First Commonwealth Financial Corp (FCF) 2010 Q4 法說會逐字稿

I would like to welcome everyone to First Commonwealth's earnings conference call. Please note this call is being recorded. At this time I will turn the call over to Rich Stimel, Communications Manager at First Commonwealth. Please go ahead.

Thank you. As a reminder, a copy of today's earnings release can be accessed by logging onto 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've 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, Mike Price, President of First Commonwealth Bank, and Bob Rout , Executive Vice President and Chief Financial Officer. After brief comments from management, we will open the call to your questions. For that portion of the call we will be joined by Bob Emmerich, our Chief Credit Officer and John Previte, our Senior Vice President of Investments.

Before we begin I would like to caution listeners that this conference call will contain forward-looking statements about First Commonwealth, its business, strategies and prospects. Please refer to our forward-looking statements disclaimer on page 2 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.

Good afternoon everyone, and thank's for joining us on today's call. This morning we released our financial results for the fourth quarter and we're pleased to announce net income of $11.9 million or $0.11 per share, compared to the net income of $2.7 million or $0.03 a share in the fourth quarter 2009. For the year 2010 saw net income of $23 million versus a net loss of $20 million in 2009. Even with ongoing uncertainty around interest rates, the inflation, the general state of the housing market, we made progress in getting our out-of-market and large credits under control. This along with the fact that we realized no additional OTTI charges in the fourth quarter enhanced our net income results for the quarter and for the year.

Our improved earnings, and relatively stable economic conditions in Western Pennsylvania allowed us to increase our dividend payout to $0.03 per share. Looking forward we continue to view the Marcellus Shale opportunity as a game changer. And we brought on a new energy lender onboard. We worked hard to position our organization and our balance sheet to take advantage of market opportunities. As it relates to our balance sheet, our success in winning transaction on corporate cash management accounts has contributed to a strong net interest margin, deeper customer relationships, and better cross-selling opportunities.

2010 also saw an extensive de-leveraging of the bank. We adjusted the risk profile of our investment portfolio by significantly reducing our use of borrowed funds to buy securities. Eliminating the future purchases of corporate debt, securities and reducing our exposure to municipal securities. We are still working through the credit issues on our trust preferred portfolios, but we are pleased that the impact of these portfolios on our financial performance has diminished significantly. Obviously credit issues were the focal point of 2010 and credit quality will continue to be a priority in 2011. Mike Price will go over the credit in detail but generally speaking we made good progress in restructuring our credit administration function, managing down the larger credit exposures, and focusing on our Western Pennsylvania footprint.

As of the end of the year we reduced the number of credits exceeding $15 million from 62 to 49. While we know there will be challenges given the uncertainty surrounding the new regulatory requirements, the general economic landscape and the weak loan demand, we're confident in our service quality and our ability to deliver. One of the few advantages of the recent economic turmoil is that it provides an opportunity to acquire talent that may not otherwise have been available to us. Banking is a people business where the quality staff focused on taking care of the customer is a bigger asset than anything you might have on your balance sheet or in your product mix. We have a good opportunity to grow small business, retail banking, and to develop our middle market capabilities.

We continue to make progress in building the structure and finding the talent to exploit these opportunities. We are confident of the opportunity that exists in the middle market area and the joint sales calling and blitzing opportunities in efforts that we've initiated. They've expanded our customer conversations and our prospecting efforts. Small business lending, corporate finance, and corporate cash management are competitive differentiators for us and we believe these areas will serve to enhance our middle market efforts.

First Commonwealth like the rest of the industry, is looking hard at operating efficiencies. We believe we have opportunities here especially in improving our processes and better technology utilization. But, it is not all about reducing costs. It is about finding ways to better deliver as a responsible community bank. Everything we are doing is about making it as easy as possible to do business with us. We feel this focus will allow us to reduce costs but also provide a stronger platform for growth. During the course of 2010 we've implemented significant technology upgrades, and will continue to assess all opportunities to improve efficiencies throughout the organization.

To that point, 2010 non-interest expense was essentially flat in comparison with 2009 levels. In improving operating efficiencies, of all types, will be a strategic priority throughout 2011. This is more important than ever given the added cost we anticipate from regulatory reform. Our mantra over the past year has been all about delivering locally which requires a comprehensive understanding of what our customers want, and a seamless system for delivering the appropriate solutions. We really do feel that we are in somewhat of a sweet spot, and that we can offer an extensive product menu of a larger institution but have the personal relationships and one-on-one interactions that you get from a smaller community bank. This is exactly how we plan to build on the momentum of our 2010 performance. So to talk about our financial aspects of that performance, I would like to turn the call over to Bob Rout, Bob?

Thank you, John. Good afternoon everyone. As John has already mentioned net income and earnings per share came in this quarter at $11.9 million and $0.11 per share respectively. Credit, other than temporary impairment issues are becoming less influential in our financial performances. Getting these issues contained along with a better risk profile in the balance sheet allows us to shift focus to more core banking and in growth related activities. Running down through some of the significant issues for this quarter, it is probably most appropriate to start with credit. Provision expense for the fourth quarter was $8 million, that is up from the $4.5 million and the $4 million in the second and third quarters of this year respectively. It is important to keep in mind that these two earlier quarters, each had substantial recoveries.

Even though we did have some good news this quarter on one of our largest credits, that positive development was offset by two new credits that tripped into non-performing status and required $6.4 million of specific reserves. Mike Price will be detailing these credit quality movements during his upcoming discussion. The other major performance issue we have been wrestling with for a number of quarters, is, other than temporary impairment, on our trust preferred portfolio. The accounting industry has been working toward a more consistent methodology concerning how best to handle the issue of potential cures for these valuations. And as I've mentioned in previous calls, First Commonwealth had been using the more restricted methodology of not considering potential cures.

In the fourth quarter, we brought our methodology in line with the industry consensus and as a result we had no other than temporary impairment on the trust preferred portfolio this quarter. Net interest income is down slightly in comparison with prior quarters and last year. Most of that decline is primarily due to all of the balance sheet restructuring of the last year that is detailed in our press release. In addition, this has not been a good economic environment for loan demand and the delinquent interest on troubled loans has also been a drag. The restructuring, the balance sheet is almost complete, with the exception of one more small group of municipal securities that we would like to liquidate and a managing down of off-sized commercial credits.

We are very pleased with how the net interest margin has performed during this restructuring period, up 16 basis points year-over-year. That net interest margin is starting to feel a little pressure here in the fourth quarter as those very attractive yields on municipal securities begin to run off, and as reinvestment rates in treasuries and security agencies -- or agencies of securities are still at relatively historic lows. And some of the pricing that we've seen on loans is shifting downward, as more and more banks are chasing the few quality credits that are currently available in the marketplace today. These net interest margin pressures will continue until the economy starts producing a more robust demand. However, we believe we still do have some mitigation of those pressures left within our deposit prices.

Non-interest income performance not including security gains and losses was a mixed bag this quarter. The effects of Regulation E as well as the shift due to consumer behavior has been a little bit more detrimental than originally expected. We are somewhat mitigating that negative impact with a strategic focus on opening more demand deposit accounts. Interchange revenue from debit card continues its upward trend. But here too, this issue goes in and out of the regulatory cross hairs. The [shore throne] is down substantially this quarter. The whole wealth management function is another area with ongoing restructuring, as we shift delivery away from product solids to an organizational structure that is more integrated, customer centric, and geographically localized. Bank owned life insurance and commercial loan swap income were up this quarter, mostly as a result of better credit matrix for corporate bonds and the upward shifts in long-term rates since last year.

Non-interest expense increased by $2.9 million in the fourth quarter of 2010, as compared to the same period last year. The most significant component of this quarter would include first, $1.4 million in severance cost, as we continue to get more efficient through better utilization of technology, and refinement of our sales and in delivery service models. Full-time equivalent in staff is down by 56 since December 2009. Credit costs associated with unfunded commitments, collections and consulting were higher this quarter as we struggled to clean up and stabilize some of the larger troubled credits. Now, with that, I will turn it over to Mike Price.

Thank you, Bob. I will focus on asset quality and the specifics of our largest problem credits. I would then like to review some of the 2010 highlights and detail some opportunities we see going forward into 2011. Turning straight into non-performing loans, we saw a decline of $7 million on a linked quarter basis and non-performing loans now stand at $117 million or 2.8% of total loan outstandings at December 31. The $7 million decrease in non-performing loans this quarter was primarily driven by the partial workout of our largest non-performing loan, the $44 million line of credit to the Western Pennsylvania developer that surfaced over one year ago. We received payments of $8 million and a partial charge-off of $15.4 million was recorded.

In December the banks signed an agreement to restructure the line of credit. This was done in conjunction with three other banks that had similar credit facilities that totaled $104 million. The agreement resulted in the aforementioned payout of $8 million for First Commonwealth and provides the developer time to dispose of his investment properties. The proceeds of which will be used to pay down the loans to the four banks. We had carried a $20.4 million reserve against this loan. With the conclusion of the restructuring agreement, a charge-off of $15.4 million was taken in the fourth quarter. And a reserve of $4.7 million was established on the remaining $20.7 million balance. In a significant additions to NPLs include two PA construction credits in Central and Eastern Pennsylvania totaling $18 million. The larger of the two is a $9.6 million student housing project, in which the borrower is experiencing cash flow difficulties which is resulting in inadequate debt coverage.

As of year end we have a specific reserve of $3.4 million on this credit. Additionally we had an $8.6 million lot development loan go into non-accrual. This credit also had a $1.3 million line of credit associated with it. This borrower is having difficulties marketing the new lots as a result of the disruptions in the housing market. At year end we have specific reserves of $3.7 million on this relationship with $3 million being provided for this quarter. I would also mention that this is one of the two relationships we have over $50 million. The remaining credits in this relationship consist primarily of commercial real estate loans. As far as the charge-offs are concerned, the partial charge-off of $15.4 million, on the $44 million line to the PA developer was by far the largest of this quarter. We also charged-off approximately $3 million on a manufacturing loan relationship which has been in non-accrual since the second quarter of 2010 and has a remaining balance of $0.5 million as of December 31.

Shifting gears, as we look at end of period loan balances, we are down year-over-year some $420 million. A couple of thoughts here. First, we had $100 million in planned 1 to 4 family mortgage runoff, in a liquidating portfolio. We had $217 million in runoff stemming from proactively reducing the 13 credits over $15 million that John had eluded to earlier. And we've also, we are reducing intentionally our investment real estate exposure. And we had some capital constraints in the first half of the year, coupled with just a lower risk appetite.

Encouragingly our fourth-quarter new loan originations were double any of the previous 2010 quarters, and our first quarter 2011 pipeline is building to higher levels. It seems the economic environment is improving. We also had some fourth-quarter signs of life in our home equity lending portfolio, as well as some small business and some selective C&I opportunities. However, it may be too early to declare that loans indeed have bottomed out. We feel good about the fundamentals on the other side of the balance sheet, in the form of low cost and demand deposits.

Average non-interest-bearing deposits grew $68.4 million or 12% year-over-year. Average savings and DDA balances grew nearly 14%, or $373 million year-over-year. These lower costing savings and DDA deposits represented about 61% of total deposits during 2009, and grew to represent some 66% in 2010. This is a continued positive shift in a mix of deposits and has helped us fend off some of the margin pressure resulting from the thinning interest earning asset balances. The engine here is small business, cash management, and just continued improvement in our sales and service execution and our mix of business. This core is also driving some of the relatively good outcomes with our non-interest income that Bob talked about like interchange and so forth.

You know, going forward in 2011, you know defensively, we are focused on continuing to monitor our large individual exposures, and manage our investment real estate concentration. You know offensively we feel like we can grow our middle market lending and our small business. We also feel like we have a nice capability with our corporate finance discipline. We are focused there on in-market relationships and opportunities. And we also can continue to leverage our improved sales and service culture in retail banking which has grown and should continue to grow households and help us win share. With that I will turn the call back to the operator, and open it up for questions.

We will now begin the question and answer session. (Operator Instructions). Our first question comes from Rick Weiss of Janney. Please go ahead.

Hi, how are you, guys, this is actually Dave [from Parton].

Hi, Dave, how are you doing?

Good, thank you. First I'd like to look at the reserve, how do you feel about the level kind of going forward? Can you expect provisions to match charge-offs or do you think you are at a point now where we have to build more from here? What are you thinking going forward?

We have here with us, Bob Emmerich our Chief Financial Officer, Bob, do you want to talk about the reserve?

Dave, I could not hear your question all that well, can you repeat it?

Yes, I was wanting to get your thoughts about the reserve level, here and how you feel about it going forward?

Well, we obviously feel the reserve is appropriate, for the risk inherent in the portfolio at year end. We do not manage to a percentage number. We have a well defined methodology for determining our ALLL and we adhere to that. 2010 was an unusual year, in that we had two large problem credits where we took charge-offs of the $42 million land loan down in Florida where we took a $34 million charge-off, and a $45 million line of credit where we took the charge-off of $15 million. You add those together, that's $49 million of our $71 million in charge-offs for just those two loans, that really aren't representative of our portfolio.

Excluding those two, charge-offs would have only been $22 million or about 50 basis points. So, if we look at the reserve, you look at the performing side if we just break it into pieces, look at the performing side we've got reserves there that are about 1.15% of the performing loans. Then, we've got the impaired loans -- and, that has been fairly consistent over the last 5 quarters -- then we have our impaired loans, a reserve of about $24 million. I look at that both, the C&I and CRE. On the C&I side that portfolio has performed very well. We only have $26 million of impaired loans in C&I. Included in that $26 million is the remaining balance on that line of credit. So, then most of the impaired is within our CRE, about $99 million.

Again, we had the guidance that was issued by the regulators in October of 1999 to write down your CRE exposure to the as-is value of the collateral. If that is your source of repayment. We have adhered to that. So, many of these loans carry no reserve because they are written down to the as-is value. And, we are comfortable with those. So, we are again feel the reserve level is appropriate, at year end.

So looking at the MPAs, about what percentage of them have already been written down to present market value and about what percentage are still at book value?

Do you mean, well, some -- of them would be written down to the as-is value of the collateral and others where there are -- there is potential for other sources of repayment besides just the collateral itself. You would still have a reserve against those.

Do you have percentages on those?

Not, not handy we could maybe get back to you with that answer. Probably, I would say at least half of those would probably would be written down to the as-is value.

Okay. Do you guys have a balance on any kind of watch list or sub-standard assets right now?

We do but we don't disclose those.

Okay. Sure. I will get back in the queue, thank you.

The next question comes from Mike Schafir of Sterne, Agee. Please go ahead.

Good afternoon, guys. I was wondering, as far as the tax rate in the quarter, is that a true up due to some of the losses during the course of the year? And so forth?

Yes, Mike that is exactly what happened as you know we had that loss in the first quarter which caused our tax rate to go to a discrete methodology, and then when you get back on to a positive earnings track we had to shift back into the effective rate. And of course that was all trued up here in the fourth quarter. I think going forward we could probably look at about a 25% effective rate going forward.

Okay. Then, also it looks like the other fee income line was quite a bit higher this quarter. And, it seems like there is some seasonality in that?

I would say most of that, Mike, is associated with improvements on our commercial loan small credit evaluations. As you know the shift in interest rates and the better outlook in the bond market credit swap per has helped that quite a bit. That probably would not be a recurring type thing going forward.

Okay so we could probably see that go back to second and third quarter type levels?

I couldn't make that prediction but this was an exceptionally positive quarter for us in that particular line item.

Okay, then I know over the course of the year, you know, there was some severance cost kind of that were incurred as you guys right sized for staff at the bank. Moving forward, how do you guys feel in terms of expenses? Are we going to be able to kind of see those stay relatively flat or is there going to be some kind of natural growth as a function of additional hirings?

That would be our objective to reduce that, from 2010 levels. I'm not going to put out an exact number but that is where we are focused.

Then, could you just remind me, the relationships in over 50 million, how we have progressed kind of, I know there was a goal to reduce those? And, where do we stand now, relative to at the end of last year?

Yes I will just take that, Mike. We had 62 at the end of last year and we had a goal to get it down to 49 and that is where we are at the end of the year.

And, then, how moving forward, where would you guys like to see that number come to in 2011?

I think that it's probably fair to say that we are always going to have some that are in excess of that number, in excess of the $15 million. I think that we are going to continue to monitor those credits, that are in excess, and work their balances down but not eliminate the relationships. I think we are getting into the comfort range right now, we are not exactly there but we are in the range.

Alright, thanks a lot, guys, I appreciate all that detail.

The next question is from Bob Ramsey of FBR Capital Markets. Please go ahead.

Hey, good morning, or good afternoon. I guess in terms of loan growth we definitely saw a slowing pace of run-off this quarter which is encouraging. I know you guys were talking a lot about growth, targeting growth going forward. I guess in terms of this quarter, was that a reflection of more origination volume or just the fact that you all had to work through some of the larger credits that you were trying to get worked through and work off the balance sheet earlier in the year and sort of looking to the first half of 2011, are we still going to see a modest pace of runoff net-net or do you think you can have positive growth?

This is MIke Price. I kind of outlined some of the headwinds that we had. Some of those are still present. There was about $277 million from the reduction that John mentioned from 63 to 49. We have a target for concentration for IRE, that had an impact on us, excuse me, investment real estate. We also saw a lot with borrowing bases and accounts receivable and inventory just down. That was pretty significant but we feel -- we saw pulpable uptick in originations, as I mentioned, about double in the fourth quarter what it was the previous third quarter. We are seeing a continuation of that so, we are kind of knocking on wood here, I think that we are hopeful that we've turned the corner.

Okay, great. Then, you know with that in mind, obviously you guys have got very strong capital levels. As you think about prioritizing uses of capital I would imagine that organic growth is near the top. If you could talk about sort of what some of the other possible uses for your capital are?

Yes, this is John, Bob. I think that I would, I would say that organic growth is our primary focus. I think that later in the year we will have our eyes open. And the markets will probably be a little bit more open to acquisitions. But, we still think there is opportunity with organic growth and we want to keep that engine -- want to re-start that engine and keep it going.

The next question comes from Andy Stapp of B. Riley & Co. Please go ahead.

Do you have the balance of early stage delinquencies at year-end?

I believe we do. You want to just give a direction, Bob, instead of the number?

Delinquency has been very flat. No real change in delinquencies.

That was my last remaining question. Thank you.

The next question comes from Damon DelMonte of KBW. Please go ahead.

Hi good afternoon. I think in your early opening comments you mentioned something about hiring of an energy lender. Can you give us a little update as to what that entails?

Yes, we think -- this is Mike. With the Marcellus Shale activity, we're seeing some opportunities on the supply side. But, we've recruited an energy lender from out of market to come in and see if we can do some more direct lending. We have a history of doing some shallow gas lending to some shallow gas drillers. But, the Marcellus is a different kind of game. We have someone from Texas that can talk their talk.

How does your traditional underwriting standards fit into this category of loans? Would you need to bring in additional risk management folks that have better exposure or more exposures to the risks associated with this kind of landing?

Actually, this is Bob Emmerich. The bank has been involved with lending for natural gas in this area for quite a while. You know, most of the gas that we've been lending on up to this point has been shallow well. I suspect a lot of it will continue to be shallow well. I think it is good that we have brought this person on that has the expertise in the field. And, I think we'll be well suited to address whatever opportunities that come up.

I think, the important part, this individual has relationships already. We are not having to establish relationships. That would be supply chain as well as the actual production itself.

Okay, great, that's helpful, thank you. Can we switch over to non-interest income? The quarterly results for insurance and retail brokerage commissions, we saw a quarterly decline. Is that more seasonal or is there something else going on there?

This is Mike. It is a little more systemic. We are really shifting to provide kind of through geographic practices, kind of a broader suite of wealth management solutions to the client. So, you're actually seeing the uptick in trust income and selling, I think that will hopefully long-term more than offset that. So, just a little higher end approach, more consultative, and perhaps, a little less product based is the thought process.

Okay, that's helpful, thank you very much.

The next question comes from Mac Hodgson of SunTrust. Please go ahead.

Good afternoon. Most of my questions, I think, were already addressed. But, on Reg E, I think you mentioned the impact was a little more than you anticipated. Can you elaborate and then maybe an outlook for that as we work through 2011?

Yes, the broad numbers we were expecting was about $200,000 a month in shortfall. We are seeing it coming in between $235,000 and $250,000. Again, some of that is the result of Regulation E and some of that is people were watching those type of charges a lot closer then they did when economic times were a lot better. That is the primary impact from those two factors. We are mitigating as we are just getting more demand of deposit customers and expanding the market a little bit. That has been helpful to mitigate that.

Mac, this is John. I think that it is fair to say that the fourth quarter, had a full quarter's worth of that Reg E effect in there and the second quarter didn't, excuse me, third-quarter didn't and the fourth quarter did. It's more representative of what we expect.

Okay, great. And, is there, is there any way to quantify the amount of loan growth that you've had organically that may have been attributed to the Marcellus Shale? It's talked about a lot obviously banks like yourselves. I am trying to, I know it's obviously a big economic driver and I'm just trying to get a sense if it's easy to quantify the impact it's having on the company.

I don't think that -- that's probably a little too broad to be able to quantify that. What I mean by that, is you're not going to just see it in the extractive industry, you're going to see it in you know, the hotels and your going to see it in the restaurants and you're going to see it in car sales and everything else.

Office space we've seen it.

You can't directly say we've got this loan because of Marcellus Shale?

There will be some, but It probably wouldn't be fair just to identify a few in a segment and say these are related to Marcellus Shale.

Okay, makes sense. That's all I had.

(Operator Instructions) We have a question from Rick Weiss of Janney. Please go ahead.

This is Dave again. My question relates to the 49 credits over $15 million. Can you give us a perspective on maybe where those credits are located and what types of industries they are in?

Yes, this is Bob Emmerich again, David. I break this up into really three categories. We've got, what we would refer to as our corporate finance or corporate banking group and a lot of these are participations with really the major corporations headquartered in Western Pennsylvania, sort of the household names that you would be familiar with. And, we have 24 names in that group. And, almost all in Pennsylvania, Western Pennsylvania, very little outside of the state. The next group would be our investment real estate area, we have 15 names there. And, those are again almost all in Western Pennsylvania. Finally, we've got our community banking names which tend to be colleges and universities, hospitals, or those sorts of facilities. And we have 10 names in that group and they are all in Western Pennsylvania.

In the investment real estate group, what is -- what percentage of total loans make up that group there?

The percentage of total loans?

Yes, in the 49 credits over $15 million of investment real estate that we just talked about in western PA.

You know, we've got - we look at the exposure which is a commitment level. And, that really wouldn't relate to the outstanding balances so I don't know if I can give you an exact number there, but it would probably be, it would be less than 10% of our total loans.

That will be all, thank you.

The next question is from Collyn Gilbert of Stifel Nicolaus. Please go ahead.

Just one quick question for you, Bob and if you mentioned it, I apologize. Can you give any color as to what an expected run rate would be on expenses next year? Or this year?

No. We are not prepared to give that out. I can tell you it will be our objective to keep them below where they were this year.

You said it would be your objective to keep them below the [171] for this year?

Yes, that is correct.

Okay. Then, I guess, just along those lines, just specifics on the professional expense that jumped in the quarter, is that, was there anything in particular driving that? Is that going to be an elevated number going forward?

That is pretty much part of all our credit related costs. There were a lot of consultants, a lot of legal fees associated with this, especially in the fourth quarter here cleanup. There was nothing unusual in there. We have a lot of folks in there helping us out with some technology things as well.

That was it, most everything else has been clearly covered, thank you.

This concludes our question and answer session. I would now like to turn the conference back over to management for any closing remarks.

Alright, thank you everyone for joining us. We appreciate your participation in today's call. We look forward to speaking with you soon.

The conference is now concluded. Thank you for attending today's presentation.