First Commonwealth Financial Corp (FCF) 2012 Q1 法說會逐字稿

I would like to welcome everybody to First Commonwealth First-Quarter 2012 Earnings Conference Call. As a reminder, today's conference call 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 on to 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 Mike Price, President and CEO of First Commonwealth Financial Corporation; Bob Rout, Executive Vice President and Chief Financial Officer, and Tony Kallson, Senior Vice President and Senior Credit Officer. After brief comments from Management, we'll open up the call to your questions. For that portion of the call, we'll be joined by Mark Lopushansky, our Chief Treasury Officer.

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 turn the call over to Mike Price.

Thanks Rich, and good afternoon everyone. I appreciate you taking the time to join us on today's call. It's been just a little more than a month since I was informed by the Board that I was being named President and CEO, and I am indeed grateful for this opportunity and excited for the future of our Company.

I'm happy to report pretty solid performance in the first quarter. A good loan growth and low-cost deposit growth drove net interest income. We saw some slippage in the spread, which concerns us, and Bob will speak to that in a minute. But we like the loan mix, with well over half on the retail side, and the most significant portion of the corporate business coming from our middle-market efforts that we really started in earnest just over a year and a half ago.

On credit quality, I've talked about key areas of strategic focus previously, and I'll start with credit quality. It really starts with us building a strong credit infrastructure that will serve us well for years to come. To that point, our provision is down significantly, and our non-performing asset levels continue to improve.

Our non-performing loans have decreased by more than 35% since during the first quarter -- since the first quarter of 2011, and our classified assets have really been cut in half over that same time period. Tony Kallson, our Senior Credit Officer, who's pinch-hitting for Bob Emmerich, will give you more color commentary in a minute.

Our second area of focus is really the thoughtful management of our strong capital position. This is about ensuring stability, but it's also about benefiting our shareholders as credit yields and as earnings return. Increasing our dividend from $0.03 per share to $0.05 per share is part of this effort.

In our third area of focus, essential to getting to where we want to be as an organization, is our ability to deliver a superior customer experience, particularly for our business clients and prospects. Here again, the empirical evidence indicates good traction. We're seeing strong household growth in retail and small business, and customer satisfaction levels are at their highest level in more than three years since we began measuring this objectively.

Our middle-market focus is now paying nice dividends. Just to give you a flavor, in the first quarter we brought on several nice relationships to include a boutique pharmaceutical company, a strong municipality, a senior living center, a commercial cleaning company, and a fiberglass manufacturer.

I can tell you I personally met with each of these businesses and their management teams, and these are exactly the kind of companies we want to do business with. We believe that this $5 million to $10 million credit segment will be a sweet spot for us, and our pipeline here is very good.

On the small-business side, we're seeing nice growth in households and non-interest-bearing deposits, but that's not translating into lending activity yet. But we feel we're very well-positioned in this space as small business confidence returns and borrowing here starts up again.

Our fourth theme is we're focused on operating excellence, and really emerging over time to best-in-class performance in a couple key areas. The four measures are credit quality, which you'll hear more about in a minute and I've talked about briefly, competitiveness in our core loan and non-interest-bearing deposit growth, we feel, is good. We've seen loan volumes rising consistently over the last six quarters, even though that didn't always translate into quarterly growth because of our de-leveraging activities earlier last year.

Our third area of operating focus is efficiency, and here our ratio remains elevated as the result of loan collection costs and other credit-related items. We had the $2.8 million write-down on the OREO property that was in the press release, and there were $1.2 million in operating expenses for another OREO property we sold in the first quarter. Admittedly, this muddies the water, but we are working hard at efficiency each month, and efficiency will be a key objective for us over the next couple of years.

The fourth key area of operating focus and measures net interest margin. The net interest margin is under pressure. Although our business mix is becoming more commercial, we don't have a portfolio of higher-yielding mortgage loans that can prop up our NIM, and we've been out of that business for five or six years. We're very focused on pricing discipline and continuing to drive down our deposit costs where we can.

The fifth and final strategic area of focus that I'd like to mention is our efforts to acquire, retain, and develop the most talented community bank team in the markets where we compete. I will end where I began. We are excited about the future of this Company, and we look forward to stringing together some more solid quarters. With that, I'll turn it over to Bob Rout, who will give you some details around the numbers. Bob?

Thank you, Mike. Good afternoon, everyone. As you heard Mike's opening comments, we experienced considerable performance improvements in a number of areas this quarter. Strong, diversified loan and deposit growth. The NIM is certainly under pressure in this unprecedented low-interest-rate environment, but certainly performance satisfactory, given the current conditions.

Our aggressive strategies last quarter with respect to troubled loan cleanup are pleasingly meeting expectations. Non-interest income and non-interest expense continue to provide challenges and opportunities, even after factoring on some of the noise in those categories from credit-related activities.

Let's start out with a little deeper dive into this quarter's net interest margin. First-quarter net interest income has benefited from approximately $163 million of loan growth over the last two consecutive quarters. The loans are still only up $63 million on a year-over-year basis, due to some involuntary and voluntary loan portfolio shrinkage during the first three quarters of last year.

As Mike mentioned, there's no doubt that yields on new quality loans are under competitive pressure. We've been able to partially mitigate this yield pressure with continued improvements in the mix and growth of our deposits As mentioned in my previous calls, we did get very active managing down deposit rates well in advance of the Federal Reserve's Operation Twist monetary easing strategy that was implemented in the fall of last year.

Those were very beneficial moves, but still not enough to entirely offset the core net interest margin compression that comes with this interest rate environment. Our net interest margin was 3.75% for the quarter on a fully taxable equivalent basis. Included in that number is about $1 million of delinquent interest that we recovered on that $11 million troubled landfill loan that paid off this quarter. That one-time benefit added about 8 basis points to this quarter's net interest margin.

In non-interest income, almost all of the non-interest income increases are credit related. We have a $1.7 million recovery from the sale of one of the three troubled loans that we identified as being held for sale last quarter. This quarter also includes $1 million of rents that we were collecting on that Pittsburgh office building OREO property. That building was sold this quarter, and the rental revenues will not continue going forward. We have some new swap-related income, as well as a positive adjustment to the credit position of those swaps.

As usual, we have a lot of credit noise in the non-interest expense category -- $1.2 million of operating expenses related to that office building I was discussing earlier that got sold; a $2.8-million write-down on a Pennsylvania land development OREO, based upon an updated appraisal. The reserve for un-funded commitments increased $1.3 million over last year. This line item has been fluctuating. Last year, we had a positive adjustment as some large troubled construction loans got resolved.

Our staff expense is up slightly due to the effect of adding a significant number of middle-market and corporate lendors throughout last year, as Mike was talking about earlier. We have for the most part offset these increases with efficiencies and reductions throughout several other categories of non-interest expense.

We believe that after adjusting for unusual credit expenses, our base non-interest expense run rate is currently about $41 million per quarter. We will be working real hard, and believe that there is ample opportunities this year to push that down to at least the $40 million per run rate per quarter. We also get questions on the effective tax rate, and we're currently estimating 25% to 27%.

Next I want to turn over the credit discussion to Tony Kallson, our Senior Vice President of Credit Administration. As Mike mentioned, Bob Emmerich is not with us today. I don't know if Bob is just being overly confident about our current credit quality position, or just tired of talking about it the last three years. But in any case he is off on a well-deserved and long-overdue family vacation. So Tony?

Thanks, Bob. First Commonwealth Bank continued to show measured improvement in asset quality. Classified loans declined $14 million, or 7% from last quarter. The ratio of classified loans to risk-based capital at the bank level is 25%. Non-performing loans declined $22.5 million, or 20% from last quarter. The ratio of non-performing loans to total loans is 2.17%. You may recall that non-performing loans peaked in the third quarter of 2011 at 161.9 million, or 4.07% of loans. Non-performing assets declined $31.2 million, or 22%.

The most significant resolutions of non-performing assets during the first quarter were as follows -- as previously disclosed, the bank was paid in full on an $11 million loan that financed a landfill; the sale of an office tower in downtown Pittsburgh with an OREO carrying value of $6.8 million; and the sale of one of the three notes moved to held for sale in the fourth quarter. This note was secured by a suburban office property and was sold for $6.8 million, or roughly 75% of the original note balance.

The bank recovered $1.7 million as a gain on sale. Subsequent to quarter-end, the bank closed on the sale of a second held for sale note that was secured by a retail property. That note sold for $5.3 million, or roughly 76% of the original note balance. The bank recovered $1.2 million as a gain on sale.

I thought I would take a minute to discuss the $2.8-million OREO write-down. While certain property valuations have improved, undeveloped land has generally continued to deteriorate as feasibility and absorption continue to be called into question.

That was the case with this property. The bank has an established process to continually update the values of its OREO properties, and promptly recognizes a write-down if appropriate. The OREO book has been reduced to $21 million, and there are only five remaining development projects with an aggregate carrying value of $6.5 million.

In the fourth quarter of 2011, a fair portion of the improvement in asset quality came from charge-offs and OREO write-downs. That was not the case this quarter. Net charge-offs were significantly lower compared to last quarter, and compared to the same period last year. The largest commercial charge-off this quarter was $1.2 million.

Given the continued improvement in asset quality, the bank realized a modest release of reserves. However, the allowance as a percent of non-performing loans increased to 74% from 62% at year-end. Specific reserves for non-performing loans amounted to $11.9 million, or approximately 13% of the $89.7- million balance.

The general reserve of $48.8 million represents about 1.21% of the performing portfolio. Management believes that the reserve is adequate for the risk profile of the loan portfolio. Credit exposure in excess of $15 million totaled $411 million, or 59% of risk-based capital of the bank at quarter end.

We are pleased with the improvement in asset quality and recognize the need to focus on maintaining favorable credit metrics as we quickly approach the averages of our peer banks. We believe that we have successfully built a credit culture and infrastructure that will allow us to continue this focus. Thank you for joining us, this afternoon, and I will now turn the call back to Mike Price.

With that, we would love to be helpful with questions you might have.

Thank you, Sir. We will now begin the question-and-answer session.

(Operator Instructions)

Bob Ramsey, FBR.

Hi, good afternoon, guys.

Hi, Bob.

I was really happy to see the dividend increase that you all announced, and I was just curious, I know in the past you all have said that as you get more comfortable with credit, that all capital options are on the table. It certainly would seem that the dividend increase signals some growing comfort there. I'm interested in how you all are thinking about other ways of deploying the capital on your balance sheet, and whether buy-backs might be a part of the near-term plan?

The first two obviously are to continue to grow organically. The second option, obviously, is dividends, and then we'll look to evaluate those other options. Bob, anything you would add there?

No, we're right in the middle of our strategic planning process, and certainly our expected growth rates going forward is going to impact what we think our capital needs are going to be, and we run that through stress tests all the time and certainly improving credit quality is a factor in those stress tests. Yes, that's on the table, but we're not ready to announce anything at this point.

Okay. I guess as you all work through the strategic planning process, will you be sharing in the future what you think the growth potential is -- the organic growth potential in your business -- or setting some goals along those lines?

We will certainly be setting some goals of where we would like to be in three to five years, and thinking about the mix of options that will get there, primarily organic growth.

Okay. Great, thank you.

We will certainly share those thoughts with you.

Thank you, Mike.

Mike Shafir, Sterne Agee.

Good afternoon, guys. Listen, I was just wondering as we think about the margin, I guess it was a little bit more impacted from an organic standpoint than I would've thought, so as we think about that moving forward, and we look at some of the leverage you can pull to help offset that, your CD costs still remain relatively high, but just maybe you can put some context around where new loan yields are coming on? How we can think about the margin from -- if we take out the 8 basis points of benefit this quarter?

Just a couple thoughts for you. The new loan yields on the commercial side, as we look at month-to-month and the trailing 12-month average, they're not off that much. It's really more of re-pricing of things that have run off with newer loans. But the averages themselves are not deteriorating that much.

We still have a little play with our funds pricing and we meet regularly on that, and grind on that with all exceptions, and we're moving those down and continue to move those down in some pretty good chunks over the course of the last couple months. So that's clearly an opportunity.

Additionally, the mix of business -- we just want a little bit more robust mix on the small business and the C&I side. We think that's healthy, not just for the margin, but for the relationship value of our core customers. I don't know, Bob, anything you would add?

Certainly, the re-investment activity within the investment portfolio is providing downward pressure, but there's not a whole lot of unique strategies that we have. I think it's an issue that's facing the industry. We just want to be careful that we're not trying to stretch and take more than the market has to offer us right now. We have a lot of good things going and this interest environment will change.

If we think about that $367 million margin, are we looking for gradual decline over the next several quarters then?

All things given equal, yes.

Okay. Then just going back to your expense levels, and thinking about a core rate of around $41 million, I'm assuming then you're backing out the collection and repossession expense, and then also the loss on sale of write-downs this quarter?

Yes.

The write-downs should certainly come down, in theory, as you get rid of some of those loans. Then also, the collection repossession expense -- how should we just be thinking about those two line items as you had one loan that sold off, and clearly you're not going to have the OREO benefit in terms of collecting the rent there, but you're also not going to have the expense?

I wish I could predict what is going to happen to those loan collection costs. Certainly as the troubled loans come down, you would expect a proportional reduction. It's also some of the larger ones that are resolving that takes so much of those collection cost resources. Yes, I would think a substantial movement down in that. As far as predicting where that's going to be, I think that would be very speculative right now.

Okay. As we think about that $41 million, $44 million goal, what time period should we think about that?

$40 million run rate?

Yes, in what time period do we think we can get to those run-rate numbers?

Oh, I think we're trying to get there before the end of the year.

Okay. All right, thanks a lot, guys, I appreciate all the detail.

No problem.

Yes sir. Rick Weiss, Janney.

Regarding the loan pricing on slide 5, I guess the competing more price rather than underwriting standards.

Hey, Rick I'm having a tough time hearing you. Could you start again?

Sure. The phone -- I think it was slide 5 maybe on the presentation?

Yes, go ahead.

Okay, can you hear me better?

I can.

Okay. With regard to price, how do you compare to the competition would be, I guess, the first question? The second one would you be willing to share some of the yields that you're seeing on commercial real estate or commercial business loans?

It's probably most appropriate on the residential real estate side, and really the refinance and some of our mortgage activity there, because that's really where we've had most of the growth the last couple quarters. I would share there that we're probably third or fourth in the market in price there. Were certainly not the price leader, but we're at that maybe 65 to 75 percentile is a crude estimate, and that's probably the most important number there.

I think, on the C&I side, it's deal-to-deal, and I would say we're in the fray. I don't see that we're winning business on price. I think it's more a matter of relationship and calling. We've been very focused on blitzes. I mean, in our small business and retail we probably made 1,500 blitz calls on specific days in the first quarter. We're just getting a lot of at-bats. I don't think we're certainly a price leader on C&I either.

Is what you're doing a change in strategy from how you priced loans in the past relative to the competition?

I would say we did get a little more aggressive on our consumer home equity loans. When we looked at the alternatives on the balance sheet with our excess liquidity, did we want to go out and buy some mortgage-backed securities or agencies at say 1.5%, or would we rather get more aggressive on some of the consumer loans.

We opted to get more aggressive on the loans. If anything's been aggressive, it's probably been in the consumer loans. The C&I, there's just too much competition out there. It's pretty hard to charge a premium, and I don't think we're undercutting prices there to get the volume that we're seeing.

The other thing where we've had some nice growth recently is in the indirect side, and we're pretty scientific. We're stacking up against maybe a dozen banks, loan-to-values, collateral types, FICA scores, ABCD, and looking precisely where we're at in the pecking order.

Again, some of our bigger-bank brother intend to be price leaders, and we can follow a little bit because our underwriting center is in the market, and there is just more, I think, relationship value there with the dealers, and we tend to do their floor plans and so forth.

I think it's fair to say that the indirect lending competition has heated up as more and more banks have gotten back into the market after being out of the market, so we are staying with the pack so that we get our share of the volume.

Okay and just speaking of the pack, it seems like the pack is pretty big in many of your markets. Would you expect more M&A to pick up? What's your perception of that?

I don't know. I just thought it had picked up a couple years ago, but I suspect it will, but I think we've all been saying that for a few years.

Right. You had Parkvale, you had Mainline with S&T, and a couple small ones. You're not seeing the big stuff yet.

So not much difference now than say had I asked this question three months ago?

Yes, and certainly even the small community banks which have to be feeling the pressure on a number of fronts, when they look at the economic potential of the region, again on a number of different levels, they're saying hey, maybe we're coming out of this. It's just not a real strong impetus to push everybody to make that decision.

I see. Okay, thank you very much.

Collyn Gilbert, Stifel Nicolaus.

A couple questions. One is, Bob, can you give us what the margin was for the month of March?

Probably not, we don't usually disclose that, and I'm not sure I have that number here with me.

Okay. Second question, on the $3 million of commercial non-performers that were added this quarter, what's the LTV of those credits, and when were they originated?

I don't know that I have the origination dates. We actually, on a gross basis, put in about $8.5 million, and then we had about $5.7 million that was received in the form of pay-downs or settlements, so that's where you get your net from. The ones that were added were not all real estate. Let me see if I can get to that list.

While he's looking for it, Collyn, why don't we go on to the next question.

Okay, I have one more if you don't mind?

Okay.

I know, Bob, you said it's really hard to predict the OREO expense, et cetera, going forward, which I can appreciate. Of the $176 million in overall operating expenses in 2011, do you know what percent of that, or not even percent, but dollar or whatever, would be considered non-provision credit expenses?

Not off the top of my head.

Okay, thanks.

I wouldn't speculate, but I'm sure it's $12 million to $14 million, that was credit related?

Okay.

Just to circle back on your earlier question, as suspected, the larger ones that went in to non-performing were not all real estate so, I'm not sure I can really give you an LTV on a lot of those.

Okay. Any other credit metrics that you could offer or structures our debt service or just a little bit of a--?

Well, the names that went in, there was at least one of these that was a C&I credit. Typically, when we're putting it into non-accrual, debt service coverage ratio is going to be less than one, that is the case here. I don't believe it's a wipe-out. I think it's close to break-even, and I know we've restructured the credit as well. We also have a real estate-based transaction with single-family homes; those LTVs are probably not in too bad a shape. I'm going to guess they're certainly not in excess of 100%, or something like that. I don't know, is that what you were looking for?

That's fine. Yes, okay. All right, that was all, thanks.

Damon DelMonte, KBW.

Can you just give us a general update on the four remaining large non-performers that you highlight on slide 8, as far as where you are in the process of resolving them?

I'll just tick through in order -- with Credit One we have negotiated a forbearance agreement on that credit and that is in a repayment situation right now. There is a tail to this. We do expect a large portion of this repayment to come at the end of this forbearance, which goes out for another two years.

On Credit Two, we've actually restructured this relationship significantly, and we've done some AB note structures here. I think what we'll find, or we certainly hope we'll find, probably Q2, maybe Q3 of this year is that we'll be able to upgrade the A-note portion of these, the B-note portion we've charged off.

I'm sorry, you've already charged it off, or you will be charging it off?

No, we have charged them off.

You have charged them, okay.

Credit Three, we actually are anticipating a pay-off on this credit. That will be refinanced or recapitalized, hopefully later this year. Credit Four, I'm not sure I have a lot to report in terms of our resolution here. I guess just the word Florida probably tells you that. Then, Credit Five I think I mentioned that subsequent to the end of the quarter we did close on that. That was moved into held for sale. We did close on that, and that transaction has already been consummated. That gain is a good number.

Just on that Credit number Five, just for my own knowledge here, when you sell a loan like this, do you get to recapture the lost interest income, or the deferred interest income at all, or no, because it's sold?

Well, when we move it into held for sale we mark-to-market that. When we sell it, I suppose if we were fortunate enough to recapture 100%, Bob, I don't know?

I don't think there's any interest recapture on this particular sale, there won't be.

There won't be.

Just to give you a little more color on that Florida one, it's a $5.7 million balance now. We have a $2.4 million specific reserve set aside for that one. That's part of a very large participation where there's multiple participants, and they're looking to try to complete that project and get it either sold or at least operating on a cash-flow basis.

Okay, that's helpful. Great, thanks. My next question has to do with the overall status of the loan pipeline. You have shown some good growth the last couple quarters. Can you give us an update on your commercial loan pipeline as to maybe where that stands in a dollar amount?

I can't, and I don't think we've given that. I just think it's comparable. Actually we had a senior officers meeting this morning, and we asked the head of that division and the small business division the status, and the middle-market person. It is about the same as it's been, which for us has been good the last couple quarters. Small business, they say the pipeline is percolating, but I've heard that before and growth there has been relatively flat.

We're seeing nice non-interest-bearing deposit growth there, which is a little kind of paradoxical, and those customers just aren't borrowing yet. Hopefully, we can get that turned around. We have a nice portfolio there, about $450 million. It would be good if that portfolio was growing robustly to help us here.

Okay, great. That's all I had for now. Thank you.

John Moran, Macquarie.

Just one detail question on tax rate, realizing of course, that it bounces around based on whatever happens in a given quarter. Now that we're through, hopefully, most of the noise on the credit side of things, is 26%-ish the right place to be thinking on effective tax rate?

Yes. I think we said what 25% and 27% was our range, I gave in my comment.

Okay. Sorry about that, I must've missed it. Just a big picture question. Obviously, you guys have exposure to shale activity and the second-order outcomes out there. In the past, I think you've shared anecdotal evidence of some benefit there. Anything that you guys care to share this quarter?

No. We just continue to track it, and I would just say that in our loan committees, which I'll be participating in one here in about a half an hour, we're probably seeing about 10% of the activity related to shale. Mostly the supply side, everything from lumber yards to steel fabricators to wastewater treatment, they've certainly been impacted by the price of natural gas over the course of the last year or so, but it's healthy and it's meaningful to us.

Got you. Thanks very much.

Wayne Archambo, Monarch Partners.

This has been touched on briefly a few question ago, but on the M&A environment, do you see yourself part of that? Are there fill-in acquisitions that you see in your contiguous market, or do you just plan to grow organically? Just give us some read on what your thoughts are there?

Our thoughts are to grow organically and to use our capital for the dividend, initially. Our stock price really hasn't warranted serious consideration there. Anything we might do well into the future would be contiguous fill-in. It would have to be complementary strategically and bring something to the table. I think we can grow and be successful where we're at, but I'm not sure that we -- right now, our stock price warrants that.

You don't see this as a 2012 event? You've got other priorities right now?

For now, yes. I also think we need to string together a few good quarters and -- but that's where our head's at. Bob, anything you want to add?

Every bank has three growth modes, whether it be organic, acquisitions, or de novo; and depending on what's happening in the market, banks will shift back and forth between those growth modes. Right now, organic's working really well for us, and we think it provides additional good opportunity. With that said, we will look for M&A, but right now we're at a disadvantage because our stock isn't trading up to the peer levels yet.

As Mike said, we'd probably need another quarter or two to validate that our performance this quarter is indicative of what's going to happen going forward. I think once that happens, we'll start seeing the stock trading, hopefully, at a more peer level.

Do you have any sense on just population growth in your markets? Is there in-migration? Is it flat? Any sense of the population growth in your markets?

We look at that every year as part of our strategic planning process, and up until a couple of years ago we were still a net loser in households, modest. I think it's stabilized somewhat, but it's probably been 9 to 12 months since I dusted off those numbers. It was pretty unspectacular, quite frankly.

Okay, thanks a lot.

Gentlemen, we're showing no further questions at this time.

Well, thank you. I appreciate you investing 40 minutes with us and your interest in our Company. You can certainly reach Bob or I if you have additional questions, and thank you again.

We thank you sir, and to the rest of Management for your time. The conference call has now concluded. At this time, you may disconnect your lines. Thank you and have a good day.