So we were keeping discipline with regard to underwriting, making sure what we are doing is smart. And at some point that those headwinds will abate and we will start to show I think commercial real estate growth in line with the mid-single digits, that we are currently seeing in the C&I area.
So I guess longwinded answer to your question, but again, I was out in the Mid-Atlantic markets last week and I feel really good about the momentum there, the pipeline there and the lenders. The customers I met with, you got couple of loan requests just on the calls last week.
We are seeing some nice growth in Kentucky, where a couple of our acquisitions were a few years ago. It’s one of our top growth markets right now. So I feel good about this stuff, but if still the headwinds abate, that’s going to be the -- that’s going to be the challenge.
And the pipelines for both commercial and resi are up over 50% from where they were at the end of 2018. So that’s helpful as well.
That’s very helpful. Thank you both. That’s it for me.
Sure.
And this concludes our question-and-answer session. I would like to turn the conference back over to Todd Clossin for any closing remarks.
Great. I appreciate the time everyone has today and it was a noisy quarter, the acquisition, we got a lot of stuff going on and with CECL and everything else, but hoping to get a chance to see a number of you at some upcoming visits. We got a pre-packed scheduled over the next few months in terms of being on the road doing investor visits. I want to thank you for joining us today, and again, look forward to seeing you in the future. Thanks, everyone.
Thank you. Today’s conference has now concluded. We thank you all for attending today’s presentation. You may now disconnect your lines.