First Commonwealth Financial Corp (FCF) 2009 Q4 法說會逐字稿

Hello and welcome to the First Commonwealth Financial Corporation fourth quarter 2009 earnings conference call. All participants will be in listen-only mode for this event. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. I would now like to turn the call over to Rich Stimel. 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 selecting the Investor Relations link at the top of the page and then selecting News on the left side of the page. We have also included a slide presentation on our Investor Relations page with supplemental financial information that we'll reference throughout today's call. With me in the room today are John Dolan, President and CEO of First Commonwealth Financial Corporation; and Mike Price, President of First Commonwealth Bank. After brief comments from Management, we'll open the call to your questions. For that portion of the call, we'll be joined by Bob Emmerich, our Chief Credit Officer; and John Previte, our Senior Vice President of Investments.

Before we begin .I'd like to caution listeners this conference call may contain forward-looking statements about First Commonwealth, its business, strategies. and prospects. Please refer to our forward-looking statements disclaimer on page two of the slide presentation for a description of risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Now I'd like to turn the call over to John Dolan.

Thanks, Rich, and hello, everyone. Thanks for joining us today. Our agenda of today's call includes an overview of the fourth quarter, key highlights for the Company, and our growth initiatives for 2010, and then Mike will cover financials in more detail and address the business line of performance. He will then wrap up with what we're seeing in terms of credit quality. Finally, we'll then open it up for questions.

Before we get started discussing 2009 performance, I'm pleased to announce that today, Bob Rout has agreed to join First Commonwealth as Executive Vice President and Chief Financial Officer. Bob brings with him 35 years of banking experience and served most recently as the CFO of another local financial institution. We're looking forward to having Bob on board.

Turning to our fourth quarter result, which are highlighted on page four of the slide presentation, we reported net income of $3.3 million or $0.04 a share. This compares to net income of $8.9 million or $0.11 a share in the fourth quarter of 2008. The year-over-year decrease was primarily a result of a $6.8 million after-tax increase in the provision for credit losses as well as an increase of $613,000 after-tax in the other than temporary impairment charges. Higher provision related to a $46.3 million commercial and industrial loan in Pennsylvania that migrated to the non-accrual status during the fourth quarter 2009. Mike will give more clarity on this credit later in the call. The other than temporary impairment charges resulted from further credit deterioration of the company's pooled trust preferred securities.

Partially offsetting the year-over-year increase in charges was an increase in our net interest income, as we were successful in shortening the maturity of our deposit portfolio and drove growth in the lower cost transaction and savings deposits. We also saw a year-over-year decline in operating expenses as we continued to impact, see the impact of our cost containment efforts. Despite the challenges, we achieved a number of highlights for both the quarter and the full year. Net interest income grew nicely in the fourth quarter and significantly in 2009 versus the comparable prior year periods. This is the second consecutive year that we've achieved net interest income growth. The last time we did this was during the 2003 to 2005 period, when we had two acquisitions. In short, this growth is being driven organically by our core banking business of retail, commercial, and wealth.

In looking at our balance sheet, which you can see on page six of the slide presentation, transaction and savings deposits grew an impressive double digit from the year-end 2008. Improved business deposit gatherings, a disruption in the Pittsburgh market, a successful summer advertising campaign, and better sales productivity were driving factors for the year-over-year performance. This core transaction and savings deposit growth was important for several reasons. First it indicated, it's an indication of strong household growth exceeding 3% in our core markets. Second, it provides less expensive and a stable source of funding, lowering our overall cost of funds. Additionally, it lowered the percentage mix of more cost and less stable time deposits, and finally it enabled us to pay down borrowings substantially, thus deleveraging the balance sheet, and this was accomplished while growing the loan portfolio in a disciplined manner at the same time.

On the asset side of the balance sheet, we prudently grew commercial loans. In consumer loans, we also posted solid growth for the second consecutive year. A brief comment on our loan portfolio. We continue to be challenged by a high level of non-accrual loans, but this is driven primarily by a handful of large credits and is not indicative of a systemic weakness in our loan portfolio. Indeed, two relationships represent $85.3 million or 58% of our non-accrual loans. Excluding the large credit that I previously mentioned, we only had $1.7 million of new non-accrual loans during the quarter, and the deterioration in our construction and loan portfolio that impacted our second and third quarter results appears to have been abated. We view this as a preliminary sign that our asset quality has stabilized.

Nevertheless, even though our overall portfolio continues to perform well, we currently have 62 credits that exceed our internal hold limit of $15 million. While the vast majority of these credits are strong, we feel it's prudent to manage down our large credit exposures through attrition and select participations in loan sales. However, this will take some time, and until then, the large size of these credits increases the risk of earnings volatility. Today, we have controls in place that we've put in place over the past 12 months to restrict the size of future exposures and define our lending market to be more close to home. We've created a strong and independent credit function under a single leader within First Commonwealth, and that's Bob Emmerich. We have focused our loan origination efforts within our core Pennsylvania markets and we've begun to strive for consumer and commercial loan balance and we will avoid concentrations. We're confident that these items will mitigate some of the risk to First Commonwealth in the future. That said, we'll continue to monitor our portfolio and make any necessary adjustments should issues arise.

Having said that, we feel that our capital position is strong and sufficient for our risk exposures. As you can see on page 15 of the slide presentations, our tangible capital equity ratio is at 7.5% year-end, and our regulatory capital ratios are comfortably above the well capitalized levels for the regulatory purposes. This provides First Commonwealth with a strong foundation from which to move our business forward. We're excited about the opportunities as we move into 2010 and the solid performance that we've built to capture future growth. We will continue to follow our conservative approach to capital preservation and we'll maintain a reasonable dividend payout ratio and build capital through retained earnings. We understand we're not where we want to be at this time.

Looking ahead into 2010, we're committed to further implementing our vision to becoming the highest performing Pennsylvania bank and delivering locally as a responsible community leader. We'll continue to diligently work to align our bank's goals with shareholder values. With that, I'd like to turn the call over to Mike for a discussion of our financial performance. Mike?

Thank you, John. I will keep my comments brief, as the supplemental financial data we have provided for you on our website gives you a wealth of detail on the financial metrics. Certainly, First Commonwealth is continuing to feel the impact of the challenging economic environment and its effects on our commercial loan portfolio, mainly in our construction loans. However, there are areas within First Commonwealth that continue to improve. I will get into those, but first I'd like to provide some additional details about our credit quality issues.

Total net non-performing loans increased approximately $15 million or 11% during the fourth quarter of 2009, significantly less than the increase in the prior two quarters. Fourth quarter additions were primarily driven by a single relationship in our C&I loan portfolio located in western PA. Regarding that credit, the bank entered an unsecured loan agreement in 2004 with an individual whose business is retail property management and development. That relationship increased over time to a total of $46.3 million. In December, the bank determined the loan was impaired. The borrower has very similar lending arrangements with three other banks, all of which are considerably larger than us. The loan is not assured national credit and there's no agent. However, the banks are currently negotiating with the borrowers jointly. First Commonwealth has made a loan loss provision this quarter that we feel is adequate.

Looking at the entire non-performing loan portfolio at December 31, 2009, which you can see on page eight of the presentation, we had $148 million, which represents 3.2% of total loans. The construction portfolio has the largest amount of non-accrual loans, but represents only 8% of our total loan portfolio. And 94% of the construction non-accrual loans are out of Pennsylvania. Also, about 17.2% of our non-performing loans or $25.5 million was shared national credits, which you can see on page 23, and nearly 48% of the portfolio were loans outside of PA. Out of state lending is a practice that we've reduced earlier in 2009.

Looking at the percentage of non-performing loans to outstanding loans by type, 17% of construction loans are non-performing, 2% of commercial real estate loans are non-performing, and 4% of C&I loans are non-performing. As John mentioned earlier, we're seeing continued improvement in some fundamentals within lines of business of First Commonwealth. As a result of our efforts, growth is balanced between consumer and commercial banking and we're getting good loan spreads and a better mix of lower cost transaction and savings deposit. Household growth continues to be solid and our attrition rates of households are remarkably low.

Regarding some of the fundamentals, as you can see on page six, total loans from year-end increased $217 million or 4.9% on an annual basis. Of that, $153 million or nearly 75% were in the commercial loans and $64 million or approximately 25% were in consumer loans. Commercial loans grew 5.7% and commercial loans increased 3.8% for the year. As you may recall, we exited the mortgage origination business about three years ago, and this portfolio has been running off since. Excluding this planned run-off, consumer growth was equal to commercial growth, and indeed that will continue to be our goal. Total deposits increased $255 million or 6% in 2009. Lower costing transaction and savings deposits increased $487 million or 20% during the same timeframe. These lower costing deposits represented over 60% of total deposits at December 31, 2009, and that compares to 57% a year earlier in 2008, and this is a nice shift in the mix of deposits. We expect the shift to continue over time, which will help drive the net interest margin performance.

I'd also like to emphasize the improvement in average FICO scores at origination. For the year, new consumer loans had an average FICO score of 247 (sic) versus 242 in 2008. Not a huge jump, but we've not sacrificed our underwriting standards to generate this growth. As John mentioned earlier, we're aligning the company's goals with our shareholders' values. Specifically, we'll continue to improve sales and service execution. On the lending side, we will have balanced growth between consumer and commercial lending. We are going to reduce our out of market real estate exposures and we will scale down our large individual credit relationships. And on the deposit side, we will further drive transaction and savings deposit growth with a focus on the small business segment.

Now I'd like to turn it back to the Operator and open it up for some questions.

I would like to add one more clarification. Mike mentioned the FICO scores were at 247, they're actually 747. I hope you guys caught that.

Sorry about that, John.

So we'll open it up for questions.

(Operator Instructions). Our first question comes from Damon DelMonte at KBW.

Hi, good afternoon, guys, how are you?

Hi, Damon, how you doing?

Thanks, John. You mentioned you had 62 credits that exceed the internal limit of $15 million. Could you give us some perspective on the size of say the top three or top five of those?

This is Bob Emmerich. We have 62 that exceed the $15 million level. We have five relationships that exceed our relationship level of $50 million, and those five are in mostly in commercial real estate, apartments and residential development, student housing, office, and hotels. Within the hold limit of $15 million, just looking at those credits, they are pretty well split between our commercial real estate business and our corporate finance business and they would consist of real estate developments. And also on the commercial side it would be the major companies headquartered within Pittsburgh.

I think I'd like to add, Damon, this is John, that those limits are probably higher than our risk tolerance at this point in time. And that's why we have instituted the policies and procedures to try to minimize that so it won't happen again.

Okay, great. And are any of those five relationships that are greater than $50 million, are any of those on a watch list right now?

Two of them on a watch list. Not the entire relationship, but just individual projects.

Okay, so just a portion of the relationship has something that's on the watch list?

Correct.

Okay, great. And then with respect to the margin, you guys saw a nice increase this quarter. Could you talk a little bit about your expectations going forward for that?

Well, Damon, this is John again. As you know, we don't give guidance, but I think that the growth that you've seen is mostly in the low cost deposits, and they will have a tendency to improve in value when and if -- I guess it's when rates do increase, and they will be worth a little bit more. So it's hard to say when that actually occurs, but that will have a tendency to be favorable, and we'll continue to monitor the asset liability mix. We're pretty matched in our adjustable rates assets and liabilities, so it's really going to be the level of the rate where the rates are, the level of rates will determine that change.

Okay, great. And then with regard to the taxes this quarter, you had a benefit of $1.7 million. I guess what was the reason for that and what can we think about for a normalized rate in 2010?

Well, I think that the tax rate in the fourth quarter, it's one of those things that trues up at the end of the year. So as the volatility in earnings occur throughout the year, that changes the impact of the tax rate. And so I would probably look more at the impact of the tax free income was greater when you have lower income before taxes, and I would probably look at that going forward being closer to where it has been in the past when we don't have the larger allowance for loan loss and OTTI charges.

So is 20% a good estimate to use?

Well, I think that sounds a little bit low compared to where we have been.

Okay, that's all I have for now. Thank you very much.

Thank you.

The next question comes from Rick Weiss at Janney Montgomery Scott.

Hi guys.

Hi, Rick, how you doing?

I'm fine, thank you. Lots of stuff going on this quarter for you, so I'll try to stick to the big picture. And just wondering, how long -- or what's your crystal ball tell you will it take to get rid of or reduce the non-performing assets, and when you can start turning around and focusing on revenue growth and really getting to your business plan?

This is Bob Emmerich.

Hi, Bob.

Most of our non-performing assets are in real estate, and real estate workouts can take a while, particularly if you have to pursue foreclosure. This is something we're intently focused on and working down as quickly as possible, but recognize that it takes time, particularly given the market for asset sales today and the prices that are in the market. We want to make the best decision for the Corporation, and if that means holding on to the asset for a little while, we would do that rather than trying to have a fire sale.

Having said that, Rick, this is John -- we are growing organically and I think that we're not, we have a different group of folks that are focused on cleaning up those non-performing assets than we have that are actually building the business, and you can see we're trying to keep both of those focuses going at the same time and we've been successful over the last year in making that happen.

Okay, and John, when you're talking about growing organically, that would be mainly in the Western Pennsylvania area I'm assuming?

Absolutely, yes.

Okay, and so that would be about 5% growth, would that be a normal run rate in like a decent year? You couldn't even get that this year because of the recession, but western PA, is that what you would expect?

Well actually, I'd be looking more at the growth opportunity being the deposit area, and that's because of the disruption that has occurred in Pittsburgh. And so I think that I would focus more on that area and I think that's going to have a tendency to drive the cost of our liabilities lower. So the growth is going to be, we're going to be probably more focused on getting into or deploying our capital appropriately with the credits. So we'll be a little more stingy on that area and we'll focus on growing the deposits and primarily focus in the small business markets.

Okay, and let me just ask you about the charge-offs and provisions, it seems like you don't really match too much with the provision and the charge-offs on a quarterly basis, more so annual. Is that the better way of looking at it on how you see life rather than worry about quarterly fluctuations?

I think that each charge off and provision is -- they're done independently, and you'll see that the fourth quarter charge-offs were a little greater than average because of the valuations that we have done on the corporate or the commercial real estate and have written those down to net realizable values. So that's probably, there's probably more volatility in the charge-offs than is related to the provision.

Okay, thank you very much.

Sure.

The next question comes from Tom Alonso at Macquarie.

Hi, good morning guys.

Hi, Tom.

Just real quickly here, thinking about these large relationships you're talking about with 62 over $15 million and five over $50 million, just doing quick math, that's a little over one-third of your commercial loans. If your goal is to move those down, where does the growth in commercial loans come from? If those are running off and they are pretty lumpy and larger and you got to move big chunks, just trying to get a sense of how you can actually grow that portfolio.

Good question, this is Mike Price. I think we can grow it in our middle market or regional lending area. We've also had a nice uptick in small business. It will be important that we continue to grow consumer. We hadn't grown consumer until the last two years for a couple of years, and we also have small market share. I mean when we look at Pittsburgh, we probably have 3% or 4% share and where you're seeing a lot of our good household growth is really probably coming from that area. So even with flat household growth we feel like we can grow in the middle market space. And then we'll be opportunistic certainly with commercial real estate in our backyard where -- that's not where we've had strain in the portfolio in the last year or so.

Okay, and then just trying to get a sense, you said that large credit, the C&I credit, the $48 million some odd, that's unsecured?

Yes, that's unsecured.

And that's the one where the borrower has relationships with other banks and you guys are negotiating together?

Correct.

Okay, I just want to make sure I heard that right. That's fine and then I guess the move down or the SNIC portfolio had a pretty decent drop in NPLs. I guess some of that stuff was charged off this quarter, that's what drove that decline?

Yes.

Okay.

We took about $24 million in charge-offs in the fourth quarter out of the total charge-offs of $30 million related to writing down real estate assets to comply with the new regulatory policy that came out October 30th. And just to add-on top of that, this is John, Tom, we did liquidate one other, one of the loans of the non-performing loans we were able to sell it at a reasonable price.

Okay, when you say that, that's the $24.5 million of the charge-offs were a result of federal guideline changes -- that's those October changes on CRE? I just don't understand what -- my understanding of those was they gave you a little bit more leeway? I don't get why the charge-offs were driven by that.

This is Bob Emmerich again. The guidance that you need to writedown the loans to the as is value of the property from an as is appraisal. And so we had reserves on these and we took those charge-offs down to the as is appraisals.

Okay. Fair enough.

You're correct that the guidance was also attempting give allow --

A little bit more leeway?

Leeway in terms of the workouts if you had a plan and were sticking to the plan.

So you basically had assets that you just wrote them down, okay. Oh, you mentioned earlier I think, John, in your prepared comments that you had shortened out the deposit maturities? Did I hear that correctly?

Yes. And that's basically taking CDs and allowing those to run-off -- particular single service household CDs and allowing us to grow more significantly in the transaction savings accounts.

Okay. I just wanted to make sure I heard that correctly. That's all I had. Thanks guys.

Thanks, Tom.

The next question comes from Matt Schultheis at Boenning & Scattergood.

Good afternoon.

Hi, Matt.

A couple of quick questions for you on your other other income item, and it looks like you increased from about $1.6 million to $3.2 in linked quarter. What drove that increase?

Let me look into that, and before the end of the call, I'll get back to you on that.

Okay. Net interest margin obviously was a nice increase, but you had something that I haven't seen anybody else really have, which was a increase in the yield on loans. And was wondering if you could comment on what drove that this quarter, particularly since I would have assumed you would have had some reversals on your $48 million unsecured credit, and if you can discuss the impact of floors on your loans?

Okay, let me answer your first question first. I think that the last quarter, the other income had some reductions in that income due to some setting up or establishing some reserve for a potential charge to income on swaps.

Okay.

So that when the credit deteriorated, we had some swaps -- back to back swaps which we had to recognize. It went through that category. So the improvement this quarter was just not having the negative in last quarter, and I think that gets to the increase in the yield as well, because we had about $2 million of reversal of interest in the third quarter of income that was earned but not yet received. By the way, just to clarify, it's a $46 million, doesn't make you feel any better, it's not $48 million, it's $46 million.

I don't want to give you $2 million more to worry about there.

I heard a couple of people use that, but in any case that's actually -- he was paid, there was no interest reversal in that credit.

Okay. With regard to overdraft protection, what do you guesstimate the impact will be on a quarterly basis when that takes effect, the opt in feature?

This is Mike Price. We're looking for that to have an impact in the second half of the year, and we feel perhaps less exposed than most of our competitors, because I think unfortunately our fee income as a percentage of our overall non-interest income was probably a lot lower than other banks. We didn't do a lot of the hold your check for three days, post your debits before your credits and really ring up those fees, so I think the impact for us is less. We're estimating about -- I think early estimates are about $200,000 a month.

Having said that, Matt, we don't give guidance.

Oh, sorry.

Well, at this point that's a guesstimate until we see whether customers opt in and all of those other fine things, so I appreciate your help and have a good day.

Thanks, Matt, you too.

The next question comes from Andy Stapp at B. Riley & Company.

Hi guys.

Hi Andy, welcome back.

Thank you. Any sense of clarity when non-performing loans may peak? Is it sooner rather than later? You just don't have any clarity yet?

John -- or Mike made comments earlier that aside from the large credit we had going non-accrual in the fourth quarter, we only had a $1.7 million of additional non-accruals. And in terms of the construction lending, I think that seems to have abated a bit, and so we're hopeful that we've seen the peak.

Okay, that's good enough, and with the peak, do you think you're there with reserve build?

We do. We're comfortable with the reserves that they're adequate. If you bifurcate the reserve and look at the performing loans, the reserve to performing loans has increased over the last year from probably oh, I think maybe 74 or 75 basis points up to 1%, a little over 1%. And I think that's appropriate for the level of charge-offs that the banks had historically. If you look at the impaired loans then, the level of reserve on those had been running in the range of 35% or so, which is fairly typical for the industry on their impaired loans. It's dropped now to about 20%, and I think a lot of that is due to the fact that we took the charge-offs on the real estate loans to get them down to the as is value, and most of our impaired loans are real estate related and they're collateral dependent. And so we look at the appraised values, we've gotten a lot of new appraisals in. And so we feel comfortable with each of those.

Okay, great. All of the rest of my questions have been answered, so thank you.

Thanks, Andy.

(Operator Instructions). At this time I show no further questions. Would you like to make any closing remarks?

In closing I'd just like to reiterate that we're committed to becoming the highest performing Pennsylvania bank and delivering locally as a responsible community leader. First Commonwealth's strengths include a long term relationship with our customers, financial stability, and solid growth within our footprint in Western Pennsylvania. We look forward to updating each of you on our progress and thanks again for joining us.

The conference has now concluded. Thank you for attending. You may now disconnect.