First Commonwealth Financial Corp (FCF) 2011 Q3 法說會逐字稿

Good afternoon. I would like to welcome everyone to First Commonwealth's third-quarter 2011 earnings conference call. This conference is being recorded. At this time, I will turn the call over to Rich Stimel, Communications Manager at First Commonwealth. Rich?

Thank you. As a reminder, a copy of today's earnings release can be accessed by logging onto 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 will 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, Bob Rout, Executive Vice President and Chief Financial Officer; and Bob Emmerich, Executive Vice President and Chief Credit Officer. After brief comments from management, we'll open the call to your questions. For that portion of the call, we will be joined by Mark [Olshansky], our Chief Treasury Officer.

Before we begin, I'd 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.

Thanks, Rich. Good afternoon, everyone. Thanks for joining us on the call. As we announced this morning our net income for the third quarter was $8.3 million, or $0.08 per share, earnings per share, just a few comments before Bob Rout walks you through the financials. The leadership team here at First Commonwealth has high expectations for the long-term performance of our organization, and in setting the stage, for sustained progress and future success, we understand that economic uncertainty is still the norm. As a result, our focus has been on -- positioning of our balance sheet; the quality of our credits; managing our liquidity; and maintaining the appropriate levels of capital. At the same time, as credit and collection costs continue to increase, we've focused on reducing other expenses. And we believe that the actions we've taken on all of these fronts will provide long-term benefits to our Company and our shareholders.

Looking at our balance sheet, our lower costing transactions and savings deposits were up year-over-year; our net interest margin remains strong, and our noninterest bearing deposit balances are up on a quarterly and yearly basis. Demand deposits continued to grow as a percentage of our total deposits but our restructuring efforts aren't without their short-term challenges. The refinement of our credit infrastructure, along with weak overall borrower demand has led to a declining loan portfolio. Our effort to derisk loan portfolio has also resulted in a significant reduction in loans, primarily our larger credits but much of this reduction has been intentional. But at the same time, loan approvals rose significantly over the third quarter and our pipeline remains robust. Balances in three of our five major loan categories have increased. Balances in our construction and residential real estate loan categories have decreased. Mike will provide details around our loan production and our line of business performance.

In terms of credit quality, the results have been mixed. We did see an increase in nonperforming loans for the quarter, and Bob Emmerich will be speaking to this issue in a little bit. But it's largely attributable to single Pennsylvania-based commercial real estate relationship, and despite the increase in nonperforming loans, we are encouraged by the fact that our level of criticized and classified assets have continued to improve. Credit-related costs have had a significant effect on both our noninterest income and noninterest expense areas. This quarter, we had a write-off of a swap value associated with a non-performing loan affecting the noninterest revenues. On the expense front, noninterest expense is down significantly from the second quarter, but basically flat year-over-year. We feel that we're making good progress in our core expenses, but the overall effects are being somewhat masked by costs associated with OREO, collection of repossession and severance. So we do feel that our continuing focus on process improvements and organizational efficiency is producing long-term benefits.

So looking at the third quarter in context of where we are trying to go, we maintained a strong net interest margin, and we're seeing the right movement in our loan production and mix. Credit quality will continue to be a priority and we like the progress we're seeing in the noninterest expense management. Our lines of business are extremely well-positioned and our customer satisfaction metrics continue to increase from already substantially high levels. So we believe that the combination of the talent we have on hand and the strength of our brand in the marketplace and our solid capital level positions us very well over the long term. With that, I'll turn it over to Bob Rout discuss our financial results. Bob?

Thank you, John. Welcome, everyone. As John mentioned, we continue to see good progress in a number of areas, but the benefits of those initiatives are not yet fully impacting the bottom line, as they are offset by clean-up costs, primarily credit related. I'll start out with a discussion of the net interest income. Net interest income has been significantly affected by our balance sheet derisking strategies, which included reducing exposures to large relationships, exiting some troublesome credits, and a much more robust credit culture. More granularities in the loan portfolio will be easier to manage in the future on a number of different levels. The investment portfolio has also undergone its own derisking with currently a composition of primarily agencies and mortgage-backed securities.

It is our ongoing investment philosophy that the investment portfolio should mitigate the interest rate risk and the credit risk that are inherent in day-to-day backing activities, not add to it. You give up a little yield with this strategy, but reduce the risk of future credit shocks. We still have a trust preferred portfolio, with the $68 million book value, and a $36 million market value to deal with but we are very aggressive with the marks on this portfolio, and are encouraged by recent performance. There's no doubt that the recent Federal Reserve moves, especially Operation Twist recently announced, creates a difficult interest rate environment for a spread bank like us. We had some room in the deposit side, and even before that Fed announcement, we were already modifying our deposit rates. Strong deposit demands allows us to be aggressive with rates, and continue the very beneficial mix changes that we've accomplished over the past couple of years.

Our focus on corporate cash management, transactional accounts, reducing single [serve] CDs, expanding product relationships, and minimizing exception pricing are all working. Loan yields are certainly pressured in this economic and interest rate environment, but we remain disciplined and we are still getting more than our share of the deals. We will negotiate on price for the right deal, but not credit terms. Noninterest income has been volatile throughout the quarters as a result of investment portfolio restructurings, the trust preferred impairments, and some other credit-related issues. This third quarter, we had no security gains or losses, and no trust preferred impairments.

But the unusual activity continues in this segment with a $5.1 million credit adjustment on our commercial loan back-to-back interest rate swaps; $3.8 million of this adjustment is related to a $21 million commercial real estate loan that was placed on nonaccrual status this quarter, causing us to reserve the whole amount of the swap exposure on that loan. The remainder of the adjustment is more related to the decrease in long-term interest rates, rather than any significant change in credit quality on those swap relationships. One of our office building OREOs is currently generating about $1 million of rental income per quarter. That sounds like a good thing but unfortunately, costs associated with operating the building offset that revenue. Those costs get classified in noninterest expense. That building is currently under agreement for sale, Subject to due diligence, and we're hopeful about getting this resolved fairly quickly.

$800,000 of gain on sale of assets this quarter is primarily related to the sale of a loan that was in nonperforming status. Also, as John mentioned, we like the direction of our efficiency initiatives, reducing full-time equivalent staff by 105 over the last 12 months, and certainly much, much more opportunity remains. Here too, our progress gets blurred by credit clean-up costs, and to a lesser extent, one-time severance cost of $500,000 for displaced employees this quarter and $1.3 million year-to-date. So with that, I'll turn the presentation over to our Chief Credit Officer, Bob Emmerich.

Thanks, Bob. First Commonwealth's nonperforming loans increased $15 million in the third quarter from $147 million to $162 million. Nonperforming assets increased by a smaller amount, $11.8 million, due to a $3.3 million decline in OREO balances. The increase in the NPLs was due to the continued deterioration of the bank's largest single relationship, a real estate developer in the Eastern part of the state. This relationship totals $63 million, and consists predominantly of loans to two large apartment projects and three lot development project. During the quarter, one of the apartment projects and two of the lot development products were placed on nonaccrual, a total of $26 million.

The bank assessed loan-loss reserves of $8.7 million against these loans, and also reserved, as Bob had mentioned, $3.8 million for an interest rate swap that has a negative market value. Also during the quarter, the bank charged off $5.1 million on the third lot development project, which had previously been placed on nonaccrual. The two loans to the other large apartment projects, which totaled $28 million, remained on accrual, as they have positive debt service coverage; and we do not believe the problems of the developer will spread to those loans, due to a different ownership structure. Although we are disappointed with that continued deterioration in the above-mentioned relationship resulted in higher NPLs for the quarter, we are encouraged that we continue to see declines in the overall total of criticized and classified loan balances.

Total OAEM balances were down $34 million, and total substandard and doubtful balances were down $27 million for the quarter. Just as in the second quarter, we did not have any new substandard loans of any significance identified in the third quarter. Additionally, we continue to see progress as we move to resolution on many of our problem names. I'd like to mention four of those. In September, we successfully auctioned off the equipment and the food processing plant that has been in OREO and realized $7.3 million in proceeds; that was approximately what the equipment was appraised for. We are having the real estate reappraised in the fourth quarter to recognize the property's current condition with the equipment removed.

Second, the office tower in downtown Pittsburgh that was moved to OREO in July is under contract for sale with the buyer finalizing due diligence. The sales agreement calls for a closing prior to year end. Third, the landfill property that has been a nonaccrual and is currently a TDR is under contract for sale, and we await the new owner to receive the necessary permits to operate the facility. And finally, we've had a Western Pennsylvania medical office building a nonaccrual due to a legal dispute between the owner and the tenant. The lawsuit has been settled and the bank expects to receive 100% of the back interest it is owed, allowing us to restore this loan to accrual.

Charge-offs for the quarter were $10 million and that exceeded provision expense of $7 million as the bank took the $5.1 million charge on the lot development loan previously mentioned earlier that had already been reserved for. The loan loss reserve of $72 million was 1.81% of total loans at September 30; the reserve covered 45% of NPL balances. The impaired balances of $152 million have specific reserves of $35 million, but I'd like to point out that they also had $48 million of prior charge-offs, which in total would result, if you added the charge-offs back to the total impaired and the reserves, it would result in a mark of nearly 40%. That concludes my remarks on credit, and I will turn it over now to Mike Price.

Thanks, Bob, and good afternoon, everyone. I will briefly address some key performance items in our lines of business. First, after being off $144 million in the first quarter, and $82 million in the second quarter, loans were off just $19 million in the third quarter. We've gained some traction and have adjusted to an appropriately tighter risk appetite. As John mentioned, and encouragingly, the third quarter was the best quarter in 2.5 years in new loans booked in our corporate banking division. The mix was decidedly C&I with a good mix of industries and sizes of loans. Through the first few weeks of the fourth quarter, our new loans booked in pipeline pertain well for the remainder of the year.

As you can see on page 6 of the supplemental deck, we were up in three of the five call code categories. C&I loans grew for the second straight quarter to $951 million, with an increase of $8 million. Commercial real estate grew to $1.285 billion, or was up $14 million as payoffs have begun to dissipate, and we saw several quality end market opportunities. Other consumer lending grew $15 million to $545 million as we saw some pick-up in both branch and indirect auto lending. Residential real estate was down, as HELOC and second mortgage volume did not offset our liquidating first mortgage portfolio.

Lastly, the construction lending portfolio continued to fall as we lost some $50 million. We're now down to just $97 million in that portfolio. If you recall, this is down from over $450 million just a few years ago. As a reminder, we consciously modified our risk appetite over two years ago, both by -- one, setting geographic limits; and two, choosing to systemically reduce our larger exposures. At the time, we also set concentration limits for types of loans and industries. It's been an adjustment but it was self-imposed. This has led directly to over $400 million in runoff in larger credits over the last two years. In the middle market corporate lending space, we've restructured and are ramping up. We've now gathered one half-dozen capable professionals, mostly from larger banks, in our recently expanded downtown Pittsburgh office. The Marcellus Shale continues to be a meaningful part of our efforts, and builds on our experience as an energy lender in shallow well natural gas.

As I turn the focus to margin, I believe our analytics in understanding the price elasticity of our loan and deposit products has invariably helped our margin. Simply, we better understand when price really matters and when it doesn't and we price accordingly. Just to give you a flavor, our trailing 12-month spread is 292 basis points for new volume for the entire loan portfolio, and is a surprising 293 basis points for the corporate banking portfolio. The numbers are a little better than one would think, given the competitive landscape and have been stable over the last couple of quarters. Deposits remains strong with $52 million of third-quarter growth, and $111 million of growth year-to-date in the very important low-cost DDA and savings category.

As you look at page 18 in the supplemental deck, noninterest-bearing DDA has gone from 13% of the deposit total in 2008 to 17% of the total in the most recent quarter. Similarly, the mix has changed nicely as well as you can see on that chart, on the right; helping us here is our continued focus on business calling and garnering core DDA from consumers, small businesses, and larger companies. Our Bank at Work Program has become a significant portion of our new consumer DDA volume. These accounts are among the most engaged and most profitable in our retail bank. As John mentioned, objective third-party measures around customer satisfaction remained high and helped differentiate our brand as a community bank. We continue to make progress with our sales and service culture, and had cross-functional third-quarter blitzes focused on the Marcellus Shale and women-owned businesses.

Our wealth team has also hosted a series of well attended forums, tailored towards landowners working with oil and gas companies. I would close by saying that we feel like we're at an inflection point with loan growth; culturally, we've absorbed a new risk appetite. There's good activity that is bearing fruit. And the capital markets will continue to pay off some deals, but probably not at this pace on the real estate side, as we've seen in the last year. With that, I thank you for your time and I'll turn it back to John Dolan for your questions.

I think we'll go ahead and open it up for questions.

(Operator Instructions) Bob Ramsey of FBR Capital Markets.

I always appreciate the overview of the five largest nonperforming relationships. You used to include on there what the specific reserve was for each one of these credits. Could you maybe tell me where we are with specific reserves on these credits today and how much has already been charged against each of them as well?

Yes. In the -- I'm doing this off the top of my head; looking at the slide deck on page 9, we've got $32 million commercial construction relationship. This is the one that I was talking about. And we've got -- it's roughly about $9 million of reserves against those loan balances.

Okay.

And we have charged about $6 million off.

Okay.

The second one is, we have a reserve of roughly $3 million against that. We charged off $15 million. The third item, we don't have any reserve against that, because we have an appraisal that exceeds the value of the loan. The fourth loan has had no charge-offs, and there was a reserve of about $3 million on that one. And the fifth one, no charge-offs, the reserve is just a little under $2 million on that one.

Great. Thank you. And then I was wondering also, if I could ask on the capital front, you guys have done a great job of actually building capital every quarter subsequent to the capital rates that you've done. You've got very strong capital with 11% TCE and building as a (inaudible) quarter. With the stock trading down here at a good discount to tangible book, what are your thoughts on share buybacks at these levels?

Bob, this is John. I think that the use of the capital, we raised it for a comfort level during this economic uncertain times. As things get a little more certain, I think that we can evaluate and have been evaluating [most] of the final level we wanted to be running at. And the ways that we want to utilize it, obviously, the best way to utilize it is going to be to continue to grow organically. And we can grow through acquisition as well, but not as favorable as organic growth, but we would be open to looking at both buybacks and dividends going forward. So we want to be actively managing the capital as it's appropriate.

Okay. Thank you. And then just along those lines, obviously the loan runoff has slowed significantly as you all have guided for, too. Do you think you'll be able to have positive loan growth in the fourth quarter, or is that a 2012 event?

Well, I think that, that would be a -- we feel -- I don't want to give too much forward guidance here, but I think we feel pretty good about the direction that we're going. Mike mentioned we're at an inflection point, we believe, so that the payouts are going to slow, and we've been able to do have a strong pipeline. So you can read between the lines on that.

Okay. Great. Thank you, guys.

Damon DelMonte of KBW.

Following up here on Bob's comments on the loan growth, so the CRE balances increased slightly this quarter, about $14 million, I believe? Could you break out for us how much actually ran off this quarter versus how much was new loan growth?

I cannot, Damon. Runoff definitely slowed, probably about August 1, and we could probably get you something there.

Okay.

We put on a couple nice properties. Western PA owner occupied one, and another one with two grocery stores and a large retailer, a nice loan there, And I don't know the [trade-offs] there.

Okay. Fair enough. We can circle back off-line on that. And could you maybe give us an update on how your energy lender is progressing in your markets, given the activity related to the shale?

I think last quarter, I had shared that indirectly and directly, probably about 20% of the volume was somehow related to the shale. And I think that probably directly, 10%, and maybe indirectly up to 20% of the loan volume. And I'm looking at the sheet that has about 49 loan approvals in the quarter. And obviously, he also assists other lenders with deals that are shale-related, but there's been a pretty nice ramp up, for sure. It's helped.

Okay. Great. And then I guess probably for Bob, could you just give us a little more color on the margin expectation as we round out 2011 and look into 2012?

Yes. Well as you know, this is a pretty difficult interest rate environment for banks. But we were -- as I mentioned in my comments, we were proactive on this. When we looked at our cost of deposits as compared to peer, we realized we had some room. And with some of these successes that Mike's been achieving, with his branches, with sales and service, we were able to make some moves again, even ahead of the Federal Reserve's announcement. A lot of those moves didn't go in until late, the third quarter. So we have continued benefits to be achieved in our deposit side. On the asset side, yes, the good deals are very competitive. We are winning our share, and we're seeing some compression in the yields but not quite as much as you might think. So that's -- we're still very positive on the margins.

Okay. So it wouldn't be unrealistic to expect it to at least hold this level for the next couple of quarters?

Again, that's forward-looking information, but we like to trend.

Okay. And then I guess just lastly, could you tell us on an aggregate basis, what the total dollar amount is of your top five lending relationships, whether they've currently be performing or nonperforming?

Hang on one second, Damon. We're looking that up.

Damon, Bob Emmerich. The question again, you want the top five relationships?

Yes, relationships.

This will be commitments or balances --

Either or both; whatever you have available.

Well, the largest relationship we've already talked about, the $63 million, and the second largest would be a C&I relationship that is $49 million. And then we have the rest -- our real estate relationships -- and one is at $47 million; one is at $43 million; one is at $37 million; and the next one is at $37 million as well.

Okay. All right. Great. Thank you very much.

Mike Shafir of Sterne Agee.

I was just wondering, the four problem credits that you feel are coming to a resolution, can we get any kind of a dollar values attached to that?

The -- well, yes, the landfill is broken out as one of the top five nonperforming loans, and the office tower, we're carrying at around $7 million, and the medical office building is $3.3 million.

Great. Thanks a lot, guys. The rest of my questions have been answered.

Collyn Gilbert of Stifel Nicolaus.

Just a question and perhaps for Mike, on the loan originations that you guys are seeing now, what would you say the average loan size is or what's in the pipeline, maybe the average loan size?

Well, just -- I'll just look at September. Just doing some quick math in my head about 14 loans and about $100 million. So under $10 million, and this is in our larger loan committee. And then if you factor in the smaller -- the small business; that's for larger loans, I think it would be probably $5 million all in.

Okay.

On the corporate banking side.

Okay. Okay. That's helpful. So the $5 million is a small business initiative?

No, $5 million would exclude small business but just smaller companies. I'm just looking at 14 companies, $100 million in September, and you can do the math. And then probably there's a mid-market segment that isn't captured here so it probably would drag average down a bit, probably close to $5 million.

Okay. Okay. And then just, Bob, a run rate on expenses? This quarter, as you mentioned in your comments, efficiency has been certainly a success here. Could we see that $41 million stabilize here now over the next few quarters?

It would be our intent, Collyn, to pull it down lower. As you know, the credit costs and of course, some of the severance activities we've had creates some volatility but core wise, we are making some really good progress.

Okay. That was all I had, thanks.

Andrew Stapp of B. Riley and Company.

How much do you have in interest-bearing liabilities with pricing in coming quarters, and at what rate?

Well, we know that the CDs, Andy, are probably running between $25 million and $40 million per month. So those are the big ones. We don't have, I don't think anything coming due over the next couple quarters or long-term debt.

Okay. What type of rates are the CDs at that are running off?

I don't have that detail with me, Andy.

So these it would've been CDs that were priced about one year to two years ago, so you can expect it to be probably 100 basis points higher.

Okay. What are you expecting for the effective tax rate in Q4 in 2012?

We're currently running between 18% and 19% right now, Andy. If our revenue projections continue on an upward trajectory, I think you could probably look for that to move up into the 21% range.

Okay. I think that's it. Thank you.

John Moran of Macquarie Capital.

Hi, guys. Thanks. Just a quick question on the amount of excess exposure over $15 million, and I apologize if I missed this in the prepared remarks, but you guys had a goal of getting that under 50% of risk-based capital. I think at the second quarter, it was somewhere around 60% if I'm remembering correctly, down from like 64% in first quarter. Just wondering if you had an update on where you guys stood on that metric?

Yes, it's Bob Emmerich. At September 30, we were at 56%.

56%? Great. Thanks very much; that's it.

(Operator Instructions) There are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to John Dolan for any closing remarks.

Thanks, everybody, for joining us on the call. And thanks for your continued interest in First Commonwealth. Have a great day.

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