First Commonwealth Financial Corp (FCF) 2009 Q2 法說會逐字稿

I would like to welcome everyone to First Commonwealth second earnings conference call.

(Operator Instructions)

At this time I would like to turn the call over to Richard Stimel, Communications Manager at First Commonwealth. Rich, please go ahead.

Thank you. As a reminder, a copy of today's earnings release can be accessed by logging on to www.fcbanking.com, and clicking on the investor relations link at the top of the page. Before we begin I would like to caution listeners that this conference call will contain forward-looking statements about First Commonwealth, it's business, strategies and prospects. Please refer to our forward-looking statements disclaimer from the earnings release for a description of risks and uncertainties that could cause actual results to different materially from those reflected in the forward-looking statements. Now I would like to introduce the President and CEO of First Commonwealth corporation, Mr.John Dolan.

Thanks, Rich. Good morning everyone. And I appreciate you joining us on today's call. I'm here with Ed Lipkus, President and Chief Financial Officer for the First Commonwealth Financial Corporation. And Mike Price, President of First Commonwealth Bank. There is a lot of ground that we would like to cover this afternoon, but given the nature of the environment in which we are operating right now, and the asset quality warrants a significant amount of time and focus. I feel particular attention needs to be paid to the credit quality issues of the second quarter. I think it goes without saying we are extremely disappointed to announce of loss of $18.6 million for the quarter. This loss is largely attributable to credit issues pertaining to our commercial real estate construction portfolio, other than temporary impairment charges and FDIC insurance costs.

Many of the problem credits were made at the top of the market and seven of these loans were participations associated with with a single lender. Deteriorating economic conditions outside of Pennsylvania led us to increase our provision for credit losses. The prolonged economic downturn that many regions have suffered had a significant impact on out-of-state commercial construction portfolio. Even though western Pennsylvania has been less hit dramatically than other areas of the country, economic conditions here are beginning to impact our in-state credits as well, but to a lesser degree. Approximately 75% of the provision increase was due to out-of-state loans. We also recorded $8.8 million other than temporary impairment charge that was a result primarily of credit deterioration in our pooled trust referred CDO's. The second quarter also saw FDIC insurance costs rise $4.7 million, driven by premium increases in the special assessment of $2.9 million.

Earlier this year started to build the infrastructure in the credit and risk areas of the Company, including higher a seasoned Chief Credit Officer and establishing a board level risk committee. We've taken aggressive action to identify the scope and the nature of the credit quality issues that came to light this past quarter. Beyond the standard annual risk assessment of our credit portfolio, we have accelerated a thorough and comprehensive evaluation, which included a review of our hundred largest relationships, and all construction loans over $1 million. In the past 30 days, we reviewed approximately 63% of our commercial loans outstanding. We revised our credit policies to formally limit the size of individual credits, as well as the size of our total relationships with individual clients. Our future involvement in out-of-state, out-of-market credits will be reduced going forward.

Over the last several quarters, our credit infrastructure and overall approach has evolved significantly. This evolution was occurring well in advance of our current credit challenges. Although there are significant economic factors outside of our control, we do believe the steps we have taken will mitigate future risks and enable us to better weather these downturns. Despite the disappointing performance during the second quarter, our capital ratios remain strong and provide the support and flexibility needed to work through this difficult environment. With the economic uncertainties everywhere, and the economy at large continuing to deteriorate, First Commonwealth Board of Directors concluded it was prudent at this time to further reduce our dividend to $0.03 a share.

In our efforts to preserve capital, we still seek to provide some level of continued return to our shareholders. We realize that a strong capital position is the foundation for success in the current economic climate, and the steps we've taken regarding issues of credit quality and the dividend will provide much needed security during the tough times. These actions will ultimately allow us to take full advantage of the market opportunities that we anticipate when the economy begins to recover. We conducted an S-cap type stress test created by the -- the one that was created by the federal government, and we fared well. Ed will get in to more details on this in our internal analysis -- and our internal analysis.

Our core banking operations results continued to improve in the second quarter. Total loans increased $79 million, the low cost transaction savings accounts increased $223 million. Net interest income increased $889,000 and the net interest margin increased from the Q1 of this year. Households growing and I'm especially pleased growth numbers we are originating in the Pittsburgh region. I hope this has given you a basic frame work on which Ed and Mike will build a detailed picture of what's happened over the past three months. And after Ed and MIke have covered the respected topics, I would like to wrap up with a brief discussion on how the second quarter events affect our strategic direction and longer term growth objectives. And with that I will turn it over to Ed Lipkus. Ed?

Thanks, John and good afternoon everyone. During the quarter, nonperforming loans increased $53 million. And we provided $48.2 million in loan reserves. And now this represented an increase of $40 million over the last quarter, $26 million of this provision was related to out-of-state shared national credits, while another $9.7 million was related to a large construction project in Florida that was not a shared national credit. Mike will be going in to greater detail on our commercial portfolio, specifically the loans going in to nonaccrual during the quarter in a few minutes. Reserve stands at 1.85% of average loans out standing. which is about double where it was three months ago. Our ratio of the allowance to nonperforming loans now stands at 101.38%.

Charge offs were $6.7 million for the quarter, of which half were due to two credits in our out-of-state construction portfolio. Mike will go in to some details here later. We did record as John indicated, an other than temporary impairment charge of $8.8 million which is made up of $7.7 million in credit-related charges on eight of our full trust preferred securities, and $1.1 million related to two bank equities. We have included in our press release, a table that details each pool, including the class, the rating, the number of banks, deferrals and excess subordination. I want to point out that any additional deferrals or defaults in the near term on these eight impaired pools, will likely result in a credit impairment charge going forward.

We presently have nine bank equity investments in our investment portfolio with a current book value of approximately $4.3 million. Two of these nine equities experienced lengthened market declines, and were subsequently written down to their current market values. As John indicated, we performed a stress test and despite the year's elevated chargeoffs we do feel confident that our strong capital position will carry us through some of the worst economic times we ever seen. After we stressed our balance sheet, using the guidance and methodology that the government put out, the results of our test showed that we would have passed the test, and we were comfortable with the cushion.

For the second quarter, we continued to see growth on the loan and deposit sides of the balance sheet. Total loans were up $79.4 million for the quarter, with $50 million on the consumer side and about $29 million in commercial growth. Average savings money market and DD&A balances increased about $169 million, or 7% on a linked quarter basis. These deposits are up some $348 million, or 15.2% compared to the balances at June 30, 2008. This continued improvement in our deposit mix really did help stabilize our margin, and Mike's going to provide additional details on what is driving the growth in loans and deposits. Our net interest margin for the Q2 was 3.73%, which represents a 19 basis point increase from the Q2 of 2008. And the margins remain relatively flat on a linked quarter basis. And that's despite interest reversals on higher levels of nonperforming assets. These reversals reduced our margin by about 2.5 basis points for the quarter.

And along with the affirmation variable balance sheet growth, we continue to take advantage of remarkably low short-term borrowing rates. Noninterest expense increased about $6.5 million, or 16.6% compared to the second quarter of 2008. We experienced increase cost for FDIC totaling$ 4.7 million, of which $2.9 million was a special assessment in the -- second quarter here. We had higher repo and collection expenses of a about $1 million. Now these expenses are largely beyond our ability to control. We had also increased expenses due to our loan and deposit growth, increases due to merit increases for salaries and benefits, and these salaries increased $375,000 for five of our new branch offices, that we didn't have in the same period last year, as well as cost associated with our small business initiative.

I do want to point out that we don't plan on building any new branches for the rest of 2009. Excluding impairment losses, our noninterest income was up about $1.8 million. This was mainly due to a favorable legal settlement of $2.1 million. We're still seeing declines year-over-year in our trust business, and service charges on the deposit accounts are still off as a result of lower overdraft activity, but these head winds were partly offset by nice increases in insurance and retail brokerage commissions which have increased nearly 26% year-over-year. We did see some improvement in our service charges., and they've increased $570,000 on a linked quarter basis. And lastly, I just want to point out that in our taxes we recognized a $16.7 million tax benefit for the quarter, but we do expect our tax rate to return in the third and fourth quarter, to a more normal basis, somewhere between 19% and 22% rate. And with that, I'm going to conclude my remarks, and turn the call over to Mike Price. Mike?

Thanks, Ed. Ed just went over the numbers in the provision, and the credit quality ratios. However we feel most key fundamentals within First Commonwealth Bank and our lines of business are improving. Our balance sheet growth is solid with good loan spreads and a better mix of low costs transaction and savings deposits. It's important to note that our growth here is balanced between retail and corporate banking.

I would now like to share some specifics on several of our problem credits that went into nonaccrual loans during the second quarter. Our current strain stems largely from the commercial real estate construction loans that were out of Pennsylvania, and were loan participations. We disclosed specific information in our press release that I will reiterate what we stated. Total nonperforming loans increased $52.7 million during the second quarter, to $81.9 million, or 1.81% of total loans, as of June 30, 2009. Significant additions to nonperforming loans during the quarter include a $20.8 million real estate construction loan, in Kissimmee Florida for condominiums. This project is approximately 60% complete.

A $10 million specific reserve has been allocated to the allowance. When this loan was originated in 2006, this project was 100% presold to individuals who placed 30% down payments. A second loan was a $9.2 million commercial and industrial loan. Cash flow and weakened real estate prices created financial issues for this borrower who develops retirement communities. And a $6.7 million specific reserve has been allocated to the allowance. A $6.2 million real estate construction loan in Ohio for senior housing and independent living, this project is approximately 80% complete. A weakened real estate prices has caused financial issues for this borrower. A $3.9 million specific reserve has been allocated for the allowance of which $2.9 million was charged off. These three loans represent 63% of the increase in nonperforming loans, and account for 44% of the provision. Additionally, all three of these loans are shared national credits. And we receive the annual report which substantiated management's review. Loans in our shared national credit portfolio represented 73% of the increase in nonperforming loans in the second quarter, and 53% of the increase in the provision.

Also, as John mentioned, to better understand and anticipate future strain, we evaluated our top 100 borrowers in the commercial real estate construction portfolio greater than $1 million. This review represented 63% of our commercial loan portfolio. We did see downgrades as interim statements became available. We feel the strain is largely caused by the economy. As we mentioned, our real estate construction portfolio is feeling the most strain. Our exposure in the portfolio that we review consists of these classifications, 23% for multifamily, about 19% of the portfolio for office building, 15% for student housing, 13% for hotel development, 10% for land, 3% for one before family residential, and 17% for other types of development loans, health care, retail, warehouse and so forth. The review that we conducted on this portfolio given us a comfort level that we identified the current problems in this portfolio.

As John mentioned we have formally limited the size of individual credits, as well as the size of our total relationships with individual clients, in order to mitigate risk and diversify the portfolio. In the past, we have felt somewhat insulated in western PA from the full spectrum of the recession. This seems to be holding true, and we are feeling the brunt of the economic environment from our out-of state-credits. We would share the following economic I believed indicators in the Pittsburgh region, commercial vacancy rates in the Pittsburgh region are lower than the national rates. Housing values in the Pittsburgh region appreciated for the 12 months ended March 31, 2009 by a little over 1%, compared to depreciation of approximately 3% for the US average. Employment in our primary market area declined about half of the national average from May 2008 to May 2009.

Just a couple of comments regarding core banking fundamentals, and John and Ed have already alluded to these. But our total loans increased $79 million or 7.1% on an annualized basis from the end of the first quarter of this year. About 36% came from the commercial sector, and 64% came from the consumer sector. Our average low cost deposits transaction and savings deposits grew $169 million, or 7% from the first quarter of this year. Our consumer households continuing to increase in a market that's losing population. In the Pittsburgh market, our consumer household growth is double the growth rate compared to the rest of our footprint, and we feel very good about that . And we are seeing even greater household great rates in our small business area where we invested.

Improvements in the sales productivity and service culture, coupled with new talent traction in our small business model, and several successful marketing campaigns are really among a cadre of contributing factors I think spurring our core banking operations. We have good momentum in the consumer and the small business area. And we really feel like we affected the turn around in the vital businesses. We are experiencing nice deposit and household growth. Wealth management is being better integrated with our consumer and commercial services area and Ed alluded to traction there we have with our financial advisors and our fees there. We are also seeing good cross sales and deposit gathering in the commercial service area, and we're pleased with the traction we are seeing in our lines of business. With that I will turn it back to John.

Thanks Mike. But before we conclude the call and answer questions that you might have, I would like to address a few more strategic items that Ed and Mike touched on. I think its important to put the second results results in context of the overall strategic direction and our long-term growth goals. Even with the challenges we face as a result of the ongoing economic conditions, and the recent asset quality issues, there is enormous opportunity in our own backyard. Our strategy has remained consistent, and our execution of that strategy led to a strong organic growth within our market. We continue to improve sales and service culture, and this has been the spark for bringing new client households as well as growing in loans and transactions savings accounts.

We generated a nice balance in our loan growth between commercial and consumer. And we believe our lines of business will continue to benefit from the opportunities inherent in the market disruptions caused by the competitive landscape in our backyard. These opportunities can be seen most dramatically in the household growth in the Pittsburgh market, which is twice the rate compared to the rest of our footprint. Obviously we are not without our challenges. The credit losses and asset quality issues had a dramatic affect on our performance. But we have identified the scope of the issue, and are working not only to contain it, but mitigate the risk of it happening again. Specifically, we will limit growth in out-of-market commercial real estate construction credits, which is currently account for 8% of our total commercial loan portfolio.

And finally, we continue to look at all areas of operations, for places to reduce cost. Significant reductions have been made to discretionary expenses. However, increases we experienced in our FDIC premiums and collection and repossession associated with our second quarter credit issues created additional challenges. But even so we are focused on reducing expenses that we have control over. We simply want to make sure that the growth initiatives are developed and implemented as efficiently as possible. So with that, I would like to thank you all for your time here today, and open up the lines for your questions.

(Operator Instructions)

We have a question from Damon DelMonte of KBW

Hi, good afternoon guys, how are you?

Good, Damon, how are you doing?

Good thanks, could you go over the internal policies you may have changed with regards to under writing, and I think you mentioned about limiting the size of exposure to any one particular borrower. And maybe tell us how the levels have changed, and maybe even discuss what your largest exposures are right now?

Well, I will say we have established a $50 million limit for the house limit., and we have 4 credit relationships in excess of that. We have looked at reducing the exposure to individual projects, or companies, and we lowered that at $15 million. And that kind of gives us a comfort level, that we have enough diversity within the $50 million level.

Okay. The individual credit you said is $15 million?

That's correct.

Okay. Let's see. How about -- Ed, this is probably directed towards you. In your comments, did you mention you had a $2.1 million one time gain this quarter? On a legal settlement?

Yes it was, Damon.

Is that in your -- other noninterest income?

Yes.

Okay, and then I'm trying to -- looking at the exhibit in the press release, what is your total shared national credit exposure?

Hang on, we are searching. Do we have a number on that? We will get back to you on that.

Okay. Well my next question kind of goes off of that, what percentage of that is nonperforming? Of your total nonperforming loans, how much of that is actual shared national credit?

Hang on. Well -- Okay. Shared national credit is $336 million in total. -- and the total related to nonperforming? Why don't we move onto the next question, and address that before the end of the call here.

And my last one is, could you comment again on the pool trust deferred exposure and the exchange with the SEC, and kind of going back to 12/31, the events that took place.

Ed you want to cover that.

Sure, well, Damon, we really don't want to go in to too much detail at this point. We are still in discussions with the SEC. And there are several variables to affect the outcome. It depends on whether they are considered type one or two, subsequent events. And then the impact that these events would have on probabilities of default that we assigned to the two issuers as of December 31, 2008. I will give you guys a range. At this point, we estimate that the 2008 net income could be reduced by $2.5 million on the low end after tax to about $11 million on the high end. For offsetting this into first quarter 2009, we would have an increase in our numbers to the good of on the low side of about $276,000 to $2.2 million, again these are after tax numbers. And those things would flow through to the balance sheet as well, and we would be at the same capital levels on March 31st, irregardless of the restatements.

Okay. So basically the SEC is kind of calling into question some of your valuation techniques, as of 12/31 because of the event that took place with those banks.

They are not really calling in to question the valuation, they are simply saying that you had two banks announce deferrals. And so there -- basically -- so I guess -- I would agree that depending on how -- what probability of default we assigned to the banks, I gave you a range of what you can expect if we had to restate.

The issue is the timing of the recognition of the loss, Damon.

Okay, got it. Thank you very much.

The shared national credit that is in nonperforming is $37 million.

Okay. Great, thank you.

Sure. Next?

(Operator Instructions)

We have a question from Tom Alonso of Fox-Pitt Kelton Cochran Caronia Waller.

Morning, guys.

Hi, Tom.

I just want to make sure I got some of the numbers correct. The breakdown, 23% multifamily 19% office, that's on the real estate construction balance of the $476 million on the balance sheet?

That's correct.

Okay. Okay. And then is that 336 shared national credit portfolio, is that comparable to the break down you gave -- in the fourth quarter -- that portfolio was what about 360, and then you changed disclosure as to the way you presented it in the first quarter, so I just wanted to make sure that's going back it's the same or similar.

It is similar. Yes.

Okay. So then, P&L's went from about $12 million to $37 million in that portfolio over the past two quarters?

That's correct.

Okay. And this was -- the hundred largest credits that you guys reviewed, that was -- I assume that includes a majority of our shared national credits if not all of them. And that's outside of the national SNIC exam?

That's correct.

Okay. And so you went through everything, and it was just these three that popped up on the radar screen that were in need of a provision?

Those are three that went into nonaccrual. We have made adjustments for others that had already been identified.

Okay. There is -- there are then -- it's safe to say additional provisions that you put -- these are the three you identified because they are the largest.

Three newly identified problems, yes.

Okay. These are new. Okay. These are new as of, I got you. Okay. Okay. Okay, and then there was one other comment that I missed, something like 8% of your commercial real estate was out-of-market, is that right? I think that was at the end there -- in your sort of closing comments, John?

8% of our commercial loans.

Okay, 8% All commercial loans.

Yes.

Okay. Okay. That's it for me, thanks, guys.

(Operator Instructions)

We have a follow up from Mr. DelMonte with KBW.

Hi. Could you give us a little color on the provision going forward? This is a pretty big reserve build we saw this quarter. I mean, is it safe to assume that you are comfortable with this level, and you think that provision similar to what we saw in the first quarter or fourth quarter of last year is a better run rate?

Well. Yes. Definitely this is an aberration we feel. We feel that previous quarters were more -- more normal. You can see that even in the last few quarters, first quarter and the fourth quarter of last year, those were high compared to our normal provisions as well.

Damon, I want to add that it's hard to sit here and predict that we would have been putting these numbers out when we had our last conference call. So we just want to add cautionary -- I guess statements here -- that as all depends on what happens with the economy. I don't want to sound , I don't know, blase, but we have to be -- we want to be careful and not get ahead of ourselves here. I think we have seen some strain as Mike indicated. We did a review and we saw some deterioration, and so it's hard to we can't give guidance and that's about all we can see on the matter, sorry.

Well, I would like to say last quarter somebody asked me the question about what I saw as losses going forward. And the question came up, how come this number significantly larger than we had put in there -- that we had talked about last time. And I think that the construction portfolio is kind of it was all current, because they have generally have interest reserves and it didn't show up as nonaccrual. But I think that our review of these credits showed in that in any where there was some strain, and I kind of like to be able to keep monitoring that going forward for our future analysis.

Okay. Then my last question, then I'll stop here. The dividend reduction, the change in your common equity is still pretty healthy at almost 7.5%. What's the thought process behind reducing the dividend to $0.03?.

I think it was a balance between -- still -- treasuring some of the payout or the shareholders that still look for the payout, but really preserving as much of the capital for during these uncertain times as we could.

Okay. Thank you very much.

Okay, thanks Damon.

Thank. We have a follow up from Mr. Alonso of Fox-Pitt Kelton.

Hey, just to your comment on the interest reserves. In your analysis, do your sort of -- were you looking at borrower's ability to come out of pocket? How does the interest reserves factor into this new analysis that you did?

We factored in to it's ability to see them through the end of the construction period.

Their interest reserves or ability to pay out of pocket?

Both, both factored in to the analysis. We also factored in the current market conditions of the properties that they're building. And so the effect of the reduced prices or the reduced demand in those areas that they will have on the end product when it's done..

Okay. Okay. Thanks.

Good.

(Operator Instructions)

Gentlemen, we have no further questions, do you have any closing statements at this time?

I'd just like to say thanks for your questions, and your attention and we look forward to talking to you again next quarter.

Thank you, this does conclude this call at this time, you may disconnect.