First Commonwealth Financial Corp (FCF) 2012 Q2 法說會逐字稿

Good day, and welcome to the First Commonwealth Financial second-quarter 2012 earnings conference call and webcast. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Mr. Richard Stimel, Communications Manager. Mr Stimel, the floor is yours, sir.

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 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'll be joined by Mark Lopushansky, 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. And now, I'd like to turn the call over to Mike Price.

Thanks, Rich, and thank you all for joining us on the call this afternoon. The second quarter was another solid quarter for our organization, with net income of $12.3 million, or $0.12 per share. Our fundamentals are sound and improving, and we're seeing the effects of good loan growth, appropriate pricing discipline, and strong household acquisition. Through the first six months of the year, we've generated $103 million of loan growth, with branch and indirect auto lending driving the portfolio. Encouragingly, we also saw momentum in small business lending in the second quarter.

On the corporate side, good traction in large corporate lending and middle markets has helped to counterbalance continued run-offs in our commercial real estate portfolio. Much of this run-off was anticipated, as we expected some of the larger loans to move to the permanent market. But overall, our corporate bank is on track through June, for its best new money production in more than three years. And I might add that that production is equally yoked between commercial real estate, middle market, and finance, those functions through six months.

At the same time, we've become increasingly effective at gathering core deposits, with demand deposits and transaction account balances up 12% through the first two quarters. This low-cost deposit growth has helped drive net interest income. With household, we've also seen strong growth in both retail and small business with particularly notable gains in our Pittsburgh market. Our market-wide retail household growth hit a new high in the second quarter. And our new middle-market relationships continue to propel household growth in our corporate bank.

As we shift to credit, our efforts around credit quality have translated into decidedly lower provision expenses. Bob Rout will touch on this, and Bob Emmerich will dig into the details. But in general, we continue to see the right trends in NTLs, OREO, classified assets and charge-offs. We've built a good foundation, and I think it will benefit us for years to come.

Although there are a lot positive takeaways for the quarter, it will be critical for us to maintain the momentum we have as our net interest margin continues to feel pressure. We've seen the margin slip since the second quarter of 2011, and this low interest rate environment will continue to challenge investment and loan yields. The anecdote for what could become a protracted low interest rate environment is really the fundamentals, growing loans, improving our asset mix, growing our non-interest-bearing deposits, maintaining our pricing discipline, picking up the pace on our efficiency efforts, improving cross sells, and making sure we don't overreach with an acquisition, the basic community banking fundamentals. And obviously, capital plays a central role.

We announced in late June a $50 million stock buyback program through the end of the year. Also in April this year, we increased the quarterly dividend from $0.03 per share to $0.05 per share. These actions were another one of our strategic focuses to thoughtfully manage capital by ensuring stability and benefiting shareholders as credit heals and earnings return. So far, the program has bought back 470,000 shares. So we're pleased with our general performance after two quarters, and we feel like we're very competitive in our core businesses of retail banking, corporate banking, and wealth. And on that note, I'll turn it over to Bob Rout for a review of the financial highlights for the quarter. Bob?

Thank you, Mike, and good afternoon, everyone. As Mike just mentioned, we continue to make very good progress trending our financial performance to higher levels. Earnings per share for the quarter were $0.12, with a little upward rounding help, and $0.22 year-to-date. Both of these numbers comparing very favorably to the comparable 2011 periods of $0.07 and $0.12 per share respectively. The primary factor in that improved performance is credit related.

In the fourth quarter of 2011, Mike focused the organizations toward clearly putting legacy credit issues behind us. That focus is now benefiting the organization on a number of different levels. Bob Emmerich will be following me with a more detailed discussion of asset quality. From a 10,000-foot level, credit-related costs, including provision expense, OREO write downs, and inflection costs are down about $15 million on a year over year basis for the six months ending June 30. That does not include the $2.9 million of recoveries on three troubled loans that were classified as held for sale in the fourth quarter of 2011 and subsequently sold in 2012; $1 million of delinquent interest deflected when a troubled loan paid off in the first quarter this year; and about $1 million of rental income from an OREO office building that eventually got sold. Those effects can be seen in the non-interest income category of our income statement.

Net interest income is down slightly between the periods despite some 14 basis point declines in the net interest margin. We, like most others spread-dependent banks are feeling spread compression in this unusual interest rate environment. We've been able to mitigate a lot of those effects by growing DDA and other transactional account balances, which are up $102 million, or 12% year over year, growing earning asset balances by $260 million the last 12 month. The interest rate risk and liquidity positioning of our balance sheet has allowed some additional short-term borrowings rather than chasing rate-sensitive CDs for funding, and cleaning up some non-performing loan has been helpful in net interest income, as well.

This difficult interest rate scenario does not look like it's going to abate any time soon, if you believe the Federal Reserve and other economic prognosticators. That provides an even greater sense of urgency towards our efficiency efforts to decrease non-interest expense. The good news in non-interest expense is the reduction in credit-related costs as troubled loans get down to more normalized levels. And we have lots of opportunities related to process and idea enhancements that just take time to address. Our salaries and benefits are up $600,000 on a link quarter basis. That is related to severance for an exiting executive, and increased incentive payouts for our retail folks that are doing a bang-up job so far this year.

We always get questions about the effective tax rate for those of you that like to do modeling. Ours was 26% to 27% at June 30, 2012. So with that, now we'll turn it over the discussion to Bob Emmerich for some additional color on credit.

Thank you, Bob. In the second quarter, First Commonwealth experienced good credit results with favorable outcomes for net charge-offs and provision expense, and continued improvement in asset quality. Let me start with the progress we made in reducing problem assets. Nonperforming loans decreased to $85 million, down from $90 million at March 31. Other real-estate-owned decreased to $19 million, down from $21 million the prior quarter. Classified assets decreased to $170 million, down from $178 million in the prior quarter, and that is down from $308 million at June 30, 2011.

We ended the quarter with nonperforming loans at 2% of total loans and nonperforming assets at 1.75% of total assets. You'll recall that at the end of the year, the bank moved three loans into held for sale, with a carrying value of $13.4 million. One of those loans was sold and closed in the first quarter. A second loan that was carried at $4.1 million was sold in the first quarter and closed at the beginning of the second quarter with a gain of $1.2 million. The third loan that was being carried at $3.9 million was sold and closed in the second quarter at approximately the value that it was being carried at. The bank currently has no loans in the held-for-sale category, and we do not foresee any further loan sales in the near future. However, we would always consider loan sales as an option for resolution of our problem assets.

In the second quarter, the bank returned to accrual status the $9.4 million balance on a loan to a technology services provider that we had previously disclosed. This loan was downgraded last year at the Shared National Credit Review and placed on nonaccrual at June 30 of last year. The Company's operations have improved such that it was profitable in 2011 and in the first quarter of this year. The Company's credit facility matured at June 30, and the borrower was given a temporary extension as it is currently in the process of refinancing its bank debt.

Those improvements in nonperforming loans were partially offset by new additions, the five most significant are the following, a $4.9 million loan to a nonprofit institution in western Pennsylvania. This loan is secured by real estate and has no reserve allocation. A $2.5 million loan to a manufacturer of medical equipment. This loan is secured by all the Company's assets and has a reserve of $1 million. A $1.3 million loan on a residential lot development for which the bank has negotiated a short payoff. A charge-off of $150,000 was taken in the quarter to write the loan down to the negotiated payoff amount. A $2.8 million loan to a water treatment plant. This loan is fully reserved for. A $3.7 million loan to a gas well servicing operation. This loan is secured by all the Company assets, and there is no reserve allocation. This loan has been left on accrual status but was classified as a TDR due to the terms of a forbearance agreement that was negotiated.

These latter two loans, the loan to the water treatment plant and the loan to the well servicing operation are part of a $21 million relationship with a shallow well gas operator whose business has been impacted by the sharp drop in natural gas prices and the falloff in shallow well drilling due to the success of the Marcellus deep well drilling. In addition to these two loans, First Commonwealth has extended loans to a related exploration and production company secured by the well interests and loans to the principal secured by real estate.

Regarding OREO, the bank was successful in selling one larger OREO property during the quarter, a medical office building that was carried on the books at $1.3 million and sold for $1.1 million. Charge-offs for the quarter were $3.4 million versus the provision expense of $4.3 million. The loan loss reserve at June 30 was up $1 million to $61.7 million, or 1.48% of total loans, compared to $60.7 million, or 1.47% at March 31. The specific reserves on impaired loans were $11.7 million, or $14.6 million of the impaired balances. The general reserves on non-impaired loans were $49.9 million, or 1.22% of non-impaired loans. This ratio has stayed pretty consistent for the last three quarters. It was 1.19% at March 31 and 1.21% at year-end.

We have normally reported on the level of credit commitments that exceed $15 million. At June 30, the commitments over $15 million were $366 million, or 52% of risk-based capital, down from $411 million, or 59.7% at March 31. I will now turn the call back to Mike Price.

Thank you, Bob. With that, we would like to answer any questions you might have.

(Operator Instructions)

The first question we have comes from Mike Schafer of Sterne, Agee. Please go ahead.

I have a couple of questions thinking about the margin moving forward. This quarter specifically, the securities and loan yields were down pretty significantly. So as we think about reinvestment yields, and it looks like you guys have a pretty vanilla securities portfolio, what can you do to try to offset some of this? I know the timed deposits are relatively high, but looking at the long-term debt and such, just wondering if you have anything coming due that could offset some of the asset yield compression that we're probably going to see?

Yes, Mike, but it will be limited. There's just not a whole lot out there in the investment arena right now, unless you're willing to compromise your risk profile. We're not willing to do that. We'll probably ride it out until things change here. As far as the investment yields, or the loan yields go, we're not seeing nearly as much compression there as we're seeing in the investment portfolios. Certainly our C&I lending and our corporate finance areas are still maintaining relatively good spreads at variable rates. And so we -- there's some room on the liability side, but not a lot. You're right about this time deposits that's going to help us going forward. And, just changing up the mix of that funding base.

And on the securities portfolio, how much cash is that throwing off on a quarterly basis?

We just looked at the full year. It's probably -- you know what, I'll have someone give you an exact number here as we move along. I don't want to just guess at the number.

Sure. And then just the reinvestment yields that you guys are putting that money back to work at. Is it still around 1.5%?

I don't think -- I think that's generous. When you look at 15-year mortgage-backed securities at probably 140 with a premium, and probably the 10-year agency stuff hovering around 1%. And if you want something with three years, you're about 50 basis points.

Okay.

So we will continue to focus on the loan growth area, as opposed to doing any type of major expansion within the investment portfolio.

Should we see that portfolio shrink or maintain at a current relative level from a securities-to-assets ratio standpoint?

I think it, at least over the next quarter to stand where it's at, maybe shrinking down just a bit.

Yes, sir. The next question comes from Bob Ramsey of FBR.

Just to follow up on Mike's questions, you did highlight there's continued margin pressure. When you strip out the delinquent interest recovery last quarter, I think you guys were down about six this quarter. Is that a good ballpark for where you're going to be in the next couple of quarters?

This is Bob Rout. I'll take a shot at that one. You're right on the calculation. It is about a 6 basis point drop. We don't see anything in the future interest rate scenario that's going to cause that to increase at this point.

Okay. Or decrease? Is that probably where we are, at least in the immediate term?

Absolutely. We're having spread compression, and we expect that to continue for the next quarter or two.

Okay. That's fair. And then I was hoping you could talk a little bit more about the repurchase agreement that you guys announced this quarter. I know you all gave an update with where you were as of the end of the quarter. Have you bought back any more shares subsequently, and could you maybe give a little more detail on the trade-in agreement I think you all said you entered at the same time?

No. We wouldn't be comfortable releasing anything more than what we did in the press release this quarter and also when we did our announcement. We are in to a 10B 5-1 program that goes through the end of August. And we'll reassess that program at that point. And see if there's a pricing change need or a brokerage change need. But no, we're not comfortable giving other information out at this point. It just gives too much intelligence to that people out there that do buy and sell our stock.

The next question we have comes from Collyn Gilbert of Stifel Nicolaus.

Just a question, and if you covered it, I apologize. The drop that you guys saw, it was a huge drop this quarter in the collections expense. Is that more a function of what was going on in some of the credit movement, or do you think that's a line, a level where you guys can carry it going forward?

I think we can carry it going forward, and it was really a function of getting through some OREO and some OREO-related expenses.

Okay, that's helpful. Tied to that, too, as we think about the reserve, where do you think a fair reserve level should settle out here in the next 6 to 12 months or so?

Collyn, it is Bob Rout. We're comfortable where it's at now, given the credit quality. It's all going to be a function of growth and changes we're seeing in the credit quality of the portfolio. And right now, we're looking for continued improvements. I don't think you'll see it swing that much. It's going to be pretty much tied into credit losses at this point and portfolio growth.

Okay. Okay.

We're not expecting major swings in the credit quality at this point.

Okay. Okay. That's helpful. Then just back to loan growth, it sounds like the momentum can pick up here. Can you quantify that a little bit in terms of what you're expecting? I think we are looking at mid-single digit loan growth for you guys for this year and next. Does that seem within reason, or how should we think about all in the loan growth that you can put on from here?

If you look at through six months, that pace is very reasonable. Some upside might be small businesses just kicking in the last quarter. And that was sluggish in the fourth -- in the first quarter of this past year. And but we're on a good trajectory in retail. And I think about this as business lines. And I apologize, Collyn, because I know that doesn't always dovetail with your reporting. But in retail, we're on a good trajectory with our branch in direct lending, and as we switch to the corporate side, I know you follow this closely. The corporate finance, large corporate and syndications, that's been on a good trajectory. But we also have middle market and commercial real estate kicking in equally with production. Now they've had more run-off. So I think if that run-off dissipates, there could be a little upside. So all in, you mix that in. I think where we've been is a good trajectory, and there might be a little upside.

The next question we have comes from Damon DelMonte of KBW.

I was wondering, Bob, maybe you could talk about your outlook for the provision. We've had a couple good -- a couple quarters that have been better than what we've seen in the last year or two. Are you getting more comfortable with the credit quality such that you would go back to a more normalized level of provisioning?

Well, this is Bob Rout. It ties in with Collyn's question. We would expect the provision expense to approximate our future charge-offs with adjustments, of course, for any loan growth that we put on. The credit quality of the portfolio we've seen the last two quarters here stabilized. We've cleaned up the last couple troubled loans. There's still a few more in there to take care of. But we're real pleased with the direction at this point.

Okay. Fair enough. And then I think a couple times you guys had mentioned about trying to capitalize on efficiency opportunities. Do you have any type of efficiency goals in mind as far as a percentage?

Well, we think that in order to be higher performing that the banks need to get their efficiency ratio down into that low 50 range. That's obviously not doable here in the near short term for us and most other banks. And then we also have the additional pressure of continued compression within the margin over the next couple of quarters. But I think I told this group just from a raw, non-interest expense number is our target is to try to get the run rate down to $40 million a quarter. We're making progress on that number once you strip out some of the nonrecurring issues.

That improvement is what Mike likes to define as incremental. Just a whole lot of ideas and process changes coming from throughout the organization, which we have fairly well engaged. In order to get us where we need to be, there needs to be a couple more transformative issues. We have two or three of those on our strategic planning discussion page. And we'll be going through that process here over the next couple of months. And hopefully come up with a couple of those.

Next question we have comes from Julie Markfis of Janney, Montgomery, Scott.

You may have covered this, but I was wondering if you could give any color on your loan growth projections going forward for your Business for the near term, but especially for the long term? And what about in terms of organic growth?

Yes, just shared that. I think through six months that roughly $107 million on the base we had of about $4 billion, we're fairly comfortable with. Think there might be some upside in small business, middle market, and a couple other segments in commercial real state where we've had a little run-off. So -- and we feel good about the teams we've assembled, and our production, we've had the secondary market take out -- anticipated most of the commercial real estate, but we've seen it take out a little bit more than we thought. And so there could be a little upside in those numbers.

(Operator Instructions)

We have a followup from Mike Schafer of Sterne, Agee.

I think you guys just actually addressed this, but I just want to confirm. I know last quarter, you guys spoke to getting to an expense run rate at $40 million to $41 million. Clearly, you're making pretty good headway to that. Are we thinking that we could get to that by the end of this year, or is that more of a gradual goal as things fall into place?

Mike, hi, it's Bob Rout. I'd like to get there by the end of the year. That's certainly our -- what we're shooting for.

Okay. And then with that, should we -- outside of the expense that's been associated with credit that's running through your non-interest expense lines, could we see further declines then in net occupancy and salary and benefits, as well, as we go through the remainder of the year?

That is certainly our goal. Yes. Mike, one other thing to follow up to your question about the investment portfolio. Over the next 12 months, we're expecting $276 million of run-off in that portfolio, maturities and paydowns. And, of course, that represents about 23% of the portfolio.

It appears that we have no further questions at this time.

Just, we appreciate your interest in First Commonwealth, and please know that Bob Rout, myself, and Bob Emmerich, if there's something you need to follow up with us, we're a phone call away. Thank you very much.

And we thank you, sir, and the rest of management for your time. The conference call has now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you, and have a good day.