Q2 2023 WSFS Financial Corp Earnings Call
Participants
Arthur J. Bacci; Executive VP & Chief Wealth Officer; WSFS Financial Corporation
Dominic C. Canuso; Executive VP & CFO; WSFS Financial Corporation
Rodger Levenson; Chairman, President & CEO; WSFS Financial Corporation
Stephen P. Clark; Executive VP & Chief Commercial Banking Officer; WSFS Financial Corporation
Feddie Justin Strickland; Associate; Janney Montgomery Scott LLC, Research Division
Frank Joseph Schiraldi; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Manuel Antonio Navas; VP & Research Analyst; D.A. Davidson & Co., Research Division
Michael Anthony Perito; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Russell Elliott Teasdale Gunther; MD & Analyst; Stephens Inc., Research Division
Presentation
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Wilmington Savings Fund Society Financial Corporation Second Quarter Earnings Call. I'd now like to turn the call over to your host for today, Mr. Dominic Canuso, Chief Financial Officer. Sir, you may begin.
Dominic C. Canuso
Thank you, Mandeep. And thanks to all of you for taking the time to participate on our call today. With me on this call are Rodger Levenson, Chairman, President and CEO; Art Bacci, Chief Wealth Officer; Steve Clark, Chief Commercial Banking Officer; and Shari Kruzinski, Chief Consumer Banking Officer. Before I begin with remarks on the quarter, I would like to read our safe harbor statement. Our discussion today will include information about our management's view of our future expectations, plans and prospects that constitute forward-looking statements. Actual results may differ materially from historical results or those indicated by these forward-looking statements due to risks and uncertainties, including, but not limited to, the risk factors included in our annual report on Form 10-K and our most recent quarterly reports on Form 10-Q as well as other documents we periodically file with the Securities and Exchange Commission. All comments made during today's call are subject to the safe harbor statement.
Good afternoon, and thank you again for joining our second quarter 2023 earnings call. Our earnings release and earnings release supplement, which we will refer to on today's call can be found in the Investor Relations section of our company's website. We are pleased with the solid performance in the second quarter across all our businesses demonstrated by growth in loans, deposits and fee revenue. Combined with strong NIM, capital and liquidity levels and stable credit performance, we remain well positioned to compete in the current economic environment.
After sharing some details on the quarter, I will provide an update to our full year outlook as we typically do with our second quarter earnings release. Second quarter results included core EPS of $1.16 per share, which is a 14% increase over prior quarter and year-over-year. Core ROA of 1.41% which is up 14 basis points over prior quarter and year-over-year and core PPNR as a percentage of assets, which declined slightly to 2.2%.
In the quarter, loans grew $197 million or nearly 6.5% annualized. C&I led almost half of the volume growth followed by CRE as construction loans converted to commercial mortgages. On an annualized basis, consumer partnerships, Spring EQ continued moderated growth at 27%. Residential mortgage grew 23% from our competitive ARM products and NewLane leasing grew 9%. Deposits grew $380 million or 10% annualized, primarily from our wealth and capital markets trust businesses. While trust deposits can sometimes be short term in nature, there are typically no or low-cost deposits and demonstrate the diversity of the overall deposit franchise.
Noninterest-bearing deposit mix was 34% and the loan-to-deposit ratio held flat from prior quarter at 75%. Net interest margin was 4.11%, with loan yields of 6.79% and total deposit costs of 1.16%. Interest-bearing deposit betas ended the quarter at 35% through the cycle. While up 7 percentage points in the quarter, the pace of beta slowed after increasing 13 percentage points in the first quarter. Core fee revenue was up 6% or $3.7 million over prior quarter and up 4% year-over-year when normalizing for the sale of BMT insurance Advisors that occurred at the end of 2Q 2022.
Growth in the quarter was from Cash Connect, Wealth and core banking fees. The core fee revenue ratio increased to 27%, even as our NIM held about 4%. The core efficiency ratio was 55.5%. When excluding growth in Cash Connect funding cost, which is more than offset in fee revenue, and normalizing the first quarter NIE for one-timers that were discussed last quarter, costs were higher 2% primarily driven by merit increases that occurred late in the first quarter along with some continued investment in technology enhancements.
Asset quality remains relatively stable in the quarter. Problem assets increased slightly and remain at levels consistent with the average over the last year. Delinquencies improved to 59 basis points and nonperforming assets held flat at historically low levels of 16 basis points. Net charge-offs increased slightly to $13 million. Recent net charge-off levels are attributable to growth in the NewLane leasing portfolio and the maturation of Upstart vintages.
Losses from these portfolios are expected to stabilize at these levels, are consistent with our underwriting and profitability expectations and have been provided for. As such, and consistent with the stable leading credit indicators across the other portfolios, the ACL increased slightly by $2.7 million. The ACL coverage ratio remained flat at 1.28%. And 4.9% when including the estimated remaining credit marks on the acquired loan portfolio. Access to liquidity remains significant and capital levels remain well above well capitalized.
When reducing capital levels by the effective AOCI, which includes the full impact of the HTM portfolio, all regulatory bank ratios remain well capitalized. We have updated our full year outlook for our key metrics, which can be found on Slide 13 of our supplement. Our outlook reflects 125 basis point rate increase in July, followed by flat rates for the remainder of the year and a mild recession to begin in the second half of the year. Our full year core PPNR is expected near 2.10% with a full year core ROA around 1.25%. Overall, our performance in the quarter demonstrated the resiliency and potential of our fee revenue businesses, the benefits of our diversified deposit base and the strength of the balance sheet. We are well positioned to continue to execute on our strategic plan and serve our markets as the largest locally headquartered community bank and trust company in the greater Philadelphia and Delaware region. We will now open the line to answer any questions you may have.
Question and Answer Session
Operator
The floor is now open for your questions. (Operator Instructions). Our first question comes from the line of Frank Schiraldi from Piper Sandler.
Frank Joseph Schiraldi
Good afternoon. I wonder, Dominic, you mentioned the noninterest bearing, 34% sold deposits, and I think you noted that the trust related deposits can sometimes be short term in nature. And just curious if you can talk a little bit about trends you're seeing or expecting there, maybe a little bit longer term than a quarter on the noninterest-bearing side. Do you still see, in general, a mix shift out of noninterest-bearing or is that potentially offset by the trust business, noninterest-bearing deposits in the trust business?
Dominic C. Canuso
Sure. Thanks, Frank. Overall, I'll speak to trust first, is that they continue to see opportunities in that business to raise short-term deposits at low and no interest rates. But as we mentioned, they can be short term in nature. So quarter-to-quarter, they may fluctuate and would show up in the noninterest bearing or the low interest-bearing DDA accounts.
Overall, as a portfolio, we would expect the noninterest bearing to continue to client as excess liquidity is consumed by our customers. And customers continue to optimize their deposit products, and we believe we're well positioned to retain those deposits, but maybe through a money market account or a short-term CD or potentially even move to AUM if they're looking for Fed products.
Frank Joseph Schiraldi
Okay. So you do expect that 34% shrink by some margin in incoming quarters.
Dominic C. Canuso
That is correct.
Frank Joseph Schiraldi
And then if you could just talk about, you mentioned in the release, you talked about on the charge-off side, 2 C&I credits that had credit events during the quarter. Just wondered if you could provide any color there, and then what that component was in terms of the overall charge-off picture?
Stephen P. Clark
Yes. Frank, this is Steve Clark speaking. Regarding the 2 commercial charge-offs, one was a classified asset that had been classified for over a year. A contractor in the HVAC space, went through a bankruptcy sale that generated less than expected proceeds, hence, the charge-off. The other was a fulfillment company, providing automation equipment for warehouse distributions. That client customer had a dispute with their largest customer over a change order, which resulted in severe cash flow difficulties. So 2 really unrelated occurrences, and really I would view as unique circumstances.
Frank Joseph Schiraldi
Okay. Is that more the driver of the -- just trying to get in terms of size. Is it more the leasing and the Upstart portfolio just maturing and those losses coming through that are driving the net charge-offs to that level? Is that more of the driver? Or is it the 2 C&I credits in the quarter?
Dominic C. Canuso
It's both. As you mentioned and as we referred to in our materials, there were these unique one-off charge-offs, but the maturation of NewLane and Upstart have driven net charge-offs to these levels. As we noted, that 62% of the net charge-offs are coming from NewLane and Upstart, and are performing within the range of expectations that -- but because of the maturation in the vintaging, they've been growing over the last 4 quarters, and we expect them to stabilize around these levels going forward.
Frank Joseph Schiraldi
Okay. Great. And then just one last one, if I could. On the wealth side, I believe you talked about the AUM being market driven, the increase in AUM this quarter. Can you just talk about any putting the market -- leaving the market aside, what net customer flows look like in that business?
Arthur J. Bacci
Frank, this is Art Bacci. We've actually seen really 3 straight quarters of record inflows in AUM. And I think that's attributed to the increased referrals going on between the commercial consumer and wealth businesses at WSFS. We have seen and continue to see some outflows, as you can imagine, just because spend rates with higher inflation, people asking for distributions, this idiosyncratic events like (inaudible) distributions are made from trust. So it's a slight, say, core positive flow. But I'm really positively looking at the future because the flow is coming in, have just been growing pretty steadily over the last 3 quarters, and we continue to see more in the pipeline going forward.
Frank Joseph Schiraldi
Okay. And then if the market is up in 2Q, when you see more of that flow through revenues in 3Q all else equal. You want to look at it?
Arthur J. Bacci
Yes, Q2 will drive Q3, but increasingly, our billing with the Bryn Mawr acquisition is a little bit more complex. We have some that bill monthly, some quarterly. But generally, because we've built in advance, we should expect the third quarter to look positive for us.
Operator
Our next question comes from the line of Michael Perito from KBW.
Michael Anthony Perito
I just wanted to follow up on Frank's question quickly. Dominic, you mentioned that 62% or so of the net charge-offs came from NewLane and Upstart. Do you have the actual like charge-off rate in both of those portfolios that you expect to kind of stabilize moving forward?
Dominic C. Canuso
Yes, we would expect Upstart to be in around 6% on an annualized basis and NewLane to be around 2%.
Michael Anthony Perito
Okay. And when you say stabilized going forward, I mean, how does that -- because in those guidance slide, you guys mentioned you assume a mild recession in the back half of the year. Does that -- is that elevated, I guess, to what would be -- you would expect to see in a nonrecessionary environment from a charge-off perspective? Or is it not really material enough in either direction to read into it that much?
Dominic C. Canuso
No. Well, it's impacting our ACL as in the first quarter when we spoke to updating the economic forecast in the ACL model. But they're all performing relatively in the range of what we've underwritten. So most of the ACL increases forecast base, not performance-based at this point in time.
Michael Anthony Perito
Okay. And maybe transitioning from that line of questioning. As you think about kind of those loss rates -- normalized loss rates in those portfolios, the environment that you guys are assuming over the next 6 months, the kind of the distance you've now put between the Bryn Mawr acquisition. Could you maybe give us an update on how we should think about the mix of your loan portfolio, the target mix of your loan portfolio going forward? I remember years ago after Beneficial you guys were -- had mentioned that you were still targeting to try to get that C&I back up to 50%. Obviously, consumer has grown a lot since then. There's been another deal, lots changed. Can you maybe just give us some updated thoughts about how you think that mix should ideally look over the next handful of quarters if you guys are kind of hitting your targets?
Rodger Levenson
Yes, Mike, it's Rodger. I would say that as we've talked about in the past, in longer term, we would like the mix to be 80% commercial, 20% consumer. And within that commercial bucket, clearly, C&I being the driver. It's a little bit different than where we were several years ago because of the acquisitions were a little heavier on CRE. But what you should expect going forward, and you were pleased with what we saw this quarter is, there'll definitely be growth in the CRE portfolio, but we would expect more growth to come from the C&I book.
Michael Anthony Perito
Got it. That makes sense, Rodger. And then just lastly for me and then I'll step back. Just the guidance update was helpful, particularly some of the exit run rates, and I don't want to put the cart in front of the horse. But just as we think ahead, I mean, is it fair to think of those exit run rates as something that -- on the ROA, and the PPNR ROA is something that, over time, you guys, you would hope in a more normalized deposit environment, there would be kind of upside to. I realize it's challenging to kind of put timing parameters around that now. But just kind of structurally as you think about your NIM, and your profitability targets longer term, is that a fair way to kind of think about those exit run rates? Or would you cite it differently?
Dominic C. Canuso
I think the way you've described it is a fair assumption. I would say it's clearly interest rate environment dependent and that there would likely be some continued deposit beta lag into next year, into the early first quarter. But from then, we would expect NIM expansion, portfolio expansion to improve both margins and ROA from there. So I think the 4Q exit range is probably a decent indicator. But obviously, depending on a lot to play out economically in the second half of this year.
Rodger Levenson
Yes. I would just add to that with the economic uncertainty going forward, the credit, as we've always said, can be lumpy and will play out over the next couple of years. And so all things being equal, that's where we're at in terms of how Dominic described it, credit may be a little bit of a wildcard depending upon the path of the economy going forward.
Operator
Our next question comes from the line of Feddie Strickland from Janney Montgomery Scott.
Feddie Justin Strickland
Just wanted to follow up on that last question. It sounds like if the Fed were to do another 25 basis point hike this week, and we potentially have another one in September and then stop. It would maybe be reasonable to expect the margin to still potentially come up in 2024 over the course of the year if we assume Fed funds remain flat. Is that right?
Dominic C. Canuso
Yes. I don't want to get into specifics of 2024, but with one -- we've assumed one rate increase tomorrow in the rate forecast. Like I said, it really will come down to liquidity trends, deposit betas. And once those settle, though, we do have tailwinds in the mix shift of our portfolio as we liquidate the investment portfolio and it migrates into loans. And that should add some tailwinds to expand margin from there. Again, a timing dependent on the economy.
Feddie Justin Strickland
Understood. That makes sense. And along that same line of questioning, I just wanted to touch on Slide 12. I appreciate you putting out in the deck where you talked about the $1 billion in securities cash flow over the next 24 months. Just trying to think about how that's going to flow through. I mean, should we think about that as roughly $125 million a quarter? Or is that runoff more front-end or back-end loaded? Just trying to get a sense of where that can go, particularly in the next couple of quarters as it relates to both increased yield and AOCI come impact.
Dominic C. Canuso
Sure. That represents the cash flow from the investment portfolio, which to some extent is interest rate driven on prepaid (inaudible), et cetera. But I think it's a fair assumption to assume it's relatively straight line over the 24-month period and would mix shift from a 2.3% yield to loan yields in the upper 6s, if not 7, depending on the rate environment.
Feddie Justin Strickland
Got it. Just one last one for me. Should we see share repurchases continue in future quarters, just given where capital is and the size of the authorization? Or do you think you'll cause on that for now?
Dominic C. Canuso
Yes. As we discuss regularly, we take a quarter-by-quarter view where we evaluate our total capital position, economic stress, credit stress in the environment and anticipated growth in the portfolio. And we believe, based on where we are today, that we would likely see in the third quarter share repurchase and capital return commensurate with the levels we had in the first and second quarter, but we take a quarter-to-quarter view and we can provide another outlook on the next call.
Operator
Our next question comes from the line of Manuel Navas from D.A. Davidson.
Manuel Antonio Navas
Just following up on those exit returns, those exit return ranges. They include a mild recession with if the recession was push back even further, would you be above those ranges or at the high end of the range?
Dominic C. Canuso
Yes. It's fair question. I think the mild recession suggests that there's very limited impact to our outlook other than what we've already incorporated into the ACL. So I think the mild recession is captured within the ranges that were given. And then to the extent a recession is -- doesn't show up, maybe it's at the high end, but of course, it would be dependent upon the type of recession we have, which is yet to be determined.
Manuel Antonio Navas
Do you have an update on deposit betas and kind of what's in the assumption for the NIM?
Dominic C. Canuso
Yes, sure. So just to clarify, through the cycle to date in June, we had a 35% deposit betas. We talked about this in the first quarter call that we expected our year-end deposit betas to be around 45%. I think that holds in this outlook. We have seen them slow down a bit. But given the Fed increases, we'll have to play that out, but we do have some capacity for deposit betas to increase the second half of the year within the NIM forecast.
Manuel Antonio Navas
Do you have kind of a jumping off point for third quarter deposit costs or like a June NIM to kind of help with that modeling?
Dominic C. Canuso
Yes, sure. So our second quarter interest of customer funding cost was a 175 for a total customer funding at 116. That was the June average and that's in the material. Our step off in the month of June was 184 and for interest-bearing and then 123 for total customer funding. And that represents the 35% deposit beta.
Operator
Our next question comes from Russell Gunther from Stephens.
Russell Elliott Teasdale Gunther
I just had a follow up on the loan growth discussion, more just how you'd characterize the updated guide. Is that mid to upper, so the upper single digit reflective of the strength and resolve in the first half of the year, kind of in that range, and you see the back half moderating? Or do you think you can kind of continue at this clip? How would you frame that?
Stephen P. Clark
Russell, I'm Steve Clark. So yes, the updated guidance, mid to high, I think, really reflects a couple of things. It reflects, yes, our performance in the first quarter and first half of the year. Our pipeline, which really has rebounded from the end of the first quarter, where we had some significant production and our pipeline reduced down to kind of the low $200 million, that's a 90-day weighted average pipeline. It's back up to $300 million at the end of the second quarter. So getting significant activity. And I really think our outlook reflects our position kind of in the greater Philadelphia market. As Dominic mentioned, the largest locally managed independent bank.
And our focus is on this market and our larger bank competitors are focused across the country. So we're taking care of customers, and we're taking advantage of opportunities that are presented to us in the current macro environment.
Russell Elliott Teasdale Gunther
I appreciate that. And as a follow-up, in terms of those opportunities, are you guys seeing the ability to recruit commercial lending talent from some of your competitors, given the position you're in? Is that a driver of growth going forward? Or how would you characterize the opportunities up there?
Stephen P. Clark
So yes, we are attracting talent from some of the local competitors. Those additions production from them aren't baked into our outlook. So that's an upside. So here in the third quarter, we expect to announce and onboard several new ads to the team. And we continue to entertain discussions, and we're frankly very selective in who we add to the team. It's a pretty high bar to join the commercial banking team at WSFS.
Russell Elliott Teasdale Gunther
Understood. Okay. I appreciate that. And then the other is just a follow up on the capital return discussion. I appreciate the quarter-by-quarter look and comments on where the 3Q buyback could look, you're kind of right around that 35% total payout that you guys tend to think about. Are there bogeys that we should think about, Dominic, going forward that would -- you would want to see materialize before kind of increasing beyond your more normal targeted payout.
Dominic C. Canuso
Sure. I think first would be to the extent there is a recession and the severity of it, followed by the impact on credit performance. That would be the biggest bogey. In the meantime, we are well capitalized, and we're positioned well to compete, as I mentioned, and we're positioned to be able to return our targeted level of capital on a quarterly basis from there, we'll reassess as we always do.
Operator
And with no further questions in queue, I would now like to turn the conference back over to Mr. Canuso.
Dominic C. Canuso
Thank you for joining the call today. If you have any specific follow-up questions, feel free to reach out to me directly. Also, Rodger and I will be attending conferences and investor meetings throughout the quarter, and we look forward to meeting with many of you then. Have a good day.
Operator
Thank you. Ladies and gentlemen, this does conclude today's call. Thank you for your participation. You may now disconnect.
