Hello, everyone and welcome to the First Bank Earnings Conference Call Second Quarter 2022. My name is Emily and I will be moderating today's event. [Operator Instructions] I will now turn the call over to our host, Patrick Ryan, President and CEO. Please go ahead, Patrick.

Thank you, Emily. I'd like to welcome everyone today to First Bank's second quarter 2022 earnings call. I'm joined today by Andrew Hibshman, our CFO and Peter Cahill, our Chief Lending Officer. Before we begin, however Andrew will read the safe harbor statement.

The following discussion may contain forward-looking statements concerning the financial condition, results of operations and business of First Bank. We caution that such statements are subject to a number of uncertainties and actual results could differ materially. And therefore, you should not place undue reliance on any forward-looking statements we make. We may not update any forward-looking statements we make today for future events or developments. Information about risks and uncertainties are described under Item 1A Risk Factors in our annual report on Form 10-K for the year ended December 31, 2021, filed with the FDIC. Pat, back to you.

Thanks Andrew. I'd like to start just by hitting on a few of the highlights for the quarter and the first half of the year and turning it back to Andrew and Peter for a little bit more detail. Overall, I'd say Q2 showed continued strength. We had great margin expansion, up almost 20 basis points quarter-over-quarter. We saw continued tangible book value per share growth which is something not all banks can say given the AOCI situation at a number of institutions. We had strong high-quality loan growth during the quarter and our asset quality trends continue to hold up well. Our core ROA, excluding PPP, continues to move higher and we continue to bring in high-quality new bankers from competitor banks in our markets. We also saw quality growth coming from both our New Jersey and Pennsylvania markets and we saw an increase in our buyback activity during the second quarter. I'd like to highlight a couple of key strong performance metrics. Our return on assets was 1.38% for the second quarter. Return on tangible common equity of just under 14% and we saw our efficiency ratio below 50% for the sixth straight quarter. We also saw our pre-provision net revenue ROA over 1.80%, again, for the last six quarters. And our net interest margin over 3.5% for the past six quarters. Lending, we were up $149 million year-to-date in loan growth, excluding PPP which translates to about 15% annualized growth for the first half of the year. Asset quality is holding up quite well, given some of the challenges and uncertainties in the economy right now. And we saw a nice rebound in SBA activity. We've got 7 closed loans so far in 2022 and we've got 18 deals in process and we continue to be very…

Thanks, Pat. For the three months ended June 30, 2022, we earned $8.8 million in net income or $0.45 per diluted share which translates to a 1.38% return on average assets. The primary factors contributing to another strong income quarter included an improving net interest margin and effective management of noninterest expenses. Net income increased $665,000 from the linked first quarter but declined slightly by $70,000 compared to the first quarter of 2021. The first quarter of 2021 income benefited from higher PPP fees and a negative loan loss provision during that quarter. After strong loan growth quarters in Q1 2022 and Q4 2021, we are very pleased with our net loan growth in Q2 2022. Excluding PPP loan forgiveness, loans were up $84 million compared to an increase in non-PPP loans of $65.3 million in the first quarter of 2022. During the second quarter of 2022, $15.5 million in PPP loans were forgiven, leaving $10 million in PPP loans outstanding. During the second quarter of 2022, we earned $493,000 in PPP fees. This compares to $860,000 in the first quarter of 2022 and $1.3 million in the second quarter of 2021. As of June 30, 2022, we have $336,000 in deferred PPP loans left to amortize. Deferred fees, I'm sorry. Total deposits were down $12.7 million during Q2 but noninterest-bearing deposits were up $3.1 million. We continue to reduce our reliance on higher cost deposits and noninterest-bearing demand deposits now represent 27.7% compared to 27.4% at the end of the first quarter of 2022. Due to our shifting deposit mix and disciplined deposit pricing, our total cost of deposits increased only 4 basis points in the second quarter of 2022 compared to the linked prior quarter. Our tax equivalent net interest margin increased to 3.76% for the quarter ended…

Thanks Andrew. The earnings release outlines very well the overall results for the lending area in the second quarter. Pat and Andrew highlighted a lot of the numbers in their remarks. My comments around the performance on lending will be focused on non-PPP-related results. As the release shows, PPP loans declined by $15.5 million to $10 million during the quarter. The second quarter represented really the third quarter in a row of solid loan growth. This year, loans grew $65 million in Q1 and followed that up with loan growth of $84 million in Q2. Six-month growth of $149 million puts us in good position to meet or exceed our growth goal for the year of $200 million or right around 10% organic loan growth. Loan growth was solid in all areas of the banks. Both the New Jersey region and the Pennsylvania region did very well as did our Specialized Lending Group. Specialized Lending Group encompasses our larger investor real estate borrowers, SBA lending and consumer lending. Investor real estate overall led the way with approximately 60% of our newly funded loans coming from that area. Our ongoing target for investor real estate is around 50% of new business, so we're watching that number closely. The portfolio can fluctuate pretty significantly with payoffs and in fact, we had a couple of sizable payoffs in investor real estate loans in early July. A summary of loan growth thus far in 2022 compared to 2021 has been really increased funding of new loans compared to 2022. Compared to 2021, I'm sorry. Increased loans in 2022 and decreased payoffs compared to 2021. For comparison quarter-to-quarter, in the first quarter of 2022, we funded $126 million of new loans. In the second quarter, we funded $143 million of loans. Regarding payoffs, payoff loans…

Thank you, Peter. Thanks, Andrew. And at this point, I'd like to turn it over to the conference organizer for the Q&A.

[Operator Instructions] Our first question today comes from Nick Cucharale with Piper Sandler.

Longer term presents more of a forecasting challenge but are there any near-term plans to raise deposit costs? You mentioned the focus on commercial deposits in the back half of the year but commentary on how you expect to not get the rate environment on the liability side would be helpful.

Yes, sure. I mean, listen, the short answer is overall deposit flows and competition are going to drive pricing on the deposit side. Our goal is to continue to grow deposits but at pricing levels that are at or below what we're seeing out in the marketplace. We don't want to drive up deposit costs just for the sake of generating short-term dollars at higher rates. I think certainly, deposit costs are going up. I think over the next couple of quarters, asset yield increases will continue to exceed deposit cost increases. Although I think the margin between those two will start to shrink as we move towards the end of the year. And as you pointed out, 2023 is a question mark, right? But what we're going to see on deposit costs heading into next year are going to be somewhat driven by what the rate environment looks like, the shape of the yield curve, the economy. Is it moving into mild recession or is it holding up? I think there's just too many variables at this point to say with any certainty what Q1 or Q2 of next year deposit costs are going to look like. But I think they'll continue to move higher incrementally over the next couple of quarters but I don't expect it will start to erode the margin at least this year.

Okay, that's helpful. And sorry if I missed it but I believe you were projecting around 10% ex-PPP loan growth for the full year at this time last quarter. Just given 7% growth through the first half, is that still your target?

Yes. We don't change our budget in the middle of the year unless there's some kind of sea change event and I'll let Peter weigh in but I think our view is it's nice to be ahead of schedule at midyear. We historically have seen a lot of production in the back half of the year compared to the front half, so it's a little bit of an unusual situation for us to be ahead of plan midyear. But I think, as Peter said and I'll let him expand on that, we feel like we're in a good position to at least meet plan and we may be able to do a little bit better. But Peter, do you want to weigh in?

Yes. The payoffs number is the killer, right? I mean that hurt us early in 2021 if you recall. We were playing catch-up all year and ultimately had a big fourth quarter and big December actually. This year, I was happy to see January start off strong and the first and second quarters have both been real good. If anybody picked up my comments, investor real estate for example, the area we monitor closely, was way up into Q2 but we did have a couple of decent sized payoffs in the first couple of weeks of July. It's hard to say. It swings up and down. The nature of our client base, they're buying and selling properties. But it's good to see the payoffs have slowed and that carries us through the rest of the year. I mean I think we'll be in good shape to exceed plan.

Our next question comes from Manuel Navas with D.A. Davidson.

What are some of your assumptions for deposit betas? Are you not kind of making them explicit?

Yes. The way we're sort of running the bank is hold as long as we can and move as little as we can while still meeting our deposit needs and our liquidity goals. In terms of how that translates, I tend to focus more on impact on deposit costs. And I think what we saw in the last quarter was an increase of about 4 basis points. I think we'll see next quarter and the quarter after that, that number creep up a little bit. But I hope it will stay kind of in the mid to low-single digits in terms of quarter-over-quarter increase on the deposit cost side.

Yes, Manuel, I'd just add, we have very few deposit accounts that are actually indexed to any rates and we do that on purpose. A couple of things. It allows some more negotiations with folks and it also allows for additional conversations with customers. We're not going to -- as the Fed moves, our deposit rates don't automatically move. On the asset side, we're about 25% give or take on the loan side that automatically move right away. Again, I'll reiterate what Pat said, I think we're going to see deposit costs move higher than what they have in the real short term but we don't have a lot of stuff that's like indexed that's going to go up right away. There's going to be conversations and that will help us kind of hold the line on deposit cost increases.

That's helpful. Can you -- is it hard to quantify then near-term NIM expansion just that it should continue to go up but kind of maybe less across the year as deposit costs do start to rise?

Yes, I think that's right. I mean the magnitude of the shift is a little hard to predict. But if you start thinking through what happened in Q2 and you say to yourself, all right, well the full impact of the increases didn't even show up in the second quarter, so you're going to get a full quarter's worth of the benefit in Q3 plus what we all expect to be another sizable increase today which will show up in the next couple of months of this quarter. Even with an increase on the deposit side, you just start to play around some numbers and it looks like the margin could continue to expand a little bit in Q3 and maybe even into Q4. But beyond that, it's hard to say.

What has been kind of just the tenor of market competition on both loan pricing and deposit pricing so far in your markets? Are you seeing banks raise deposit costs yet? Are you seeing banks push -- are you seeing customers push back on loan pricing yet? Or are both kind of that competition remains muted?

Well, I mean, listen, the competition is out there, right? I mean, I think given some of the M&A activity in the market and with some recessions here on the horizon, I think some banks have dialed back some certain categories of lending and other things. I think the competition is still there, maybe not quite as fierce as it might have been a couple of years ago. But listen, there are certainly borrowers who are saying, hey, I think rates are going to come down, so I'm going to hold off and wait to execute my project until I get a better rate of interest. But most businesses and candidly most real estate investors, they're in the game. It's not -- you may not like the rates that are out there but as long as you're buying assets at the right prices and you're generating reasonable returns, we're still seeing activity. I think the environment right now is -- it's a reasonable one from a competitive standpoint. And certainly, banks are moving up deposit costs but I think most folks are doing it in a similar way to us which is try to move as little and as slowly as possible.

It seems like you're in a great position with loan growth so far this year, that it's okay that the pipeline is a little bit lower than it has been. And you're already seeing some payoffs in July. Is that kind of a welcome slowdown with the loan-to-deposit ratio getting to like 3%?

Yes. I mean I think we like the pipeline to stay robust because even if we want to dial back loan growth a little bit, it's better to have more options and be more selective. Even though, as you mentioned, it's down a little bit, it's actually not really down much over historical averages. And quite honestly, with prepayment activity, with prepayment activity reduced from prior levels, a lower pipeline and slower prepayment activity could still translate into higher net loan growth than what we saw in prior year. I wouldn't read too much into that. And I think to your point, the way we think about liquidity and loan growth is we want to grow loans with high-quality core deposits. And if for some reason there's challenges generating those, that could lead to a slowdown in loan growth just because we don't want to book business without being able to fund it from a core basis. I think the fact that we're ahead of plan just gives us the opportunity to be selective and maybe that selectivity leads to a slower back half of the year or maybe with the number of opportunities and the reduction in prepayments, maybe we'll end up exceeding plan anyway.

Our next question comes from David Bishop with Hovde Group.

A quick question. I noticed in the earnings release it looked like you guys were maybe a little bit more aggressive on the hiring front. Just looking at the FTE employee count, that was up pretty nicely this quarter. Was that you all just seeing some opportunities from some of the bigger M&A transactions within your market? And any commonalities or tenor to those hires that sort of stand out or are they deposit gathers, loan generators? Just curious maybe on the hires.

I think, David and I'll ask Andrew to jump in here, that the uptick in the second quarter is more a seasonal factor because we have a pretty active and robust intern program. We tend to bring in a decent group of folks that help us out during the summer and so I think that weighs in on the numbers. Because yes, we have been adding but we've also been replacing and we've had some folks leave. Sort of excluding the interns, I think the overall number is probably relatively flat. But Andrew, you want to jump in here?

Yes. It was the total FTEs was 219 at the end of last quarter; it's up to 233. Eight of those additions are intern related, so there's six additional. And sometimes it's timing-related in terms of when positions are filled or when people leave. But yes, I think there has been a few good hires, as Pat mentioned, from some larger institutions. Some of that is just replacement hires. There hasn't been a huge shift. The biggest shift is some of those seasonal interns which factor into that number. And if you exclude them, we're up six people. And some of it is replacements or filling open positions and one or two of them are kind of new additions from some bigger banks. Not a huge shift in number of employees.

Got it. The growth you were alluding to in terms of expenses is not going to be a huge outlier with sort of big signing bonuses and such. It sounds like just normal ebbs and flows into the second half of the year, correct?

Correct.

Got it. And then, Pat, maybe just the discussion around loan growth and the concentration with investor real estate, trying to keep that at 50%, do you see an opportunity to grow maybe the pure C&I book a little bit more? Maybe just some update on the state of the multifamily market in your core markets. Thanks.

Yes, sure. The answer is yes. I think we do expect to see continued growth on the C&I side. We had a couple payoffs and paydowns on the C&I side in the first half of the year, somewhat unexpected. We had a sale leaseback from a customer that ended up paying off a commercial real estate loan. And then we had another customer who had a great offer and decided to sell the business which was a significant paydown on the C&I side. I think that was more of a timing issue in terms of C&I growth not as strong as we've seen. But the pipeline there is very active. And on the commercial real estate side, I think we had a couple of fundings in the quarter, a couple of payoffs that we expected in the quarter that didn't happen until early July. I think the increase in CRE during the quarter was somewhat of a timing issue between the fundings and the payoffs. But Peter, I'd love to have you jump in and add any color to that.

Yes. No, I mean I think you hit upon it. We invest in real estate, it's a big part of our business and we want to keep doing it. We just like to moderate the mix between the two. Frankly, over the past few years with struggle, we've always had a little higher level of investor real estate deals in our pipeline. It was a good sign for mentioning here to see as many C&I deals in the pipeline as there were investor real estate in terms of dollars.

We currently have no further questions in the queue. [Operator Instructions] We have no further questions registered, so I'll hand back to Patrick Ryan to conclude today's call.

Great. Thank you, Emily and thanks to everybody for taking some time to listen in on the call. We appreciate your interest. Appreciate the questions today and we look forward to catching up with everybody after the third quarter earnings release. Thanks, everyone and have a great day.

Thank you, everyone, for joining us today. This concludes our call. You may now disconnect your lines.